Swiss pressure to reconfigure financial system after banking crisis

(Bloomberg) — As Credit Suisse headed toward insolvency early last year, a group of Swiss bankers, technocrats and regional officials were already busy laying the groundwork for a new kind of financial infrastructure.

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Nine months after the Swiss bank was rescued by rival UBS Group AG in March 2023, the cantons of Zurich and Basel issued the first tokenized bonds settled in Switzerland’s experimental digital currency. Lugano’s city government followed suit soon after.

On Thursday, the country’s central bank announced it will extend the pilot program under which these bonds were sold for two years, describing it as “very successful.” Rival financial centers have yet to catch up to the Swiss blockchain-based system.

Tokenization projects are underway in virtually every major financial center in the world, but in Switzerland, the efforts have taken on additional significance as authorities try to change perceptions surrounding its diminished banking industry.

The forced marriage between Switzerland’s two largest banks has sparked widespread criticism that authorities waited too long to intervene. For some, it was further proof that a banking system designed to discreetly manage the money of the world’s rich was no longer adequate to guarantee Switzerland’s place among the preeminent financial centers.

“Switzerland is known as one of the most important financial centers in the world, but we have lost time,” said Paolo Bertolin, deputy finance director of the city of Lugano. The country’s financial sector “is dormant,” he added.

The central premise of tokenization is, at least on the surface, relatively simple. By representing an asset like a share or bond in the form of digital tokens on a blockchain, everything from settlement to recording ownership can be done faster, less complex and potentially more securely, its proponents argue.

Read more about how tokenization works

There are hundreds of tokenization projects underway around the world, some run in-house by large global lenders like JPMorgan Chase & Co. and others overseen by central banks or public sector bodies like the Bank for International Settlements. Use cases range from pillars of the global economy, such as trade finance, to more enigmatic applications, such as tokenizing a century-old violin. In addition to Switzerland, tokenized securities are also listed in markets such as the US and Luxembourg.

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Citigroup Inc. predicts there will be up to $4 trillion in tokenized securities by 2030.

“Over time, more and more assets will be transferred to digital exchanges – initially illiquid assets, and perhaps with new regulations traditional assets could also be transferred,” said Marni McManus, head of banking at Citigroup for Switzerland, Monaco and Liechtenstein.

Where Switzerland is more advanced than others is in integrating the various aspects of issuing and trading tokenized securities.

World Bank Digital Bond

SIX Digital Exchange, created in 2021 for trading digital bonds and shares, claims to be the first platform of its kind in the world to be fully regulated.

In 2023, Switzerland went a step further and allowed tokenized bonds issued in SDX to be settled in a central bank digital currency, part of the pilot program that the Swiss National Bank is now scaling up. On June 11, a 200 million franc ($224 million) bond sold by the World Bank – the first digital fixed income instrument from an issuer based outside Switzerland – was settled in this way.

“I believe it is important that we remain at the forefront of financial innovation,” central bank President Thomas Jordan said in an interview on Thursday when asked about extending the pilot program.

Settlement and clearing of financial transactions in a CBDC – as opposed to a private token – eliminates credit risk, according to the Swiss central bank. In the US, digital bonds issued to date have been settled in private digital tokens that do not have the same safeguards as a central bank-backed currency.

“The lack of digital money compatible with distributed ledger technology is often a significant obstacle to the advancement of this technology,” Moody’s Corp. said. in a statement on Friday. “Switzerland is the most advanced country in this area.”

Even as tokenization advances in countless applications around the world, skeptics question whether blockchain-based systems will offer tangible advantages over existing ones. Even proponents say it will be years before tokenized assets largely displace their traditional counterparts.

It is also unclear how long Switzerland’s advantage will last. Stock exchanges in several other countries, although still far behind the Swiss system, are racing to catch up.

Meanwhile, CBDCs have sparked controversy in many parts of the world amid fears they erode privacy. In the US, presidential candidate Donald Trump said he would “never allow” a central bank-issued digital dollar, saying it would represent “government tyranny.” The Federal Reserve has been hesitant to experiment with CBDCs.

The difficult battle of Lugano

When Lugano employee Bertolin approached big banks to help issue SIX’s first tokenized bond in the months before the UBS-Credit Suisse deal, the only company willing to take on the role was Zuercher Kantonalbank, a 250-year-old Swiss lender. .

Another challenge was persuading Moody’s Corp. that a tokenized security should receive the same credit rating as a traditional security. It took three months of negotiations involving rating agency Zuercher Kantonalbank and SDX before Moody’s analysts were convinced that using a digital platform did not bring additional risks, Bertolin said.

“DLT-based bond issues have specific characteristics,” Moody’s said, referring to the digital ledger technology. “A broader set of attributes needs to be analyzed compared to traditional bond issuances.”

Lugano sold the first digital title before the CBDC pilot program began. It took around 90 minutes for investors to purchase the 100 million franc issue, according to Bertolin. The second issue, of similar size and settled in digital francs, sold out in 25 minutes.

Bertolin, who worked as a banker earlier in his career, said he is not sure whether support from a central bank explains the difference. But two decades of seeing Switzerland’s financial sector lose global influence – first through the erosion of banking secrecy and then the demise of Credit Suisse – have convinced him that laying the dice on new technologies will be key to making up lost ground.

“Now we really have to hurry to regain this leadership in the financial sector once again,” he said.

–With assistance from Myriam Balezou.

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