DLT holds major promise for digitizing assets in the bond market: an industry where paper-based inefficiencies rule. This decentralized peer-to-peer digital system records transactions between parties in multiple places at the same time. Unlike a traditional database, a distributed ledger does not require an administrator to update the records. There is not one central location for data storage.
Pilots are in place to extend use cases to equities, structured products, mortgages, repo markets, life insurance, annuities, and health care claims.
DLT is no longer a blockchain experiment. Instead, it is tried, true, and tested technology. The global repo market demonstrates DLT’s value: faster settlements, increased liquidity, and reduced costs — the real-life use cases blockchain’s been looking for. Pilots are in place to extend use cases to equities, structured products, mortgages, repo markets, life insurance, annuities, and health care claims.
Goodbye traditional bond markets, hello future
Financial services firms started investing significantly in blockchain once they began seeing its transformative potential. Digital assets then began to evolve alongside the crypto industry, yielding early successes in asset digitization in the bond market.“Fixed income markets offer an excellent example of DLT in action,” says Horacio Barakat, Head of Digital Innovation for Capital Markets at Broadridge. “The technology makes it easier to leverage smart contract technology, which can help digitize and mutualize workflows between counterparties, or execute corporate actions such as bond coupon payments and principal repayment.”
In comparison to physical bonds, which are issued and traded over the counter and prone to mistakes and delays, tokenized bonds automate these processes and enable instantaneous transactions. Tokenized bonds also offer real-time data availability, platform security, transparent audit trails, and the opportunity to establish secure digital identities — all of which help to reduce the operational risks involved in the process.
DLT’s potential is not limited to one area of capital markets. Exchanges and central securities depositories (CSDs) are focused on applying DLT to standard bonds in contrast to custodians and banks, which are prioritizing cryptocurrencies.
“While crypto remains for now the most common use case for DLT, this is not a trend that is expected to continue,” says German Soto-Sanchez, Head of Corporate Strategy at Broadridge.
As big as Bitcoin is, the disruption to the $10 billion worth of yearly transfers is much bigger. The cost savings could be tremendous, and change the way in which bank transfers settle.1
“Planned pilot projects reveal that there will be a shift. Soon DLT will take center stage in the form of securitized assets, green bonds, private equity, ETFs, and private debt,” says Soto-Sanchez.
Tokenized green bonds begin to blossom
While brokers and investment bankers focus on equities, institutional investors are pursuing DLT’s opportunities with green bonds.S&P Global Ratings estimate that $1.5 billion of digital bonds have been issued last year.2 We saw exciting developments in the space, led by central banks and corporates.
In February 2023, Hong Kong issued the world’s first government tokenized green bond worth $102 million.3 The Hong Kong Monetary Authority, which was responsible for the launch of the digital bonds, says it is rolling out a blueprint of measures to encourage more companies to issue tokenized bonds in the city.
Sovereign bonds aren’t the only ones being digitized: corporate bonds are starting to make their mark. Siemens became one of the first companies in Germany to issue a digital bond in February 2023.4 Underpinned by a public blockchain, the digital bond removes the need for paper-based global certificates and central clearing. Instead, investors can purchase the bond directly without needing a bank to function as an intermediary.
There are hurdles to overcome
Rebuilding the world of capital markets won’t be easy. One of the biggest challenges comes from within: deployment isn’t being made a priority.5 Firms are understandably cautious to invest time and money into large projects against the current economic backdrop.“Companies should embark on DLT projects with a realistic understanding of the challenges they face,” says Barakat. “DLT is becoming a mainstream, but we are still in the earliest stages of that process. Standards are still forming around technologies, protocols, and rules.”
Legal and regulatory constraints have long been a global hurdle for widespread digital asset adoption. Recent announcements from regulators signal that change is underway, however, and that clear frameworks are coming.
The final hurdle to DLT adoption is the network effect. The more firms that sign up for DLT, the better. Buy-side operations have been slower to sign on than sell-side firms, which see more immediate benefits. For the buy side, the biggest benefits of new technology platforms materialize only when the systems begin to attract enough users to produce network effects.
The repo revolution
The most successful DLT use cases to date have been those that deliver substantial and immediate benefits to their earliest users. There are opportunities within the global repo market — a sector with cumbersome, error-prone, and paper-reliant processes — for major transformation.Blockchain technology can simplify and streamline these trades by digitizing the underlying securities in a repo transaction while transferring ownership via smart contracts.
“Within the repo market, DLT and smart contracts have shown that they can play an instrumental role in driving efficiencies, reducing risk, and enhancing liquidity while leveraging the existing legal and account frameworks,” says Vijay Mayadas, President of Capital Markets at Broadridge.
Emerging digital platforms use blockchain technology to provide a single location where market participants can agree, execute, and settle repo transactions. Users are saving millions of dollars through operational efficiencies, risk reduction, and increased collateral liquidity. These digital platforms are not limited to one type of repo transaction either: intraday, overnight, term, and open repos are being processed on bilateral and intracompany bases.
The creation of these new digital platforms is the result of collaborations with some of the industry’s biggest players. Big broker-dealer and buy-side names such as Natixis,6 Société Générale,7 and UBS8 are all firms that have been involved in such projects.
What’s next for DLT?
The feedback for DLT across the industry has been extremely positive. Exchanges and CSDs are confident that the faster settlements enabled by DLT are helping them prepare for T+1 regulation. Broker dealers and investment banks are reporting that their DLT platforms have generated new product revenues, increased customer retention, and reduced their overall operational risk.Looking ahead, nearly two-thirds of European firms (65%) believe that DLT will become the core of financial markets infrastructure in 10 years’ time, compared to 60% of US firms and 54% of Asia-Pacific firms.
“We are only at the beginning. DLT will be as profound as regional database technology, internet protocol — and arguably, over time, the internet itself,” says Chris Perry, President of Broadridge.
With the help of industry groups and governing bodies, DLT is set to make transformations that will eventually spill into other sectors. In February, the European Commission launched a regulatory sandbox for innovative use cases that involve DLT across all industries.9 The scheme has been set up to facilitate cross-border dialogue between regulators and supervisors on the one hand, and companies or public authorities on the other. This initiative is another exciting step in the right direction to help blockchain technologies disrupt all industries across the globe for the better.
1 Accenture Consulting. (n.d.). (rep.). Banking on Blockchain: A Value Analysis for Investment Banks. https://www.accenture.com/t20170120t074124z__w__/us-en/_acnmedia/accenture/conversion-assets/dotcom/documents/global/pdf/consulting/accenture-banking-on-blockchain.pdf
2 S&P Global Ratings. (n.d.). Digital bonds: The disruption is underway. Digital Bonds: The Disruption Is Underway. https://www.spglobal.com/ratings/en/research/articles/230227-digital-bonds-the-disruption-is-underway-12651017
3 Hong Kong Monetary Authority. (2023, February 15). HKSAR Government's inaugural Tokenised Green Bond offering. Hong Kong Monetary Authority. https://www.hkma.gov.hk/eng/news-and-media/press-releases/2023/02/20230216-3/
4 Siemens issues first digital bond on Blockchain. https://press.siemens.com/global/en/pressrelease/siemens-issues-first-digital-bond-blockchain
5 DLT in the real world 2022. ValueExchange — DLT in the Real World 2022. (2023, February 8). https://thevx.io/campaign/dlt-in-the-real-world-2022/
6 Natixis. (2022, September 12). Blockchain is already a reality here at Natixis. Asset & Wealth - Management and Corporate & Investment Banking. https://natixis.groupebpce.com/articles/blockchain-is-already-a-reality-here-at-natixis/
7 About Us. SG FORGE. (2022, September 2). https://www.sgforge.com/about-us/
8 UBS AG launches the world's first digital bond that is publicly traded and settled on both blockchain-based and traditional exchanges. UBS. https://www.ubs.com/global/en/media/display-page-ndp/en-20221103-digital-bond.html
9 European Union. (n.d.). Launch of the European Blockchain Regulatory Sandbox. Shaping Europe's digital future. https://digital-strategy.ec.europa.eu/en/news/launch-european-blockchain-regulatory-sandbox