Europe's Regulator Wants Proof Tokenised Collateral Can Be Sold When It Matters

The European Securities and Markets Authority, the EU's markets regulator, has asked the industry for evidence on whether tokenised assets can safely be used as collateral, Cointelegraph reported. The questions it is putting are legal, liquidity-related and operational, and the authority says it will use the answers to decide whether further regulatory measures are warranted.

Collateral is the asset a counterparty posts to cover an obligation, and a clearing house's entire function rests on being able to seize and sell that asset quickly when someone defaults. The question ESMA is asking is therefore narrow and unglamorous: if a tokenised security is posted as margin and the poster fails on a bad day, can the clearing house actually liquidate it, legally and in practice, at a price close to the one on the screen.

Why liquidity is the hard part

The timing sits alongside the International Monetary Fund's finding, reported this week, that tokenised equity markets are less liquid and more volatile than the traditional markets they mirror, even as demand for round-the-clock trading grows. Thin and volatile is a tolerable combination for a trading venue. It is a much harder combination for a collateral pool, because collateral is by definition sold at the worst moment, when the holder has already failed and the market is already moving.

The legal leg is just as awkward. A tokenised instrument may be a wrapper over a share held by a custodian, in which case enforcing against the token means enforcing against the custody arrangement underneath it. Different member states, and different structures, answer that question differently. ESMA is asking the industry to document how it works rather than assuming it does.

Operational risk is the third leg

The operational questions cover the mechanics: who holds the keys, what happens if a chain halts, how a transfer is finalised and whether that finality is recognised under existing settlement law. A clearing house operates to timetables measured in hours, and an asset that cannot be moved during an outage is not collateral in any useful sense.

What a call for evidence is

A call for evidence is not a rule and it is not a proposal. It is the step before either, in which a European authority collects submissions and then decides whether to propose anything at all. The outcome ranges from no action to a technical standard, and the process routinely takes more than a year. What it does signal is that the regulator has identified tokenised collateral as a question it does not currently have an answer to.

That matters for the wider tokenisation case. The argument for putting securities on a chain has always included collateral mobility, the idea that an asset can be pledged and recalled in minutes rather than days. That benefit only exists if a clearing house will accept the token in the first place. Until European regulators are satisfied on the three risks ESMA has named, the mobility is theoretical.

Firms with views have the usual route: submit evidence, with numbers, on how tokenised instruments have actually behaved in stress. There has not yet been much stress to point at, which is itself one of the things ESMA is likely to hear.