Bond markets yet to cash in on digital dividend

DEEP LOOK | The process by which bonds are issued, settled and serviced has remained largely unchanged for decades, with market infrastructure still largely reliant on traditional approaches that involve multiple intermediaries. Blockchain solutions could herald big change – eventually. In the meantime, non-blockchain platforms are promising increased efficiency for issuers. 

Blockchain-based bond issuance platforms have been promoted as the future of corporate fundraising but with debt capital markets still dominated by manual processes, progress towards tokenised issuances remains painfully slow.

The pivotal advantage of blockchain-based bond issuance platforms lies in their ability to ensure immutability of records and network resilience, explains Jean-Marc Stenger, CEO of SG Forge (a subsidiary of Societe Generale Group regulated as a digital asset service provider under French law).

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“The programmability and ease of structuring embedded in these bonds streamline key processes from issuance to transfer, custody and cancellation,” he says. “This significantly reduces the likelihood of errors, facilitates faster settlements, and allows for comprehensive tracking of use of proceeds, key performance indicators, and allocation reporting.”

Attestation of execution via automated smart contracts saves time for operations staff, observes David Creer, crypto offering/global DLT, crypto and e-money lead at financial services software provider GFT.

“Through the use of cash-on-chain solutions for settlement of bonds it is also possible to settle bonds more quickly and therefore improve workflows in liquidity management, increasing the number of bonds that can be settled at scale,” he says.

In the secondary market the technology promises real time securities transfers and transaction closures and minimisation of risks associated with liquidity, settlement and counterparties through so-called atomic mechanisms for delivery versus payment.

Limited corporate issuance

In February 2023 Siemens issued its first digital bond on blockchain. Worth €60 million, it had a maturity of one year and was sold directly to investors without the involvement of central securities depositories. The transaction was completed within two days.

Ralf Thomas, chief financial officer observes that since the company supports the digital transformation of its customers “it is only logical that we test and utilise the latest digital solutions in finance.”

Siemens outlines the operational and cost benefits of accessing finance this way, instead of through traditional capital markets, as follows:

• It makes paper-based global certificates and central clearing unnecessary

• The bond can be sold directly to investors without needing a bank to function as an intermediary

• The settlement period is reduced significantly

The company would not comment on specific cost benefits, but confirmed that the interest rate of the digital bond was in line with outstanding Siemens bonds.

Despite the apparent success of this issuance, it remains the highest profile corporate digital bond issued on blockchain to date.

A July 2023 report from asset-based finance industry trade association UK Finance acknowledged that tokenised issuances account for a tiny fraction of traditional securities issuance with many of these issuances backed by financial institutions or governments rather than corporates.

So why have there been so few blockchain-based corporate bond issuances?

Barriers to adoption

In a presentation to the International Capital Market Association’s fintech and digitalisation forum in December 2023, Josselin Hebert, senior digital innovation officer at the European Stability Mechanism acknowledged that blockchain had “moved down the hype cycle” and that the technology behind distributed ledger-based bonds had not yet delivered on its potential.

Hebert observed that the bonds issued to date offer limited liquidity and collateral eligibility and that further work will be needed to explore whether it will be possible to enhance secondary trading of tokenised securities. He also noted that regulations vary across jurisdictions and that it is difficult to assess whether harmonisation is achievable.

“We think that blockchain is an enabler, but building critical mass is dependent on many more factors than the technology,” says Johan Hörmark, head of business development for investment banking and equities at SEB. “There is an increased cost in maintaining parallel infrastructures and it comes down to whether there will be a more diverse landscape or if we can all agree on standards as we have done in traditional capital markets.”

He also refers to the risk of new platforms leading to market fragmentation before eventually consolidating. In addition, issuances will have to follow local laws and regulations so their development will depend on the willingness of governments to facilitate experimentation and sandboxes.

“Several of the distributed ledger technology-based infrastructures are capped at amounts not making it possible to move issuances at scale,” adds Hörmark.

Significant limitations remain

Existing constraints emanate from a shifting legal framework, limited adoption and interoperability of distributed ledger technology platforms, and the absence of a fit-for-purpose wholesale digital currency.

That is the view of SG Forge’s Jean-Marc Stenger, who says the main limitations these hurdles create are around liquidity of distributed ledger technology-based securities and the market depth for primary issuances.

“Crucially, many of the heralded benefits rest on digitisation of the full value chain that necessitates integration and interoperability of cash payments,” he says.

Blockchain will play a structural role in the future of digital fundraising, but it is not solving all problems on its own, observes Guénolé de Cadoudal, head of the digital assets group at Crédit Agricole CIB, who recognises that solutions and offers from banks will need to be built in addition to the technology.

“There are a number of limitations that are linked to regulations (trading capacity, overseas distribution, product size and type) or connectivity between these new platforms and the legacy world,” he says. “No platform is yet at industrial grade with the capacity to process existing volumes and it is likely that the two worlds will co-exist for a while.”

From a technical perspective, there are no limitations on the type of bond that can be issued. However, David Creer of GFT agrees that banks and other financial services institutions are moving over to these platforms slowly and are still in either partial or individual testing stages.

An alternative approach

In the meantime, digital debt capital markets issuance platforms offer the promise of more efficient processes based on existing debt capital market infrastructure.

According to Raja Palaniappan, CEO of issuance platform Origin, most of the steps in the lifecycle of a trade can be summarised as ‘put data into a document, email that document, recipient takes data out of that document and puts data into system’ multiple times across front, middle and back office, and legal. 

“It typically takes five days between a bond being launched in the market and the issuer receiving the cash,” he says. “Most of the delay comes from the time it takes to prepare, review, sign, and distribute the transaction documents (term sheet, pricing supplement, subscription agreement).”

Palaniappan describes the administrative effort required to issue a bond as unnecessarily cumbersome with a lot of ‘paper pushing’ that could easily be automated.

In May 2023, Volvo Treasury issued a dual tranche €1 billion benchmark senior unsecured bond on the Origin platform, which automatically drafted all key pre- and post-transaction documents.

Volvo Treasury mainly uses Origin for post-trade administration – in other words, it does a trade in the traditional way on capital markets through a syndicated book building process. Once that is done, details of the trade are put into Origin and all post-trade documents are generated by the system.

“This is not a new way of executing a trade, but rather a new way of doing the post-trade administration,” explains Danijel Afolter, portfolio manager market operations at Volvo Treasury – the treasury unit of Sweden-based truck maker group AB Volvo. “Usually a law firm would draft these documents manually, but we have standardised these documents so that everything is available at the click of a button. Legal counsels are still involved of course, but everything is done on the platform.”

The company uses multiple banks in the funding process, each of which has its own term sheet template.

“By standardising this process we hope to cut down the time and effort we put into these things so we can focus on the core business,” says Afolter. “However, leveraging the full benefits of the platform will depend on us having all our banks there, which we don’t have today. Also, a couple of new features need to be added to streamline the process, although we are engaging actively in these discussions.”

Maximising the opportunity

Palaniappan says the technology is best suited to issuers who use euro medium-term note, global medium-term note or other debt issuance programmes as this allows the issuer to come to market with a ‘final terms’ or ‘pricing supplement’ for each drawdown that refers to the main base prospectus rather than drafting an entirely new prospectus each time.

“By reducing the frictional cost of issuance using technology and automation, issuers are able to take advantage of the best conditions for issuance,” he adds. “They are still selling the same bonds to the same end investors using the same dealer banks to facilitate the process. It is just that rather than relying on a messy web of emails and Word documents, the entire process runs smoothly over a platform.”

The use of smart contracts automates critical aspects of the issuance process, making capital markets accessible to micro, small and medium-sized enterprises previously excluded by high barriers to entry, suggests Hannah Frojd, head of marketing with Swiss blockchain-based debt platform Obligate.

“[But] while blockchain offers a solid solution for many types of bond issuances, challenges such as regulatory compliance and market acceptance remain,” she concludes.