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Blockchain bonds: digital issuance breakthroughs build buzz

Panel (clockwise from top left): Ian Hall (moderator), Paolo Bortolin, Dina Buse, Nena Dokuzov and Bruno Batavia

With a growing number of public authorities exploring the issuance of bonds using blockchain technology, government fintech pioneers are enthusiastic to explore this emerging fintech application, writes Ian Hall

Blockchain – a decentralised shared digital ledger of information about transactions – is growing in prominence across financial services.

Governments and the public sector are also tuning in to this emerging technology’s benefits, with a growing number of bonds – which are issued when authorities want to raise money, for example to support public spending – being issued using this technology.  

The World Bank started the ‘blockchain bonds’ ball rolling five years ago with the launch of bond-i – the world’s first bond to be created, allocated, transferred and managed through its life cycle using distributed-ledger technology (DLT).

The European Investment Bank (EIB) issued its first digital bond on a public blockchain in 2021 (partnering Banque de France). In November 2022 the EIB issued its first euro-denominated ‘digitally native’ bond using private blockchain technology – its second fully digital bond issuance – and, earlier this year, launched a bond denominated in pound sterling using a combination of private and public blockchains.

At a national level, Israel’s Ministry of Finance and the Tel Aviv Stock Exchange announced in October 2022 that they are to pilot state bond issuance using blockchain; Hong Kong authorities announced a successful issuance of tokenised green bonds – the first such issuance by any government globally – in February 2023; and, in March 2023, Brazil’s central bank stepped up its exploration of tokenised federal government bonds.

Municipalities have also been getting in on the act. In January 2023 the Swiss city of Lugano’s public authority issued a six-year bond of up to CHF 100 million (about £88m/$108m) via blockchain – a move trumpeted by those involved as a public sector ‘first’.

To explore this trend, Global Government Fintech convened a webinar on 23 March 2023 to ask: ‘Blockchain-based bonds: what potential for the public sector?’.

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Lugano’s pioneering issuance

Lugano’s deputy chief financial officer Paolo Bortolin was the opening panellist, giving the inside track on the municipality’s blockchain bond issuance.

The affluent lakeside city is already home to 3Achain, an ‘institutional blockchain platform’ promoted by the public administration. The municipality has also been working with a private company, Tether, to ‘leverage bitcoin technology as the foundation to transform the city’s financial infrastructure’ through an initiative known as ‘Plan B’ (where the ‘B’ is written as ‘₿’, like the digital currency’s logo).

Its pioneering digital bond was dual-listed on Zurich-based SIX Digital Exchange (SDX) private, permissioned blockchain-based platform and the traditional SIX Swiss Exchange infrastructure.

Bortolin and colleagues had “many big meetings” over whether blockchain issuance would prove more risky. But, crucially, Moody’s gave the digital bond an ‘Aa3’ rating – the same rating assigned to Lugano’s traditional issuances. “With a lower rating, we would have just stopped the project,” Bortolin said.

“Everything went well. We ‘opened the book’ at 9am and an hour-and-a-half later it was closed,” he said. The bond spread was “exactly the same” as a traditional bond “so there was no additional cost”.

“I was scared that the investors would not buy because they wouldn’t know how to manage the bond after they bought it,” he admitted. “But with an investor call we reached 35 investors. We explained that the bank would manage it for you.”

The issuance was the first digital bond approved by the Swiss National Bank (central bank) for its ‘General Collateral Basket’ (making it the first digital native asset accepted as eligible collateral for SNB repos – repurchase agreements) and it was included in the Swiss Bond Index.

RELATED ARTICLE Swiss city issues blockchain bond – our news story (27 January 2023) on Lugano’s digital bond issuance

Latvia and Slovenia eye ‘potential’

Dina Buse from Latvia’s Ministry of Finance and Nena Dokuzov from Slovenia’s Ministry of Economic Development and Technology had similar starting points: although the two European Union (EU) member states’ governments are yet to commit to issuing a bond via blockchain, they are eyeing the possibility of doing so.

Buse, who is deputy director of the ministry’s financial market policy department and head of its credit institution and payment services policy division, emphasised the importance of EU regulatory developments.

The Baltic state, she said, needs to implement the 27-member bloc’s pilot regime for market infrastructures based on DLT – part of the digital finance package introduced by the European Commission in 2020 – and “go for a very fast track” implementing the EU Markets in Crypto-Assets (MiCA) rules. “There has to be preparation before you reap the benefits of fintech and all this new technology,” she said, adding that at a national level Latvia has recently published a fintech strategy.

Blockchain, she said, has “potential” for government bond issuance, including for sustainability bonds. Latvia’s State Treasury issued the country’s first sustainability bond, with a maturity of eight years and raising €600 million (about £530m) in 2021.

“We see that in the market there is very high potential for uptake,” Buse said, lauding financial technology’s ability to save time, costs and improve efficiencies.

Dokuzov led the preparation of an ‘Action Plan for Blockchain Technology’ in Slovenia five years ago and represents the central European nation in the European Blockchain Partnership (among numerous further international blockchain-related roles). She echoed Buse’s view on the importance of EU legislation, also mentioning the Digital Operational Resilience Act (DORA).

Blockchain is a “very promising” technology for bond issuance, she said, adding that although it was partly a case of “waiting for [EU] regulation”, Slovenia already has national blockchain infrastructure named SI-Chain and has recently adopted a capital markets strategy.

“It’s not a one-way process [awaiting] what we get from the [European] Commission,” she said. “There is also [the opportunity] to develop something at the national level and then integrate it into what will be developed by the Commission, also within the DLT pilot regime.”

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Brazil ‘moving to next step’

Bruno Batavia from Banco Central do Brasil (BCB) provided the webinar’s fourth perspective.

The South American nation’s central bank is, he said, engaged with DLT and tokenisation in a growing number of ways, including through: progress towards the introduction of a central bank digital currency (CBDC); projects in an accelerator-style initiative (known as LIFT Lab) and regulatory sandbox (test space); and through a working group on tokenisation (which launched in January).

The tokenisation of government bonds is being explored alongside the National Treasury (in Brazil the central bank is responsible for government bonds’ ‘back-end’ infrastructure and is also the dealer). “We [BCB] thought it would be interesting to partner with the Treasury and explore how we could move further from what we have nowadays in terms of infrastructure,” Batavia explained.

In technical terms, he described a DvP (delivery-versus-payment) settlement method “delivering federal government bonds against deposit tokens from financial institutions or payment institutions”.

“We’re adopting an infrastructure based on DLT [that] can handle multiple assets, not only government bonds,” Batavia continued. The BCB is also looking at areas including programmability and plans to explore the establishment of a “marketplace for peer-to-peer trades,” he added.

He presented a timeline of activity, showing a plan to ‘integrate’ federal government bonds in early 2024. Areas to be evaluated include (potentially) green bonds. Working alongside the Securities and Exchange Commission (CVM) the BCB plans to “onboard tokenised securities and other financial products” later next year.

The overall aim, he said, is to create ‘Pix for financial services’ – a reference to Pix, the high-profile Brazilian instant payments initiative that launched in 2020. “We think blockchain technology, smart contracts [self-executing contracts that have terms of agreement between buyer and seller written into lines of code] and tokenisation can help us to move to the next step,” Batavia said.

RELATED ARTICLE Brazil selects nine proposals to develop digital currency – our news story (14 March 2022) on Brazil’s central bank selecting nine private-sector proposals to progress as it explores the opportunities and challenges presented by CBDC

‘All about a learning curve’

Panellists were asked to elaborate on what was motivating their organisations to explore blockchain bonds and any scepticism and resistance they may have met.

“If you take Switzerland, we have probably one of the most advanced financial infrastructures in the world,” answered Bortolin. “So, the question is: ‘why are you doing all this?’. It’s because we want to innovate, we want to keep going, to be in the top of the world [in terms of] efficiency.”

Blockchain, though, has potential for “all” countries, he said, stating that technology laggards may have further to travel but can also leapfrog hesitant nations and “just go straight to the most innovative” technology.

He acknowledged challenges from “citizens and politicians”, saying that “not everybody agrees that we have to go to this direction”.

“But my answer is very easy,” he said. “Blockchain and crypto technology – it’s here. I was convinced in 2018, 2017 already. So, why should we not do it? We should test it, try it, integrate in our processes, try to understand – be ready for the next step. Because if now I’m accepting bitcoin and [Lugano’s own blockchain-based payment token] LVGA, I can integrate it into my processes. When the digital Swiss franc [potential central bank digital currency – CBDC] comes, then I’m ready with my processes. It’s all about a learning curve.”

He emphasised that, as a public administration, risk avoidance is important. “I’m not going to issue a bond on a public blockchain that I don’t know will still be there in 10 years because a bond is maybe for 20 years,” he said. “So I chose SDX, the official stock exchange, so [there was] no risk – and Moody’s confirmed that [with its rating].”

REGISTER NOW Global Government Fintech Lab in Dublin, Ireland on 18 May 2023 (the event includes a session on blockchain)

‘Ready to embrace change’

“This is a very innovative technology and it will be [the] very, very near future,” responded Buse. “We are ready to embrace change. Also, our institutions are ready [for] new models. Our financial regulatory authority is developing [use] cases in its sandbox, together with market participants.”

“I think in the future we will see even more financial services using blockchain technology,” she continued. “We are embracing the idea that we should ‘go to the next level’ of bond issuance, especially looking at green bonds and sustainable bonds. And, of course, more widespread use of blockchain technology [across] the public sector as well – for smart contracts, for the possibility to make tax payments also in virtual currencies.”

In the same vein, Dokuzov was enthusiastic for blockchain bonds’ potential as financial markets become more ‘decentralised’ arenas. But, in terms of overcoming scepticism, taking actions to boost awareness, understanding and trust of innovative technology among regulators, ministers, businesses and citizens is important, she said.

She made a comparison with the internet’s rise to ubiquity. “Today, we don’t care which internet provider we have – we know that we have the web… when we switch into ‘web 3’ [the third generation of internet-based technologies, incorporating concepts such as decentralisation and token-based finance], we hope that also people will be there – educated, trained and change-minded to embrace new technology,” Dokuzov said.

Cost-saving through fintech

In terms of blockchain bonds specifically, Bortolin foresees a growing number of public administrations taking the plunge.

“I think many bonds will be issued on SDX (so, digitally),” he said (in the Swiss context), adding that the impact of a potential Swiss wholesale CBDC (for interbank and similar large transactions) would “help a lot for atomic settlement” (whereby the transfer of one asset occurs only if the transfer of the other asset occurs) “so we can issue the bond and trade bond[s] instantly.”

“I believe that in five years everything will happen on digital platforms,” he continued. “At that point, we can reduce dependency on the banks. This means that we will reduce a lot of costs.”

“Most important is that we can reach a broader base of investors because imagine I can sell a €100m bond in €20 tranches, instead of €5,000 tranches – I can reach maybe five million people for 20 [Swiss] francs,” he continued. “This means that I don’t need the big investors that ask me for a higher spread. I can save a lot of money on the spread because I can reach so many people at the same time, in small amounts, which today is not possible because of the cost of investing in bonds through a bank.”

FURTHER READING Global Government Fintech’s Blockchain topic section

Bonding together

With momentum building, the coming months will surely see further public administrations making announcements about blockchain bonds.

In terms of international knowledge-sharing from those who have ‘been there, got the t-shirt’, the Hong Kong Monetary Authority (HKMA) is planning to publish a white-paper to summarise what has been learned from its tokenised green bond issuance, set out next steps and a publish a ‘blueprint’ for issuing tokenised bonds in Hong Kong.

Bortolin said he has “received calls” from countries including Japan and the UK – where the Treasury wants to have a financial market infrastructure sandbox to test the use of DLT for settlement and trading in operation by the end of 2023 – as well as other nations keen to hear about Lugano’s experience.

“There is interest,” he acknowledged, adding that private banks, too, had been picking up the phone to Switzerland to find out more.

Government fintech pioneers are in demand as trends continue towards digital transformation and digital money.

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