Opening address by Lesetja Kganyago,
Governor of the South African Reserve Bank,
at the launch of the Project Khokha 2 report
6 April 2022
Good day, ladies and gentlemen.
Welcome to the virtual public release of the Project Khokha 2 (PK2) report.
The project was launched in January 2021 as an initiative under the Innovation
Accelerator of the Intergovernmental Fintech Working Group (IFWG) led by the South
African Reserve Bank (SARB) through its Fintech Unit.
PK2 explored the implications of tokenisation in financial markets through a proof-of-
concept (PoC) that issued, cleared and settled SARB debentures using distributed
ledger technology (DLT). In doing so, PK2 built on Project Khokha 1 (PK1), which
many of you are familiar with.
PK1 was our initial financial technology (fintech) policy exploration and technical trial
in the use of DLT for interbank settlements; it explored the use of DLT for interbank
settlements by successfully replicating some functions of the South African real-time
gross settlement (RTGS) system on DLT.
Innovation in financial services in general, and in digital financial services in particular,
has made significant progress since the launch of the PK1 report in June 2018.
One of the most noteworthy trends affecting financial markets over the last half-century
is what is referred to as 'dematerialisation'. Following advances in computer
technology since the 1960s, financial markets started to move away from recording
securities ownership in a physical ledger to recording ownership on centralised digital
ledgers. Over time, this led to centralised financial market infrastructures such as
central securities depositories and central counterparties evolving to play a critical role
in recording the ownership of assets and, by extension, managing the risks involved
in the process of recording the transfer and ownership of value.
Building on this initial convergence towards the digitalisation of financial markets,
tokenisation goes one step further by representing different forms of traditional assets
(such as money and securities) as tokens on DLT-based platforms. Such DLT-based
platforms move the recording of transfer and ownership of value from individual
ledgers kept by centralised financial market infrastructures to shared distributed
ledgers.
DLT-based infrastructures may require fit-for-purpose money which is appropriate for
such DLT-based platforms. This has resulted in several central banks opting to further
explore the viability of tokenised central bank money in financial markets. Such
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exploration although largely conceptual at this stage is important given the growth
in technological innovation and the use of new forms of payment instruments facilitated
by the rapid pace of innovation.
In our experimentation during PK2, two forms of tokenised money were created to
allow for settlement.
The first form of money was a tokenised form of central bank money which was a
liability of the central bank issued onto a specific DLT owned and operated by the
SARB in the PoC. This form of money was used to purchase SARB debentures in the
primary market.
The second form of money was issued by commercial banks as a stablecoin and used
for purchasing SARB debentures in the secondary market.
In this way, PK2 explored and expanded on how settlement in central bank money
and commercial bank money can happen on DLT.
The debenture token market benefitted from having a riskless settlement asset in the
form of a wholesale central bank digital currency (wCBDC) used for settlement. This
reduced the settlement risk, particularly that payment might fail or might be uncertain
due to riskiness in the settlement asset.
The wCBDC prototype developed in PK2 was also the preferred asset in other
instances. It served as the reserve asset guaranteeing the value of the wholesale
stablecoin issued by commercial banks, and it was used to make payment to
debenture token holders upon the maturity of the debenture. The role of the central
bank in the tokenised debenture token market was therefore similar to the current role
played by the central bank.
Our attempts to learn more about the relevant technology have been guided by a few
principles that can also be referred to as 'the five Ps of fintech policy exploration'.
Purpose-driven projects
From a central banking perspective, practical exploration should always be
conducted with a purpose. Central banks should therefore 'play' to learn and gain
deeper insights into technology-based innovation and its potential impact on their
mandate as well as on any relevant policy and regulatory frameworks in the financial
system.
I refer to the term 'playing' deliberately because our exploration with technology often
happens in a controlled environment, whether it is a PoC such as Project Khokha or
whether it is a 'regulatory sandbox' in the event of live transactions on a confined basis.
Since DLT-based innovation is still quite nascent, it is difficult to reach definitive
conclusions on its potential implications. In this way, practical experimentation helps
inform our thinking about different scenarios which may arise in the future.
PK2 was an experimental research project. It followed an exploratory approach, which
enabled the PoC to contribute to the complex discussion surrounding tokenisation in
financial markets.
PK2 does not signal support for any particular technology, nor does it signal any
specific shift in policy direction. The project was not about replicating the status quo.
Rather, it was about challenging our thinking around designing for a different future.
Playing in collaboration
This has been a guiding principle for much of our work has been the following African
proverb: "If you want to go fast, go alone, but if you want to go far, go together." The
technical teams are continuing to explore how they can build different applications in
addition to the ones built for the prototypes during the main phase of PK2. This is to
ensure that we can get the maximum shared learning out of our collaboration.
the SARB's
The PK2 report is contribution to broader discussions surrounding the
regulatory treatment of crypto-assets and financial market innovation. We hope that it
provides meaningful insight to the discussions taking place between policymakers and
regulators as they continue to consider the most appropriate way to amend the existing
domestic legal and regulatory frameworks.
We recognise that digital currency innovation cannot be explored in isolation. The
SARB continues to draw on the insights emerging from various initiatives, including
(but not limited to) our ongoing study into the feasibility, desirability and
appropriateness of a retail central bank digital currency (CBDC), to enrich our
understanding of digital currency implications.
It is also important to acknowledge the inherently borderless nature of DLTs and the
critical importance of international collaboration. The SARB was a proud participant in
the Bank for International Settlements (BIS)-led Project Dunbar, which considered how
a multi-CBDC platform could be used for international settlements. The Project Dunbar
report was released two weeks ago, and I would like to strongly encourage you to read
it, as it provides insightful supplementary views and information to the PK2 report.
Such initiatives further emphasise the need to consider interoperability and integration
between various digital currency and transfer-of-value platforms.
Pondering the outcomes
This outcome explores the implications of DLT-driven innovation through practical
exploration. Such exploration leads to practical insights which require further analysis,
research and dialogue. However, pondering on the lessons learnt and the insights
gained should not lead to 'analysis paralysis' or unnecessary pontification.
It is important to interrogate the efficiencies and benefits that new technology may
introduce. In the context of DLT-based platforms in financial markets, potential
efficiencies relate to:
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increased transparency in the holding of securities;
•
reduction in costs due to automation; and
•
the removal of multiple manual reconciliation processes across a network of
intermediaries.
One of the primary risks stems from the lack of regulatory certainty as the existing
legal and regulatory frameworks for financial markets were not designed for trading,
clearing or settling on DLT.
Promoting responsible innovation
This looks at how innovation should be done in a way that the financial system is taken
forward to benefit society as a whole. This includes contributing to achieving objectives
such as:
•
improving efficiency;
•
lowering barriers to entry for financial activity; and
•
addressing any challenges restricting access to meaningful financial services.
Policy and regulatory implications
The insights gained through practical exploration should lead to greater regulatory
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clarity both for innovators and for regulators and should be in the broader interest
of ensuring a level playing field for all market participants.
As financial services regulators in South Africa, we follow an activity-based and
technology-neutral approach, although we are not technology-blind. It may well be that
innovation enabled by DLT may change the risks involved in a particular business
process, for instance reducing or even eliminating counterparty risk, which may in turn
require us to reconsider the appropriateness of specific regulations.
Regulators need to move with caution when considering developments before they
implement any regulatory changes. They should be fully appreciative that regulated
entities require clarity before fully committing to entering DLT-based markets.
Conclusion
As I conclude, some may ask whether central banks and regulators will still be relevant
in a world based on some of the decentralised principles explored in Project Khokha.
From a regulatory perspective, I think it is unlikely that decentralised markets will be
suitable in all instances or that decentralisation will guarantee the achievement of
public policy objectives such as consumer protection, financial stability as well as
safety and soundness, which fall within the mandates of central banks and regulators.
The role of central banks, regulators and policymakers should, however, evolve with
financial markets to ensure that we continue to fulfil our mandates in future financial
markets.
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Central banks, regulators and policymakers can and indeed must play an active
role in shaping a potential move to DLT-based markets through playing with purpose,
playing in a collaborative way, pondering the implications of innovation, promoting
responsible innovation for the public good, and informing an appropriate policy and
regulatory response.
Thank you.