One of the lessons learned from recent market shocks – including the 2020 dash for cash and the UK gilt market crisis in 2022 – is that when volatility strikes and market participants must suddenly generate large amounts of cash to meet a spike in variation margin (VM) calls, liquidity can quickly drain away and destabilize the market. In response, a growing number of market participants are looking at alternatives to cash and government securities to meet their VM requirements, prompting ISDA to explore how tokenization could be used to unlock a broader array of assets to post as collateral.

By the end of last year, leading derivatives market participants subject to the non-cleared margin rules had collected $1.5 trillion of initial margin and VM, up 6.4% from the previous year, according to the ISDA Margin Survey. The use of cash as collateral for VM has fallen over time. In 2020, cash represented 80.0% of total VM received, but this dropped to 68.3% in 2024, while the proportion of government securities rose from 12.7% to 17.8% and other securities climbed from 7.4% to 13.8% over the same period.

There is clearly a growing appetite from some market participants to extend the range of collateral that is used to meet VM requirements for non-cleared derivatives, but progress has been limited. Some counterparties are reluctant to exchange anything other than cash and government securities due to economic, capital and operational constraints. For example, money market funds (MMFs) offer a potentially stable source of collateral, but the current workflow requires collateral to be posted as cash and then transformed by the custodian, which can lead to increased liquidity and operational risks.

Tokenization could help to alleviate some of these workflow challenges. Once an MMF is tokenized, it can be much more efficiently mobilized as collateral and shares of the fund could be directly posted and returned, without any need for liquidation within the collateral management workflow (counterparties can still liquidate MMFs to raise cash when needed). Meanwhile, the physical delivery challenges that have previously prevented gold from being posted as collateral could also be overcome with tokenization.

ISDA is engaging closely with experts across financial markets to identify and address certain legal, regulatory and operational challenges to enable the effective adoption of tokenization in the derivatives market.

ISDA will focus its efforts on two key areas. First, we will work to establish clear and consistent legal and regulatory frameworks to bring certainty, enable cross-border adoption, improve market confidence and accelerate institutional deployment. This will include making sure derivatives transactions on tokenized assets are underpinned by robust documentation and legal opinions so that market participants can use these assets with the same safety and efficiency as traditional instruments. Firms will also need regulatory certainty that tokenized assets will be permitted as collateral under the margin rules for non-cleared derivatives.

Second, we will work with other industry participants and trade associations to establish interoperability, underpinned by common data models, smart contract standards and messaging protocols to reduce fragmentation, lower integration costs and enable scalable, cross-platform connectivity and programmability. The Common Domain Model, an open-source data standard for financial products, trades and lifecycle events, has a vital role to play here in establishing the common data standards needed to mitigate technological fragmentation.

This is an exciting opportunity that promises to bring significant improvements to the timeliness and efficiency of collateral management, delivering greater choice and flexibility for market participants. ISDA will continue to work with stakeholders across financial markets to overcome the hurdles and realize the potential of this powerful technological innovation.

Several ISDA working groups are exploring the use of tokenized assets as collateral. To find out more, contact collateralinitiatives@isda.org.