Commonwealth Bank of Australia has built a blockchain for debt capital markets which has been tested by Queensland Treasury Corporation for the issuance of semi-government bonds.
The new technology, which needs regulatory approval before it can be used for a real deal, eliminates settlement risk because the transfer of title is linked with the payment and the transaction is executed and settled instantaneously.
CBA described the structure as a "virtual cryptobond" and said it was the first time in the world a bank has conducted such an experiment alongside a government financing authority like QTC.
It is understood several other state governments are examining the technology which can increase probity given the blockchain provides an irrevocable date and time stamp for all bids and provides a clear record of all allocations.
Sophie Gilder, the head of blockchain at CBA, said the semi-government bond market is a "very opaque market, and there are many intermediaries required to bring a deal to market. There are a lot of steps, most of which the market doesn't see. We wanted to explore building an entire market place in digital form. What we have done with this experiment is prove the use and effectiveness of the technology."
CBA's development team created the bond using a "smart contract" to manage the transfer of ownership (which is automatically updated if the bond is sold in the secondary market) and to automate coupon payments. This eliminates the need for someone in a back office to manually process payments.
The technology also creates a more transparent bookbuild for the issuer, CBA said. Under current processes, potential state government bond investors dial in their orders to a salesperson in the bank managing the deal. Depending on their banks' systems, the order might be entered into multiple places.
But CBA's blockchain allows investors directly to enter their bid ticket directly into the blockchain via a simple interface. Throughout the process, the issuer sees the live bids in real-time and at the end of the tender, the issuer sees all bids by price and volume at each level. When they push a button to allocate at the best price for which they have sufficient volume, the system settles automatically, transferring ownership right away and facilitating payment at exactly the same time.
Because it has been designed as an "atomic transaction", both title and payment is made at exactly the same time or neither occurs – the title cannot move without the payment.
"That is a huge benefit because you don't have to worry about settlement risk any more – it is instantaneous and it is binary, it either happens or doesn't," says George Confos, CBA's executive general manager of business and corporate finance. "Mundane, manual processes prone to error just disappear."
The debt capital markets blockchain could also be used for other relatively illiquid debt instruments such as syndicated loans, which could help banks manage risk and boost liquidity in that market.
Before blockchain technology is rolled out to real deals in the capital markets, it will need to be approved by the Australian Prudential Regulation Authority, Australian Securities and Investments Commission, Austrac and the Reserve Bank of Australia.
CBA is planning to discuss its experiment with these regulators over the coming months.
Mr Confos said he expected the technology would appeal to them because by giving them a "node" to the blockchain, regulators will be able to more closely monitor buying and transfers of assets. He said the technology could increase liquidity and the amount of debt capital raised in the future.
"If [regulators] want the Australian debt capital markets to grow this is a step in the right direction," he said. "We hope it will lead to larger growth in the market, because issuance will not be the painful process it has been."
Grant Bush, the deputy CEO at QTC, which both issues debt for the Queensland state and local government and invests cash for them, said QTC is "looking at the long-term implications of the technology as a semi-government issuer and broader market participant" and the collaboration with CBA and other stakeholders "is proving to be extremely useful".
CBA created a digital currency to facilitate the payment for the bond through its blockchain, and Ms Gilder called on the RBA to consider issuing a digital version of the Australian dollar, which she said would provide the market with more confidence.
"For the blockchain to recognise its full potential as an asset register and a payments mechanism, you need a blockchain-friendly form of currency," she said. "In the future, we would hope the RBA will look at issuing a centrally issued, blockchain-friendly digital currency, which would help because then the currency would be exactly the same as a fiat currency dollar in your account today just in blockchain form."
The central banks of Canada, the United Kingdom, Singapore, China, Denmark and South Korea are all considering whether to issue new digital currencies to assist the rollout of blockchain in those jurisdictions.
The private, "permissioned" blockchain has been built in CBA's innovation lab in Sydney. In future, the "nodes" of the network could be in the offices of issuers, regulators or investors.
CBA created a private version of the Ethereum smart contract technology but says it is not wedded to using Ethereum and is also experimenting with other technology.
Ms Gilder said smart contracts would not replace the entire legal documentation for bond issuance because computers are not adept at tests that require human judgment, such as determining force majeure events in contracts. "But what computers are good at is performing clear tasks where the parameters are absolutely black and white," she said – such as issuing the coupons.
Mr Confos said it is hard to determine when new technologies will come to market but he said momentum for blockchain was strong.
CBA says it is continuing to work closely with several institutional clients across a variety of industries – across logistics, government, commodities and financial institutions – to explore how blockchain can improve trust, security resilience, transparency, efficiency and user experience in payments, capital markets, international trade, and particular use cases in both the public sector and particular industries.
- Commonwealth Bank
Unable to follow, try again
- James Thomson