Why tokenized collateral needs a cross-rail strategy

Joint-publication by EY and Transcend.
Todd Hodgin, Global Head of Product, and Sandeep Arora, Chief Operating Officer at Transcend, are contributing authors of this article.

Tokenized collateral offers new collateral management choices, but firms need visibility across traditional and digital infrastructures.

In brief

• Tokenized collateral is ushering in a transition period where traditional and digital infrastructure will operate side by side.
• More ways to mobilize collateral may improve liquidity, but the hybrid transition will also make eligibility and routing more complex.
• Firms should move to build cross-rail visibility, interoperability and governance before tokenized collateral markets fully standardize.

For decades, collateral has moved through an established market infrastructure where custodians, central securities depositories (CSDs), central counterparties (CCPs), triparty agents and other intermediaries support collateral management by moving, managing and pledging assets. Now a second set of rails is emerging: Distributed ledger technology (DLT), tokenized assets, digital asset custodians, smart contracts and new digital market infrastructures are creating alternative ways to hold, transfer and mobilize collateral. Market participants are building these rails to enable greater transparency, faster movement of assets and more automated collateral workflows, ultimately driving financial resource efficiency to unlock trapped liquidity, reduce funding costs and strengthen balance sheets.

This creates a new challenge for financial institutions. Firms will need to determine which rail to use, where collateral will be accepted, how quickly it can move, and what costs, operational requirements and constraints apply to each option. A receiver may accept a traditional security but not a tokenized version, or vice versa. Some participants may require specific custodians, digital wallets, tokenization providers or ledger networks. What was once a relatively straightforward collateral movement process will become a more dynamic routing decision. More options will bring more complexity.

Institutions will need visibility across both traditional and tokenized environments, along with the ability to understand where assets can be used, how they can be mobilized and how those choices affect optimization. Success will depend not simply on tokenizing assets but on building the operating capabilities needed to manage collateral efficiently across both rails.

The collateral management challenge across traditional and digital rails

Collateral has become a strategic issue for financial institutions. Margin requirements, liquidity demands, funding costs and balance sheet pressures continue to shape activity in capital markets. At the same time, tokenization is advancing beyond experimentation into practical institutional use cases, as market infrastructure providers, custodians, banks and asset managers explore how tokenized assets can support collateral mobility, settlement efficiency and new liquidity models, including intraday liquidity, 24/7 mobilization, near-instant repurchase agreements and financing transactions.

This is needed in today’s highly fragmented collateral management ecosystem. Assets are dispersed across custodians, CSDs, CCPs, triparty agents, legal entities and internal platforms. Many firms still rely on batch reporting, manual reconciliation processes and disconnected systems that limit their visibility into collateral inventory and usage.

These constraints can create significant operational and financial challenges. In normal market conditions, they may contribute to trapped liquidity, higher collateral buffers and higher funding costs. During periods of market stress, they can make liquidity management more difficult by limiting firms’ ability to source, substitute or post collateral when timing is critical.

Preparing for tokenized collateral adoption

To capture the benefits of tokenized collateral while managing transition risk, firms should focus on several foundational capabilities:

The future of tokenized collateral and connected market infrastructure

Business value will define the future of tokenized collateral, and interoperability is a key component to realize the desired benefits. During the transition phase of market development, success will depend less on stand-alone tokenization initiatives and more on the ability to connect tokenized collateral into broader market infrastructure, management workflows and liquidity management processes.

Before the market converges around common standards, firms should expect more ledgers, more tokenization providers, more custody models, and more variations in how collateral can be delivered and accepted. The ecosystem is likely to become more complex before it becomes simpler.

That is why preparation matters. Firms that prepare early can shape their operating model, select the right partners and build the capabilities needed to navigate the transition effectively.