Banks resort to blockchains to reform the expensive bond market

A growing number of banks are experimenting with issuing bonds in blockchains, in a change they say could end up revolutionizing an asset class that has lagged behind in adopting new technologies.

Blockchain, the digital book that records and verifies transactions and holds cryptocurrencies like Bitcoin, has the potential to streamline the process of selling new debt, which means substantial cost savings, according to bankers.

“I think blockchain has a real future in the debt capital markets,” said Sean Taor, head of RBC’s European debt capital markets. “If you can use blockchain from start to finish, you assume a lot of the costs, a lot of the risks in terms of counterparty and liquidation risks.”

In April, the European Investment Bank raised € 100 million from a two-year bond registered on the ethereum blockchain network, in the first such deal involving a banking union. The deal came three years after the World Bank sold the first bond to create and manage using blockchain.

Last year, Singapore food producer Olam International sold a bond using HSBC’s blockchain-based liquidation platform, while JPMorgan has also tested the use of blockchain technology to issue financial instruments.

For broadcasters the motivation is obvious. Over the life cycle of a bond, using blockchain technology could save at least 35% of the costs associated with issuance, according to a study conducted last year by German fintech technology firm Cashlink, automating processes such as l emailing and manual updating. of bail documentation. The use of blockchain could also reduce the number of intermediaries involved in the process, for example, bonds should no longer be registered in a central securities depository.

A similar 2019 study by HSBC on the green bond market (where a general ledger would help streamline the process of tracking the use of bond income) identified much greater savings of up to 90%.

Bonds issued by blockchain are not denominated in cryptocurrencies, but use the same underlying technology to reconcile orders from different systems, record and update asset ownership, and allow the transaction to be settled without the need for extensive manual control. Instead of the settlement lasting three days, as usual, the money can flow to the issuer smoothly once the price of the bond has been set.

“It’s essentially a glorified database,” said Matthew McDermott, head of digital assets at Goldman Sachs, one of the banks that managed the EIB deal alongside Santander and Société Générale. “This technology reduces the number of intermediaries involved in a given transaction.”

The bank has had more than 100 individual meetings with investors and potential issuers about the potential use of blockchain as a result of interest generated by the transaction, McDermott said.

Part of that is just a hype about new technology. I’m not sure it’s as revolutionary as it sometimes stands out

Blockchain also offers a way to easily locate current bondholders, often a tricky task in the relatively fragmented world of fixed income, where bonds are often traded directly “without a prescription” rather than on centralized stock 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 Coalition Greenwich’s market structure. “A universal database of who owns what, at least in theory, avoids the need for it,” he said.

Issuers would also find it easier to communicate with investors – some bonds, for example, contain clauses that allow bondholders to resell to the company if it changes hands.

In addition, banks could also save money on commissions charged by trading venues and allow agreements to be traded without ceding data to the rest of the market.

If they reduce some of the barriers to participation in bond markets, blockchain technologies could end up opening them up to much smaller players, according to Denis Coleman, co-head of Goldman Sachs ’global financing group. “This is just the beginning of a journey, but you could see the democratization of bond markets,” he said.

The HSBC report, which was co-authored by the Sustainable Digital Finance Alliance, recommended the creation of blockchain “DIY” bond platforms, which would allow smaller companies to take advantage of debt markets with minimal fixed costs.

Some of the claims about its potential may be exaggerated, McPartland said. The massive investment needed to change the systems that underpin debt markets is likely to occur slowly and regulators will not necessarily approve it, he argued.

“Distributed ledgers will have a role to play in helping markets be more liquid and transparent,” he added. “But some of that is just a hype about new technology. I’m not sure it’s as revolutionary as it sometimes gets.”