Network management and the CBDC revolution
Initiatives focused on central bank digital currencies (CBDCs) are becoming increasingly ubiquitous. Interest in CBDCs, an electronic form of central bank money that can be used by both businesses and consumers to make payments, is gathering momentum and has the potential to fundamentally transform financial services.
In fact, the COVID-19 crisis has accelerated a number of CBDC initiatives amid mounting public health concerns about the handling of physical cash, according to the Bank for International Settlements.1 In addition to expediting cross-border payments; reducing cash management costs; enhancing transparency and facilitating wider financial inclusion among un-banked communities, CBDCs could significantly reshape the securities services model. Standard Chartered assesses how custodian banks will need to evolve in order to meet the increasing institutional client demand for digital assets, including CBDCs.
The market for CBDCs
According to John Ho, Head of Legal, Financial Markets, at Standard Chartered, a number of countries have launched their own CBDC trials or proof of concepts. These include China, the UK, Canada, Singapore, France and most recently the US, a shift that has happened largely in response to investors’ attitudes towards digital assets. A recent study by Fidelity Digital Assets, for example, found 36% of institutional investors have exposures to digital assets, while 60% agreed that these instruments should have a place in investment portfolios.2 Many clients increasingly believe that digital assets, such as CBDCs, could be quite attractive in these current market conditions as they are uncorrelated to other asset classes and maintain demand for central bank money.
Jyi-Chen Chueh, Head of Group Custody Services Product at Standard Chartered, said some investors believe CBDCs carry a reduced counterparty risk relative to stablecoins as the former are issued by central banks and the latter by commercially-run institutions. As a result, investors transacting in CBDCs will be taking on central bank risk whereas those using stablecoins have to consider their exposures to private issuers, which might be more decentralised, less regulated and whose value and liquidity may be affected by market forces. Trading CBDCs is therefore seen as being less risky among investors.
However, Fidelity pointed out that some investors still have reservations about digital assets, citing their volatility; a lack of fundamentals and concerns about market manipulation.3
Time for custodians to act
In response to growing client interest in digital assets generally, more custodians are starting to develop digital asset servicing capabilities. Zhu Kuang Lee, Head of Product Innovation at Standard Chartered, said a handful of custodians are looking to create digital wallets to facilitate the safekeeping of CBDCs. However, Lee added the industry does need to collaborate and agree on standards around CBDCs, especially for cross-border transactions.
Aside from supporting clients’ growing digital asset ambitions, custodians could also net a number of operational benefits if CBDCs become more widespread. A 2020 survey of 145 market participants by the International Securities Services Association (ISSA) and The Value Exchange found 60% of respondents believed CBDCs would be the primary payment funding mechanism to enable DLT (distributed ledger technology) adoption in the wholesale cash and securities markets, putting them well ahead of real-time gross settlement interfaces.
Chueh explained CBDCs could - in theory - be transacted 24/7 using DLT which would reduce settlement risk, especially on cross-border trades where, for instance, inherent frictions linked to time-zone differences might be alleviated. This could potentially alter how CSDs (central securities depositories) and CCPs (central counter-party clearing houses) operate from the perspective of a trade lifecycle. Additionally, the growth of CBDCs may also result in changes to the role of network management as new technologies and market infrastructures emerge to support trading of digital assets.
Chueh added that while network management will evolve, the principles behind it would remain the same. “In a CBDC world, there will still be a network of custodians and market places to manage and oversee. However, some of the traditional, and often local market infrastructures and connectivity might change with the increased adoption of transnational digital assets. Moreover, the role of the custodian in providing expertise and easy access to multiple markets, including new digital ones, will still be there,” he said.
As CBDCs are such an embryonic concept, few network managers have yet to fully digest what the implications of this asset class will be. However, some forward-thinking network teams are beginning to educate themselves about CBDCs as they prepare to future-proof their businesses against disruption.
This article first appeared in The Network Forum Journal.
1 Reuters (June 11, 2020) Pandemic pushes central bank digital currencies into top gear
2 Fidelity (June 2020) The Institutional Investors Digital Asset Story
3 Fidelity (June 2020) The Institutional Investors Digital Asset Story