Frequent borrowers set to lead digital transformation
Exclusive survey of public-sector issuers reveals widespread plans to test and promote primary market tech projects
Public sector borrowers have always been at the forefront of developments in the bond market. The burgeoning digitalisation process is no exception.
OMFIF surveyed 21 of the top public sector borrowers around the world. Debt management offices at sovereigns, supranationals and government agencies were asked for their views on the digitalisation of their marketplace. Are they working on it themselves or do they plan to? What will the market look like? What will the technology be and who will develop it? Who will pay for the development? Who will set the rules?
The survey uncovers their plans, expectations and preferences for the digitalisation of their marketplace. The question is when, not if, the market will become fully digital. Around half of those polled think the process would take a decade or more. The rest expect it to happen within five years.
Progress is unlikely to be uniform. Simpler products, like commercial paper, are likely to be among the first to be upgraded, with proper benchmarks and structured products to follow shortly.
Although banks are working hard on developing and implementing new technologies, issuers are split on whether it will be banks or fintechs that provide the technology on which the digital bond market operates. Several respondents remarked that we are likely to see a consolidation in the market through mergers and acquisitions. Around three-quarters of respondents believe multiple issuers will use the same platform, but only one-fifth think there would be a single platform for the whole market.
The rise of competing standards and their eventual consolidation could risk fracturing the market, splitting liquidity. Generally, issuers appeal to bodies like the International Capital Market Association to provide market standards to avoid this.
Opinion is also divided on whether the blockchain technology underpinning digital bonds should be public or private. A few years ago, answers were likely to have been much more firmly in favour of private and permissioned systems but, as knowledge and understanding of the technologies have spread, market participants are gradually becoming more comfortable with the data protection standards public blockchains can offer.
The difference of opinion may reveal something more profound — neither solution will triumph completely. The market will instead be built on a combination of different protocols, which participants can select from based on their preferences.
There are some topics on which issuers are more united. Most agree that a digital bond market will need a new cash settlement facility, with just over half favouring central bank digital currency.
Although banks’ books of investors are jealously guarded commercial information, many issuers are still of the opinion that some of this information might be centralised for the sake of efficiency, without compromising banks’ proprietary information.
The SSA market is a fiercely competitive place. Banks must constantly scramble to distinguish themselves and demonstrate their value as a member of a syndicate to distribute a benchmark. This survey shows just how important these borrowers believe the digitalisation process is to the future of the market. They take their responsibilities as market leaders seriously and look to the dealer community for advice and guidance on all aspects of the debt issuance process. It may not be long before digital bonds expertise is a prerequisite for banks wishing to win business in the SSA market.
Borrowers’ thoughts on implementation of digital capital markets
As the efforts to digitalise capital markets advance, problems and challenges will undoubtedly arise. Some issuers who completed the survey offered additional thoughts on what these issues might be and how to mitigate them.
How will we get from individual platforms to a market utility? Who would provide it?
‘All these new platforms cannot coexist, so we will see a market consolidation.’
‘The European Central Bank would be an attractive independent party to provide a common market infrastructure and organise its governance.’
‘The International Capital Market Association is an obvious candidate to set a market standard.’
Could there be central pooling of investor information without compromising banks’ commercial advantage?
‘…sounds difficult because of the general data protection regulation.’
‘This might increase cost efficiency, but it would require changes with respect to applicable know-your-customer rules and procedures.’
‘Issuers are already pooling information about the greenness of certain investors.’
‘Factual information about investors could easily be pooled on a central platform — contact information, type of investor, their KYC package. Banks could import this data and combine with their own commercial information about historical participation in deals and precise classification.’
‘Investors currently hide behind their custodians. On the blockchain this would not be possible and the role of custodians would get diluted. I’m not sure how decentralised finance helps to ensure markets can transparently function, however simplifying infrastructure, for example removing custodians, can certainly help.’
‘Blockchain is only valuable for simplifying database infrastructure and removing unnecessary players and cost (custodians mostly) from the ecosystem of markets.’
‘DeFi is not the way to go for regulated capital markets. Blockchain can be a great tool to streamline the market infrastructure and reduce cost.’
‘The role of paying agents needs to be revisited. Counterparty risk, capital cost and operational risk could be mitigated by the use of central bank facilities.’
Are you actively working on applying new technology to your bond issuance process?
72% of borrowers either already are or intend to actively work on applying new technology to their bond issuance process.
When do you expect to launch pilot/test programmes or bonds using blockchain?
Within the next three years, half of public sector borrowers will have performed a test blockchain bond operation.
Most sovereign, supranational and agency bonds will be digital within three years, five years, 10 years or more, or never:
100% of borrowers agree that the SSA bond market will become fully digital at some point.
Who will provide the technology for digital bonds?
Issuers are split on who will provide the technology, with 43% saying banks and 48% saying fintechs.
Do you think that blockchain will be the technology underpinning digital bonds?
Issuers are evenly divided on whether public or private blockchains will underpin digital bonds, with 40% favouring public, permissionless systems and 45% favouring private networks.
Who should bear the costs of new digital infrastructure?
The majority, 57%, of respondents said that issuers and banks should bear the cost, while 14% said it should be investors. The remainder, 29% of respondents, said that all three should share the cost.
How would digitalisation affect the know-your-customer process?
38% of issuers believe there will be more centralisation of investors’ KYC information.
Is a central bank digital currency a necessary component of an efficient digital bond market?
72% of issuers believe the market needs a new cash settlement facility, with 52% hoping for a CBDC.
Do you think that, in the future, each issuer will have their own digital bond issuance platform?
76% of issuers think that groups of issuers will use the same platform, while 19% said there will be a single market-wide utility.
Which segment will be more impacted by the digitalisation of bond markets?
70% of issuers believe the primary market will be more affected by digitalisation than the secondary market.