(Bloomberg) — As Credit Suisse was heading toward collapse early last year, a group of Swiss bankers, technocrats and local officials was already busy laying the groundwork for a new kind of financial infrastructure.
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Nine months after Swiss banks were bailed out by city rival UBS Group AG in March 2023, the cantons of Zurich and Basel issued the first so-called tokenized bonds settled in Switzerland’s experimental digital currency. The Lugano city government followed suit soon after.
The country’s central bank said Thursday it was extending the pilot program that sold these bonds for two years, describing it as “highly successful.” Rival financial centers have yet to build a system comparable to Switzerland’s blockchain-based system.
Tokenization projects are underway in almost every major global financial hub, but the effort takes on added importance in Switzerland as authorities try to change perceptions of the banking industry’s atrophy.
The sudden marriage of Switzerland’s two biggest banks sparked widespread criticism that authorities waited too long to step in. For some, it was further evidence that a banking system that developed to surreptitiously manage the funds of the world’s wealthy was no longer suited to ensuring Switzerland’s status as the preeminent financial hub.
“Switzerland is well known as one of the most important financial centers in the world, but we’ve lost track of time,” said Paolo Bertolin, deputy chief financial officer of the city of Lugano, adding that the country’s financial sector was “asleep.”
The central premise of tokenization is, at least on the surface, relatively simple: By representing assets like stocks and bonds in the form of digital tokens on the blockchain, proponents argue that everything from payments to recording ownership could become faster, simpler and more secure.
Read more about how tokenization works
There are hundreds of tokenization projects underway around the world, some run in-house by large global financial institutions like JPMorgan Chase, others overseen by central banks or public bodies like the Bank for International Settlements. Use cases range from pillars of the global economy like trade finance to more exotic applications like tokenizing centuries-old violins. Tokenized bonds have also been listed in markets in Switzerland, as well as the US and Luxembourg.
Citigroup predicts that the value of tokenized securities will reach $4 trillion by 2030.
“Over time, we will see more and more assets transferred to digital exchanges – less liquid assets at first, but new regulations may see more traditional assets transferred as well,” said Marni McManus, head of banking for Switzerland, Monaco and Liechtenstein at Citigroup.
Where Switzerland goes further than other countries is in integrating various aspects of tokenized bond issuance and trading.
World Bank Digital Bond
Established in 2021 to trade digital bonds and digital shares, SIX Digital Exchange claims to be the first fully regulated exchange of its kind in the world.
Switzerland will go a step further in 2023 by allowing tokenized bonds issued on SDX to be settled in its central bank digital currency, as part of a pilot program the Swiss National Bank is now expanding. On June 11, a CHF200 million ($224 million) bond sold by the World Bank – the first digital bond issued by an issuer based outside Switzerland – was settled this way.
“We believe it’s important that we remain at the forefront of financial innovation,” central bank Governor Thomas Jordan said in an interview on Thursday when asked about extending the pilot program.
According to the Swiss National Bank, settling and clearing financial transactions with a CBDC rather than a private token would eliminate credit risk. In the United States, digital bonds issued to date have been settled with private digital tokens that do not have the same safeguards as central bank-backed currencies.
“The lack of digital cash compatible with distributed ledger technology has often been a major obstacle to the advancement of this technology,” Moody’s said in a statement on Friday. “Switzerland is furthest along in this area.”
Tokenization is making progress across a variety of uses around the world, but skeptics question whether blockchain-based systems can offer tangible advantages over existing systems, and even proponents say it will be years before tokenized assets widely overtake traditional assets.
It’s also unclear how long Switzerland’s lead will last: exchanges in several other countries are racing to catch up, though they are still far behind the Swiss system.
Meanwhile, CBDCs have sparked controversy around the world over concerns that they could infringe on privacy. In the United States, presidential candidate Donald Trump has said he will “never accept” a digital dollar issued by a central bank, saying it would represent “government tyranny.” The Federal Reserve Board is reluctant to experiment with CBDCs.
Lugano struggles
When Lugano’s Bertolin was looking for a major bank to help issue the first tokenized bonds at SIX a few months before the UBS-Credit Suisse deal, the only firm willing to take on the job was the Cantonal Bank of Zurich, a 250-year-old Swiss financial institution.
Another challenge was convincing Moody’s that tokenized bonds should receive the same credit rating as traditional bonds. It took three months of discussions involving the rating agency, Cantonal Bank of Zurich, and SDX before Moody’s analysts were convinced that the use of the digital platform did not pose any additional risks, Bertolin said.
Regarding digital ledger technology, Moody’s said that “DLT-based bond issuances have unique characteristics” and “a broader range of attributes need to be analyzed compared to traditional bond issuances.”
Lugano sold its first digital bond before the CBDC pilot program began. Bertolin said it took investors about 90 minutes to snap up the CHF100 million bond. A second bond of a similar size, settled in digital francs, sold out in 25 minutes.
Bertolin, a former banker, said he didn’t know whether central bank support explained the difference, but after two decades of watching the Swiss financial sector lose global influence, first the breaches of banking secrecy and then the collapse of Credit Suisse, he is convinced that betting on new technology is key to regaining lost ground.
“Now we must act urgently to reclaim leadership in the financial sector,” he said.
–With assistance from Miriam Barezow.
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