Blockchain bonds prepare for launch
What future for syndicate bankers in a blockchain world?
The first blockchain-powered bond issues are expected to emerge in a matter of weeks, as technology start-up BlockEx puts the finishing touches to a digital asset issuance platform that it believes could ultimately squeeze out bank syndicate functions.
After developing a white-label cryptocurrency brokerage platform to sit on top of existing exchanges, BlockEx is expanding its ambitions. It hopes to become a leading exchange for the issuance of digital assets including bonds, equities and syndicated loans.
The firm is also readying a de-materialisation tool that splits large blocks of bonds into smaller units by recreating them in digital format, and is preparing the first fully KYC-compliant bitcoin exchange in an effort attract more institutional cryptocurrency trading.
The bond platform enables issuers to create “smart contracts” that specify coupons, payment dates and maturities, with the flexibility to create retail-friendly payout structures such as monthly or even daily coupons. The digital assets are sold directly to investors, cutting out bank intermediaries and potentially slashing issuance costs by more than half.
“Our concept is to make it easy for institutions to issue an asset,” said Adam Leonard, CEO of BlockEx. “Our aim is to template as much of the process as possible. Whether it’s a US$10m or a US$1bn issue, a company can use the asset creation tool, pick documentation and get the money in just a single day.”
The full lifecycle platform aims to settle trades within 30 seconds and leaves a secondary market that generates an indelible history of buying and selling activity using distributed ledger technology.
The firm is in the process of signing a partner law firm to automate the documentation process. Around a dozen potential issuers are queuing up, according to the firm. The first wave comprises small and medium-sized enterprises eyeing US$10m-$50m issue sizes, which are largely shut out of the capital markets due to syndication costs that average US$200,000-$400,000 according to BlockEx estimates.
“With the digital asset tool, costs can be substantially less than half, or even a quarter of current costs, and the big added benefit is that it leaves the securities with a secondary market,” said Aleks Nowak, CIO of BlockEx.
BlockEx is in discussions with potential investors - including some big-name exchanges - but is not alone in its ambitions. Swiss exchange group SIX recently developed a digital bond issuance prototype in conjunction with Digital Asset Holdings, though it has no immediate plans for launch.
EQUITY AND LOAN TEST
Similar efforts are afoot across other asset classes. BNP Paribas is preparing the first live test of a blockchain platform to issue and settle non-listed equities in the next two weeks. Developed in conjunction with tech firm SmartAngels, the platform also provides a marketplace for private equity investors to trade at a fixed price.
“We wanted to keep the peer-to-peer aspect of blockchain and felt that the point of contact between an issuer and investor in the non-listed market made it the most applicable area.” said Philippe Ruault, chief innovation and digital officer at BNPP Securities Services. “There is a real need for investors to be able to buy and sell portfolios at a fixed price, as today you have no infrastructure to do it.”
While the technology is potentially transformational for the non-listed markets, Ruault remains sceptical of an expansion into the well-established infrastructure of listed markets.
“While you could potentially extend the technology to a large IPO, you have to keep in mind the limitations as it could be difficult to manage high volumes of transactions,” said Ruault. “While the regulator is ready to support us for small to medium corporates, as soon as it becomes a real IPO they want us to keep the existing infrastructure and stick to regulation.”
Blockchain is also moving closer to reality in the leveraged loan market after Synaps Loans, a joint venture between Ipreo and Symbiont, saw 200 people dial into a 90-minute demonstration earlier this month.
“We built a spec that included many use cases that cover the whole lifecycle of a loan, from origination to secondary trading and even into amendment functionality where lenders got to vote and the smart contract tallied those votes and adjusted the facility accordingly,” said Joe Salerno, managing director of loan trade settlement at Ipreo and chief executive officer of Synaps Loans.
The platform aims to improve settlement times, which averaged 18.4 days in 2016, according to IHS Markit. That has garnered criticism from the SEC, which recently voted to shorten bond settlement times to two days from three.
Firms including Barclays, Wells Fargo, Eaton Vance and KKR participated and industry consortium R3 managed the proof-of-concept testing. Credit Suisse helped arrange the project.
With banks under intense pressure to cut costs amid stringent capital requirements, even some syndicate managers have become convinced that blockchain will transform the way that securities are issued in the future.
“The thing about technology is that everyone overestimates its impact in the short term and underestimates it in the long term,” said one London-based bond syndicate head. “Blockchain will change the world eventually, but in the mean time we’ll have transacted US$5trn of bonds.”
Armin Peter, UBS’s global head of syndicate, told IFR that the blockchain concept of collapsing origination, settlement and trading into a single function will ultimately prove disruptive (though possibly not for five to 10 years) and suggested that frequent issuers could be the most likely candidates to make early use of the technology.
“Our most important functions as syndicate managers is to minimise execution risk and find the optimal price for securities,” Peter said. “Issuers are most fearful of failed deals because of the impact on their reputations and their outstanding pricing curves. So they will be nervous of making those risks bigger.
“But the fixed-income markets where price transparency is clearest and execution risk is lowest are government bonds and the SSA sector.”
Such issuers will also benefit from their familiarity as credits and standardised documentation. And even if their deals price a basis point or two below their curve because they have used a non-traditional system, that should be offset by the price savings from using the new technology.
Banks are certainly not resting on their laurels. Many have partnered with fintech start-ups to ensure their place in a more digital world, but see continued demand for their role as intermediaries.
“The trust aspect of a financial institution brings value to the model,” said Ruault. “Blockchain is due to be a trust machine but to attract the market you need someone to take some form of responsibility in terms of loss of assets.”
Some blockchain experts disagree. As a public ledger open to inspection by all participants, blockchain technology has already given rise to a US$17bn market-cap currency without the support of a central bank.
“Blockchain is a trust fabric and once you’re part of it, you’re part of a trust community,” said Haydn Jones, managing director of specialist consultancy Blockchain Hub.
“The traditional way is to put an intermediary in the middle of a transaction, but what a bank intermediary does with trust, blockchain does with code. That resolves the trust asymmetry challenge and enables markets to operate on a trustless peer-to-peer basis.”
Syndicate officials have long defended their role in ensuring a healthy aftermarket by placing bonds with trusted buyers that are unlikely to flip assets for a quick profit.
According to James Godfrey, MD for capital markets at BlockEx and a former credit trading head for banks including Mizuho and Nomura, digital ledger technology turns that trust into real transparency through a permanent trail of trading activity that would shed light on flippers.
“With a fully transparent ledger the issuer knows exactly who is holding those bonds at any time,” said Godfrey. “It’s a big change for the buyside and not always a comfortable one, but any concerns are offset by the efficiencies and savings, which are considerable.”