December 6, 2021


Skillful Business Crafters

The First Digital Bond Issued In A Regulated Market By The Swiss Exchange Points To A Need For Standards

Momentous events do not appear to be significant when they happen. Scarcely anyone noticed when the bitcoin paper was uploaded to the cypherpunks mailing list back in 2009. Now, it has spawned a few new industries and shaken up many established ones. Similarly, the release of the first digital bond in a regulated market announced by SIX yesterday did not cause any significant waves. Of course, it is unfair to compare the effects of the release of a homegrown piece of code by a lone wolf to the actions of an institution like the Swiss Stock Exchange. However, both are linked through the data-structure called the blockchain.

The bond market is relatively staid, however it does not lack drama, such as the Argentinian sovereign default and its attendant tussles or the near destruction of the global financial system by bonds backed by US sub-prime mortgages and now a digital bond. Bonds are considered a safer bet as the seniority of bond debt makes them less risky. The Capital Markets factbook by SIFMA for 2021 states that the outstanding value of global bond markets outstanding value increased by 16.5% to $123.5 trillion in 2020, while global long-term bond issuance increased by 19.9% to $27.3 trillion. Contrast that to the global equity market capitalization which increased by 18.2% year-over-year to $105.8 trillion in 2020, mostly fueled by increases in stock prices. Yearly bond issuance dwarfs the issuance of equities. Equities are a perpetual instrument, while bonds have a term and often pay a recurring or built in coupon. Equities are high risk, high return whereas most bonds are low risk, low return.

A press release from the Swiss Exchange dated November 18, states that SIX placed the first senior unsecured digital CHF bond with a total volume of CHF 150 million which mature in 2026. The bond is doubly innovative because it consists of two exchangeable parts linked together. The digital part (Part A) of the bond for CHF 100 million and the traditional part (Part B) of the bond for CHF 50 million. Each is meant to be traded and held in different structural sub-organs of the exchange. The coupon amounts to an anemic 0.125% per year. This is par for the course for bonds, a safe instrument, it was heavily oversubscribed. In effect, the returns are negative if you take inflation into account; in that it is better than cash. The net proceeds of the bond will be used for the general financing purposes of SIX.

The DLT used is R3’s Corda. Corda is not a blockchain according to many including its CEO. Under the covers, Corda is backed by a micro-ledger, a mini blockchain. This bond issuance is a test run for the SIX Digital Exchange, a manifestation of the SIX mandate to operate infrastructure services.

In digital bonds, for trading, for custody, for post trade operations and processes, standards matter. Bonds cannot be said to be fully digital until the common operations can be automated and digitized. Calculation of coupon payments and value underpins risk analysis and secondary markets, which operate on price depend on bond attributes. A lack of standards bedevils the bond world. Costs mount for institutions who create their own infrastructure to define, value and track bonds. Primary and secondary market valuations often rely on commonly used infrastructure like Bloomberg. This is natural for instruments that have evolved over hundreds of years, if not thousands. Standards development organizations such as the InterWork Alliance (IWA) are important in the digital context.

Now known as IWA, a GBBC project; IWA started its life as the Token Taxonomy Initiative (TTI) inside the Enterprise Ethereum Association (EEA). The DNA of the EEA is Ethereum and its rich suite of de facto token standards. These de facto standards created a revolution in alt-tokens and created DAOs, DeFi and an explosion of NFTs. This revolution is now spreading to other public and private blockchains. TTI created The Token Taxonomy Framework (TTF) which is open sourced on github. TTF defines a set of basic building blocks of a token language as well as the crystallization of this language in a specific type of bond. This token language is spoken in a platform neutral way. In other words, the token can be built on Solana, on Hyperledger Fabric, on Polychain, on Polkadot as long as the token and its interface and attributes can be implemented. The token behaves in a strictly deterministic way. It is also possible to reason about the value of the token, as well as deal with negative emergent events with built in circuit-breakers and other guard-rails.

The basic definition of any TTF digital token is expressed using a short token formula. From this token formula, artifacts from the code for templates of functions to business functionality documents are generated. This ensures that everyone, from technologists to business users to compliance folks, work from the same functional specification. These are standards for the modern age, that contains tooling to generate all the artifacts that hang together, including a visual representation of a token. A series of purpose built artifacts all generated from a common token formula. A digital token is the base of an ecosystem that for any instrument also consists of contracts between counterparties and analytics built on the interaction between the token and the contracts, thus creating what is in effect a multi-party system that powers the lifecycle of an instrument. This is the key to digitizing instruments such as bonds that have existed since the Mesopotamian times.

This realization led to the creation of the Inter Work Alliance based on the TTF, delinked from the EEA. So far, the story has a through line that arouses skepticism in people who have been battle-hardened by working in Capital Markets tussling with the broken and fragmented financial market infrastructure. This is a real challenge for adoption by business types in traditional finance. A certain amount of skepticism, a healthy suspicion of blockchain which many associate with Bitcoin, and a sense of deja vu stymies adoption. The merger of IWA with the Global Blockchain Business Council addresses this issue head-on. GBBC, founded by the indefatigable Sandra Ro, is one of the most influential Blockchain Industry associations with more than 350 institutional members and 70 jurisdictions. The GBBC along with the World Economic Forum had already started on a survey of Blockchain standards called GSMI. The natural next step for GBBC, is to partner with an organization who has a pedigree in standards development. The merger between the IWA and GBBC was announced in September and completed recently.

In the meantime the IWA has not been idle. The sustainability working group has been the most active and have created token standards to track the various forms of the voluntary emissions market. This market based approach covers both emission allowances and carbon offsets and tackles the top-of-of the mind topic brought to the fore by COP26. These sort of initiatives may help humanity escape the “blah-bah-blah” mentality that constrains us. A market based approach cannot work if emission allowances are huge and carbon offsets are priced low. Of course the pricing of these offsets have to be prohibitive and traceable for the world to escape the singularity of a greater than 1.5 degree rise in average global temperatures since pre-industrial times.

The standard for digital bonds, when a simple formula fans out into an implementation that every party on a multi-party system can agree on and automatically generates a variety of tools for creating and monitoring bond behavior in a platform neutral way, with extensions to price and risk manage digital bonds, creates cost efficiencies. Bringing down the costs will democratize the investment landscape and make participation more decentralized. Further, viewing the bond through the prism of standards, unlocks the possibilities for new behaviors and new products. Thus revolution and evolution are unleashed through standards. A new working group has been reanimated inside the IWA to look at debt capital markets. This group is composed of both traditional players and new actors with all the tools of the TTF at their disposal. Suffice it to say that the creators of the latest digital bond are active in this group. GBBC is poised to guide and amplify that standard and take it to many enterprises and jurisdictions.