Next-generation technologies, including distributed ledger technology (DLT) and artificial intelligence (AI), have the potential to transform global capital markets, addressing numerous issues plaguing the industry, such as operational inefficiencies, high costs, and heavy reliance on intermediaries, a new whitepaper by UBS Investment Bank’s Strategic Ventures says.

The paper, titled “Towards Digital Capital Markets”, provides a comprehensive perspective on how next-generation technologies, particularly DLT, have the potential to transform global capital markets for the better.

It highlights how DLT can bring greater efficiency to global capital markets by standardizing and consolidating transaction processes. The technology can also offer real-time recording of transactions, reducing the role of intermediaries and accelerating settlement times.

DLT models are especially promising for tokenization, where financial instruments, such as bonds and cash, are represented digitally on a blockchain. Tokenization allows for fractional ownership of assets, increasing accessibility and liquidity for a broader range of investors. By leveraging blockchain technology, it enhances transparency, security, and efficiency in transactions, reducing costs and settlement times. Additionally, tokenization opens up new opportunities for innovation in financial products, democratizing access to traditionally illiquid assets like real estate or private equity.

One further benefit of moving to DLT-based business models highlighted by UBS Investment Bank’s Strategic Ventures is faster, more secure transactions. Smart contracts can automate settlement processes and enforce compliance with more targeted human-led intervention.

Moreover, DLT can potentially shorten settlement cycles from multiple days to near-instantaneous “atomic” settlement, allowing assets and payments to be exchanged immediately and irreversibly. This capability could streamline complex processes like bond settlements and associated lifecycle events, removing, for example, the need for ex-dividend periods and reducing related operational costs.

Supplementary to DLT, AI can add another layer of efficiency and insight to capital markets. By monitoring and processing vast datasets in real-time, AI-powered analytics models can, for example, aggregate and analyze fragmented market data to help institutions manage risks and uncover commercial opportunities.

Additionally, AI can significantly improve trade reconciliation by automatically addressing discrepancies between trade and settlement data, reducing operational errors and counterparty risks.

Regarding regulatory compliance, AI-driven systems can scan transactions to ensure regulatory adherence, alerting institutions to potential violations in real time.

Challenges in capital markets

While functional, capital markets suffer from inefficiencies. Structural friction, due to non-interoperable national and regional systems, leads to increased costs and elongated transaction lifecycles.

Additionally, many financial institutions still rely on legacy systems, which face increasing difficulties in meeting the complexities of modern client and regulatory needs. This results in unnecessarily enhanced risk and liquidity demands just to keep the markets moving.

Inefficiencies in collateral management add complexity. Mismatches between available and eligible collateral and margin requirements cause liquidity bottlenecks. Furthermore, collateral transformation, where one collateral is converted from one form into another, is relatively slow and costly, particularly during market stress.

Regulatory differences across jurisdictions add another layer of complexity, allowing firms to exploit less stringent regulations and thus creating global systemic risks. Finally, opacity in markets, particularly in derivatives and fixed income, increases perceived risk. This complicates fair value assessments, and ultimately bakes-in inefficient outcomes.

Rising adoption of DLT

Adoption of digital tokens and DLT has increased significantly over the past years. In the banking sector alone, over 60% of European Union (EU) banks surveyed by the European Banking Authority in 2023 were actively exploring, experimenting with or using DLT solutions, highlighting strong industry interest. Notably, 22% had already started using DLT applications.

The public sector is also contributing to this movement. In Europe, the Eurosystem is conducting exploratory work to test DLT for the settlement of wholesale transactions in central bank money. Similarly, the Bank for International Settlements’ Innovation Hub has launched several projects exploring this theme.

The Global Financial Markets Association (GFMA) estimates that smart contract-driven automation could save the global financial industry US$15-20 billion annually in operational infrastructure costs, particularly in areas such as settlement and corporate action administration.

DLT can also unlock new opportunities, especially in illiquid and private asset classes like investment funds. The global value of tokenized illiquid assets currently stands at US$0.3 trillion. By 2030, the value could exceed US$16 trillion, according to GFMA.

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