Hong Kong Monetary Authority (HKMA) has released a report setting out potential next steps to promote the wider use of tokenisation technology for bonds.
Authorities in the special administrative region of China undertook a successful tokenised green bond issuance – the first such issuance by any government globally – in February. At the time a white-paper was promised ‘in due course’ to summarise what had been learned, propose next steps and provide a ‘blueprint’ for tokenised bond issuances.
‘Bond Tokenisation in Hong Kong’ has now arrived, detailing the experience and the HKMA’s current thinking as authorities look to ‘unlock the potential’ of distributed-ledger technology (DLT). It considers what could further be done to promote tokenisation in the bond market, including the exploration of further use cases and enhancing Hong Kong’s legal and regulatory framework
The HKMA assisted the government in the HK$800 million (about £81m/US$102m) offering, made under the Hong Kong ‘Government Green Bond Programme’ (GGBP) – an initiative to encourage the development of green finance. DLT has been used forprimary issuance, settlement of secondary trading and coupon payment, and will be tested out in maturity redemption.
The 24-page report is likely to make interesting reading beyond Hong Kong given the growing interest among authorities worldwide in using blockchain for bond issuances.
RELATED ARTICLE Hong Kong issues first tokenised green bond – our news story (21 February) on the tokenised green bond issuance
‘Multiple challenges to be overcome’
The HKMA’s chief executive, Eddie Yue, writes in the report’s foreword that the issuance – dubbed ‘Project Evergreen’ – ‘showed the potential in DLT to enhance efficiency, liquidity and transparency’ in bond markets. He describes bond tokenisation as ‘still at its infancy’ and that ‘multiple challenges would have to be overcome for it to be widely adopted’.
The report includes a table listing ‘key efficiency savings’ as including: paperless creation (‘removing the need for a physical global certificate and manual mark-ups thereon in the traditional bond creating process saves man-hours and eliminates the risk of manual processing error’); the facilitation of interaction between different parties on a common DLT platform; and atomic delivery-versus-payment (DvP) settlement (‘bond transfer and cash payment on a common DLT platform instead of separate channels allow settlement to be done instantly and simultaneously on a DvP basis, reducing settlement delay and settlement risk’).
Eight pages are devoted to ‘deal structuring considerations’ in areas including the applicability of securities regulations; ‘native versus non-native tokenised issuance’ (bonds issued directly on the DLT platform or first issued off-platform and then tokenised on the DLT platform); and credit ratings.
In respect of credit ratings, the potential additional risks associated with issuing in digital form versus conventional form is an ‘important consideration’, the report notes.
‘Digital bond issuances involve DLT platforms, which leverage rapidly changing blockchain technology and, as a result, new capabilities are not fully proven in use and remain largely untested in financial markets,’ the report states. ‘To help address potential risks, it would be useful to have in place clear business continuity plans [that specify the steps to be taken by the platform operator and relevant parties in case of a DLT platform disruption or failure. […]. To address the concern of an irremediable disruption or failure event, parties may also consider keeping a regular off-chain mirror record of the database and having in place measures for migration of the database to an alternative platform.’
In respect of listing, the report also mentions that Hong Kong ‘has not yet developed a designated market for digital bond listing, while secondary market trading of bonds in Hong Kong in general takes place by way of traditional OTC [over-the-counter] trading’.
RELATED ARTICLE Swiss city issues blockchain bond – a news story (27 January 2023) on Lugano’s public authority issuing a six-year bond of up to CHF 100 million (about £88m/$108m) via blockchain in a move trumpeted as a public-sector first
Fields for future exploration
A section of the report setting out potential further use cases states that aspects and features that could be further tested include different tokenisation platforms and currencies, as well as standardisation of documentation, real-time impact tracking and reporting, tokenisation of repo transactions (repurchase agreements) and also retail use cases.
In respect of platforms, the report notes that a number of commercial tokenisation platforms have been developed in recent years and each platform may offer different functionalities. ‘In order to assess the benefits that could be achieved from different technological set-ups, and explore the feasibility and potential of cross-platform interoperability, more issuances may be conducted using different DLT platforms,’ it states.
In respect of documentation, it states that standardisation protocols, if widely adopted across the market, ‘can potentially streamline certain business-as-usual processes, promote straight-through processing and pave the way for wider DLT adoption’. It gives the example of a ‘Bond Data Taxonomy’ released by the International Capital Market Association (ICMA) in March.
The report states that the ‘feasibility of incorporating real-time tracking and reporting features (for example in respect of environmental, social, and governance issuances) may be further explored’, whereby the DLT platform collates and feeds data collected directly from underlying assets and makes such data collected accessible to end-investors.
In respect of DLT’s potential for retail (general population) issuances, the report states that ‘in the longer term, subject to identifying and addressing potential legal, regulatory, technical and operational issues, tokenisation at the retail level may potentially simplify the conventional retail bond issuance/subscription process, lower denomination which permits broader investors base to participate in an issuance, and automate the primary issuance and secondary trading processes which could bring efficiency and potentially improve liquidity.’
RELATED ARTICLE Israel to pilot issuance of digital government bonds on blockchain – our news story (26 October 2022) on Israel’s Ministry of Finance and the Tel Aviv Stock Exchange (TASE) ‘examining the application of the issuance of digital government bonds on a blockchain infrastructure’ in explorations titled ‘Project Eden’
Eyeing future issuances
The section of the report focused on legal and regulatory considerations points out that, at present, some paper processes are still maintained in digital bond issuances.
‘Fully digitalising these processes could enhance efficiency gains, though it may take time for the industry to replace existing market practices and conventions which have been in place for decades,’ it states.
‘The legal and regulatory framework may […] need to be fine-tuned to fully digitalise processes,’ it states. ‘For instance, for bearer bonds [for example, a bond issued by a government] being capable of native issuances, legislative amendments to introduce the concept similar to possession of ‘electronic transferable record’ as in the laws of other jurisdictions will be required, taking into account any potential knock-on effect to the laws on negotiable instruments more generally,’ it explains,
The report offers a concise conclusion, stating that the HKMA and government ‘will work with the industry to conduct further tokenised issuance(s) to advance development on this front’.
‘We are in discussion with key market players on future tokenised issuances, which may, subject to solution readiness, include new features that can create further efficiency gains, expand investor reach and pave the way for wider adoption in capital markets,’ it states.
WATCH THIS Blockchain bonds: digital issuance breakthroughs build buzz – a write-up of a Global Government Fintech webinar (23 March 2023) featuring representatives from Lugano (Switzerland), Latvia, Slovenia and Brazil discussing ‘Blockchain-based bonds: what potential for the public sector?’ (the write-up contains a link to a video recording, which is 1hr 23min 29sec)