Distributed Ledger Technology in Debt Capital Markets
Introduction
Debt capital markets (DCM) have been a considerable area of development for distributed ledger technology (DLT). Due to standardized transacting procedures, DCM are well suited for the adoption of DLT. An increasing number of both private and public companies around the world have begun to utilize DLT debt securities. This article will briefly explain the issue with the conventional process, the solution, and practical examples from around the world.
The Problem
Conventionally, DCM are reliant on the collaboration of numerous entities to successfully facilitate transactions. These entities include issuers, lenders, underwriters, solicitors, bond councils, and clearing houses.
Third-party intermediaries are crucial to the industry because they establish trust between issuers and investors. However, with many third parties involved, it is difficult to expedite deals efficiently. While trust plays a pivotal role in DCM, parties establishing that trust are also responsible for inefficiencies that lead to transacting delays and higher costs.
The Solution
DLT provides a single source of truth for all parties involved. Data containing details on the security are written onto the DLT and are instantly available for agreement among all participants. DLT is able to perform issuance, sales and trading, clearing and settling, post-trade services, asset servicing, and custody on bonds [1]. This provides transparency, trust, and validation between the issuer and investor.?
The issuance and lifecycle process of bonds are substantially affected by DLT. Native digital asset bonds inherently transform how the execution, clearing, record keeping, and payment facilitation on a bond take place. For non-native digital asset bonds (tokenised bonds), implementation of DLT to record information on bond transfers can increase efficiency and provide direct communication between issuer and investor [2].
Bonds issued on DLT, paired with programmed cash solutions are intended to minimise settlement risk. This is attained by programming digital cash and digital bond transfers to take place simultaneously. For this to transpire, multiple DLT networks may be necessary.?
Smart contracts play a big role in carrying out DCM functions. Self-executing contracts are written on DLT and are specifically coded to meet the demands of prospectuses. Terms of the bond, coupon rates, maturity, issuance amount, approved operators, and transfer conditions can be incorporated into the smart contract. At appropriate intervals, the smart contract will record information and trigger transactions.
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Practical Examples
This past summer, the IDB Group (Inter-America Development Bank) along with Davivienda, issued Columbia's first bond using DLT. The bond was underwritten by IDB Invest and was authorized, issued, and traded completely on the blockchain. This process allowed Columbia's Davivienda Bank to trial reduction costs through a complete trading cycle. This pilot was conducted on “La Arenera'', the sandbox for fintech innovation testing in Columbia.
The success of this pilot was monumental for all involved. The president of Davivienda noted, “The use of this technology transforms the role of actors in the securities market and the way in which bonds are issued and processed, resulting in a more transparent, rapid, and secure market” [3]. The project promotes benefits of decentralized technologies and their efficiency in dealing with the region's capital markets.?
DLT also provides advantages in the issuance of government bonds. Government debt raising is a complicated process due to large-scale synchronization between multiple parties, combined with strict monitoring and regulation. Project “Eden” is a PoC (proof of concept), currently taking place in Israel, for the issuance of government bonds using DLT [4].?
Participants (banks) in the PoC will connect to the dedicated blockchain and their acquired bond units will be issued into their e-wallets. The capital provided, in digital currency, will be transferred from participants’ e-wallets and into an e-wallet allocated for the State of Israel. DLT will facilitate these transactions and keep a record of the bond cycle.?
In the DCM industry, trust, transparency, efficiency, cost-effectiveness, and limitation of risk are highly sought after. DLT has the capability to incorporate all of these characteristics and revolutionise DCM.?
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