A growing number of banks are experimenting with issuing bonds on blockchains, in a shift they say could eventually revolutionise an asset class that has lagged behind in adoption of new technologies.
Blockchain — the digital ledger that records and verifies transactions and underpins cryptocurrencies such as Bitcoin — has the potential to streamline the process of selling new debt, leading to substantial cost savings, bankers say.
“I think blockchain has a real future in debt capital markets,” said Sean Taor, head of European debt capital markets at RBC. “If you can use blockchain from start to finish, you take out a lot of the costs, a lot of the risks in terms of counterparty and settlement risks.”
In April the European Investment Bank raised €100m from a two-year bond registered on the ethereum blockchain network, in the first such deal involving a syndicate of banks. The deal came three years after the World Bank sold the first bond to be created and managed using blockchain.
Singaporean food producer Olam International last year sold a bond using HSBC’s blockchain-based settlement platform, while JPMorgan has also tested the use of blockchain technology for issuing financial instruments.
For the issuers the motivation is obvious. Over the life cycle of a bond, using blockchain technology could save at least 35 per cent of the costs associated with issuance, according to a study last year by German fintech firm Cashlink, by automating processes such as the emailing back and forth and manual updating of bond documentation. Use of blockchain could also cut down the number of intermediaries involved in the process — for example the bonds would no longer need to be registered with a central securities depository.
A similar 2019 study by HSBC looking at the green bond market — where a public ledger would help streamline the process of tracking the use of the bond’s proceeds — identified much larger savings of up to 90 per cent.
Blockchain issued bonds are not denominated in cryptocurrencies, but they use the same underlying technology to reconcile orders from different systems, record and update ownership of the asset, and allow the transaction to be settled without the need for extensive manual cross-checking. Rather than settlement taking three days, as is typical, money can flow to the issuer seamlessly once the bond is priced.
“It’s essentially a glorified database,” said Matthew McDermott, head of digital assets at Goldman Sachs, one of the banks which handled the EIB deal along with Santander and Société Générale. “This technology reduces the number of intermediaries involved in any given transaction.”
The bank has had more than 100 one-to-one meetings with investors and would-be issuers about the potential use of blockchain as a result of the interest generated by that transaction, McDermott said.
Blockchain also offers a way to easily locate current holders of bonds — often a tricky task in the relatively fragmented world of fixed income where bonds are often traded directly “over the counter” rather than on centralised exchanges.
Billions of dollars have been poured into analytics to help traders locate debt securities to buy or sell, according to Kevin McPartland, head of market structure at Coalition Greenwich. “A universal database of who owns what, at least in theory, avoids the need for that,” he said.
Issuers would also find it much easier to communicate with investors — some bonds, for example, contain clauses which allow bondholders to sell back to the company if it changes hands.
Moreover, banks could also save money on fees charged by trading venues and allow deals to be negotiated without giving away data to the rest of the market.
By lowering some of the barriers to participation in bond markets, blockchain technologies could eventually open them up to much smaller players, according to Denis Coleman, co-head of the global financing group at Goldman Sachs. “This is just the very start of a journey, but you could see the democratisation of bond markets,” he said.
The HSBC report, which was co-authored by the Sustainable Digital Finance Alliance, recommended the setting up of “DIY” bond platforms on blockchain, which would enable smaller companies to tap debt markets with a minimum of fixed costs.
Some of the claims made about its potential may be overblown, McPartland said. The massive investment necessary to change the systems that underpin debt markets will probably happen slowly, and regulators won’t necessarily approve, he argued.
“Distributed ledgers will have a role to play in helping markets become more liquid and transparent,” he added. “But some of this is just hype around a new technology. I’m not sure it’s quite as revolutionary as it’s sometimes made out to be.”