Popular excitement about the use of blockchain reached fever pitch a couple of years ago – coinciding with the first bitcoin bubble – and has tapered off since. Yet behind the scenes, enthusiasm about the potential for distributed ledger technology (DLT) to resolve many of the most inefficient and troublesome aspects of capital markets activity, particularly surrounding bonds, has continued to build.
To gauge the extent of this potential, and to assess how readily new applications can be scaled and implemented in capital markets, Standard Chartered brought together an expert panel in a Virtual Conference on Digital Transformation in Financial Markets in December 2020.
Making the pain go away
“So many organisations are looking at blockchain because it’s a very efficient way to solve some of the pain points that bond market participants are facing,” commented Vinoy Kumar
Global Head of Digital Assets for Standard Chartered and one of the moderators of the discussion.
First among these, panel participants heard, is complexity. It might not be surprising that G3 bond issuances in the Asia-Pacific region (excluding Japan and Australasia) rose 10.4% year on year to above USD300 billion in the first three quarters of 2020.1 But it is perhaps a surprise that the arrangers of these bonds – including securities firms, local financiers and global banks – numbered above 180, demonstrating the growing complexity of the market.
Moreover, a study cited by panellists showed that the process from the moment an issuer plans to raise capital to the security being launched has more than 650 discrete steps. Management of the bond across its lifecycle – from keeping track of the order book to price discovery to trades, custody, payment settlement for coupons, repayment at maturity and post-trade tax reporting – entail thousands more.
Very few, if any, market participants have a view across all these steps. And many stages of the process rely on outdated technology, from phone-based orders to blizzards of documents either being emailed back and forth, or needing printing and wet signatures – not to mention the need for custody of physical certificates.
Three ways blockchain can help
There are three ways blockchain can resolve many of these complexities.
- The first lies in resolving issues of trust: participants and service providers who must interact through the lifecycle of an asset each have competing interests. Establishing trust is therefore hard. With blockchain, each party can hold a node, they can have equal access to data, they can collaborate on control of the blockchain system as well. This leads to higher trust, because they know other parties cannot tamper with the data.
- The second problem is unequal access to data across the whole security ecosystem, and the lack of a “golden source” of data that each can access. Blockchain allows data sharing in a controlled and secure way, allowing each participant to have access to a bigger combined data pool.
- The third issue centres around efficiency. Having a single data source would mean many manual processes, such as reconciliations, could be eliminated, as would the need for physical documentation, enabling near-real-time transaction settlement. “Smart contracts”, meanwhile, could streamline many routine aspects of bond transactions, like coupon payments, even if more complicated matters (such as what happens in the event of a default) would still need human judgement.
This democratisation of access to assets would benefit issuers, who would be able to diversify their sources of funding, while end-investors would gain through more portfolio diversification with smaller investments and more precise exposures.
What needs to happen to scale it up?
With such benefits on offer, why haven’t blockchain applications been rolled out across debt capital markets on a large scale yet? Many blockchain innovations were first demonstrated in the unregulated cryptocurrency space. Attempts to replicate that in highly regulated securities markets requires a lot of things to change to see a similar impact.
Panellists agreed that regulation will be crucial to enabling broader adoption, while – in parallel - addressing three remaining issues: detailed requirements for digital assets, whether settlement by blockchain is considered final from a legal perspective and further clarification around tax treatment of digital assets.
All panellists agreed that the potential of blockchain to revolutionise capital markets was far more than just hype. As Aaron Gwak, Managing Director and Head of Capital Markets, ASEAN, for Standard Chartered and co-moderator of the discussion concluded, ““With the right co-ordination between issuers, arrangers, investors and regulators, blockchain has the capacity to greatly improve access to debt capital markets and raise servicing standards– for the benefit of all participants.”