Tokenisation: The next frontier for investing?

What do a €100 million 2-year eNote issued by the European Investment Bank (EIB) in 2021 and a €60 million 1-year bond issued by Siemens in 2023 have in common? And – more to the point – why are such tiny deals noteworthy when viewed against the trillions of dollars of bonds already in existence in the highly liquid global public bond markets?

The answer is that both are among a handful of ground-breaking trades said to be paving the way for an eventual revolution in the global economy, one in which traditionally closed markets may be opened up to a far wider pool of investors than ever before. Both are blockchain-based digital bonds, underpinned by the concept of tokenisation: a token being a digital unit of value representing a share of an asset.

“There remain substantial barriers to a wider democratisation of markets.”
 

While a blurring of lines between private and public markets and between institutional and retail investors has been a significant trend in recent years, there remain substantial barriers to a wider democratisation of markets. According to Stephen Coghill, head of Quantitative Analytics in M&G’s Private Fixed Income team, the ultimate impact of tokenisation is expected to be greatest in private markets, where there is currently little or no liquidity and a reliance on inefficient paper-based assets. However, there have already been some early moves in public bond markets to trial the new technology too.

Digital pioneers

The EIB has been leading the way among supranationals. Its €100million eNote – its first blockchain-based bond – was issued under a French law that facilitated the registration of digital securities.

Meanwhile, Siemens’ announcement that it was to issue a short-dated, small-sized blockchain-based digital bond felt appropriate for a company that prides itself on its pioneering spirit since its foundation in 1847. The company, one of Europe’s largest and possibly oldest industrial manufacturers, issued its bond on a public blockchain, or digital ledger platform, called Polygon that had been set up by a group of engineers in Mumbai in 2017.

Software coding creates a series of smart (automated) contract capabilities to handle secure and decentralised transactions. It facilitates direct bond offerings to investors without the need for a traditional financial (‘TradFi’) institution or central clearing.

The absence of a ‘digital euro’ means that investment in Siemens’ new bond, and coupon payments, involves classic bank transfers for now – the transaction is not fully digital yet. The bond has a mechanism for peer-to-peer trades on Polygon. If the digital ledger is not operational for any reason, Siemens can switch the entire bond to another digital ledger, or replace the digital bond with a traditional (‘analogue’) bond, or call the digital bond without bondholder consent.

Unlimited potential

One of the main reasons why the finance industry has started to take proper notice is that any asset can effectively be tokenised – from more readily-traded funds, bonds, stocks, real estate and commodities, through to assets such as fine art and intellectual property.

This ability to create fractional amounts of assets that can be traded with ease opens up historically tricky assets to a wider investor base than has been the case previously.

Tokenisation creates an immutable, digital record of ownership on a blockchain. Furthermore, tokens can be customised through smart contracts to better reflect the underlying assets. For example, in the case of a real-life bond, there would be a smart contract between the bond and the token that includes information about the underlying bond: if the bond can’t be traded for two days ahead of a coupon payment, this would be built into the digital asset. This means that the full life cycle of the bond is reflected through its tokenisation.

Once created, tokens can be traded near instantly between parties at any time of the day or night. It allows faster settlement and lower costs of trading. The result is that significant operational efficiencies can be achieved for issuers by eliminating manual processes and certain intermediaries. 

“Once created, tokens can be traded near instantly between parties at any time of the day or night.”
 

In future, once central banks have fully launched digital currencies, payments can be automatically paid through to an investor’s digital wallet, cutting out intermediaries such as brokerages, custodians, clearing houses and potentially the banking system itself, although this remains some years away at present. 

Steaming ahead

It is still too early to tell who will be the winners and losers from this revolution, although traditional intermediaries clearly see the direction of travel and are among those trialling new technologies. Nevertheless, the industry overall has only taken baby steps so far, with individual players carrying out their own pilots across a range of different technologies and approaches.

A good analogy here is the early development of steam engines and railways in the UK in the 19^th century. During this period competing engineers developed their own lines with little thought about how a network of interconnected lines would eventually come together.  

From a technological and regulatory perspective, Singapore is probably the most advanced market to date through its development of its ADDX platform. This is a private markets investment platform that lets individuals invest from as little as US$10,000 in unicorns, pre-IPO companies, hedge funds, and other opportunities that traditionally require minimum investments of millions of dollars. ADDX is regulated by the Monetary Authority of Singapore (MAS) and is open to all non-US individual accredited, corporate accredited, and institutional investors.

In Europe, a number of countries including Germany, France, Switzerland and Sweden have been making progress in developing legislation that will determine how tokens reflect the underlying currency. As well as its €100million 2-year eNote, the EIB has sold a number of other issues denominated in Swedish krona, sterling and euros. The inherently reduced liquidity of these issues means they only work as a buy-and-hold strategy and have so far largely been sold to local investment managers. 

The UK and US, which have both been more focused on cryptocurrencies to date, are currently lagging behind. However, the Bank of England and the Treasury are currently exploring the possibility of a ‘digital pound’, and this is likely to change in the coming months as the revolution gathers pace.

Meanwhile, in November 2023, UK asset managers were given the greenlight by the Treasury to develop tokenised versions of their funds after achieving government backing for a push to experiment with the blockchain technology.

This article is based on a blog published on Bond Vigilantes by Miriam Hehir, Director of Credit Research and first appeared in the inaugural edition of Ampersand. For more insights, visit www.bondvigilantes.com.

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.