SSAs to spur digital evolution of bond market
After years with little in the way of technological improvements, momentum is finally building behind several projects that could reshape primary capital markets. These systems will undergo their first tests in the SSA market. Intriguingly, the winner could come from either the public or private sectors. Burhan Khadbai reports
Innovation in the debt capital markets begins with public sector borrowers. The digitalisation of the bond market is no exception. Sovereigns, supranationals and agencies are kick-starting initiatives to transform the processes of issuing bonds.
One of the most ambitious project is the European Distribution of Debt Instruments (Eddi), which aims to create a one-stop shop synchronised platform for selling euro bonds and handling everything from bookbuilding to settlement.
The European Central Bank is developing Eddi, in conjunction with five of the best-known borrowers in the euro public sector bond market — the European Stability Mechanism, the European Investment Bank, KfW, Bank Nederlandse Gemeenten and the Council of Europe Development Bank.
Kalin Anev Janse, chief financial officer at the ESM in Luxembourg, is a key supporter of the Eddi project, believing there is a big opportunity for a homegrown solution to catapult Europe’s debt capital markets into the digital age.
“The biggest problem is that there is no pan-European, neutral and harmonised channel for the issuance and distribution of euro debt,” he says. “Instead, there is a considerable amount of fragmentation. Eddi would help overcome this problem.”
Eddi aims to cover both ends of a debt transaction. The pre-issuance component would offer functions to support an upcoming debt issue through the creation of an order book, the collection of orders and the allocation.
Once allocations are decided, participating central securities depositories (CSDs) would distribute the bonds simultaneously using the ECB’s TARGET-2 Securities settlement infrastructure.
Eddi’s post-trade component is its unique selling point. Unlike the dollar bond market, in which the majority of bonds are settled through one system — the US Federal Reserve’s Fedwire — there is no single mechanism in the eurozone bond market.
Another unique feature of Eddi is that it is creating the first public sector-backed debt issuance platform.
“We are not commercially-driven,” says Janse. “Eddi is a public non-profit initiative. It comes closest to a fair and neutral set up, led by the ECB and eurosystem, with European data on government and SSA debt in European hands. When and if this is developed, it will be truly disruptive as a technology, which will be beneficial for all the stakeholders in European bond transactions, for the euro and the CMU [Capital Markets Union].”
However, a number of concerns have been raised with Eddi.
In response to the ECB’s market consultation on Eddi, the International Capital Markets Association identified 12 issues, including a perceived conflict of interest with the ECB running Eddi, with the central bank being the largest holder of euro bonds.
“The big question is whether the perceived benefits of Eddi, post-trade and pre-trade, are worth the likely cost and disruption for market participants,” says Leland Goss, ICMA’s general counsel in London.
Investment banks also voiced their criticisms of Eddi, saying that the private sector already has solutions to the problems in the primary bond market and that Eddi should instead focus on the post-trade aspects.
The ECB’s governing council is expected to make a decision on whether to approve Eddi in 2020.
Private sector platforms
One private sector initiative that is being developed is agora, which is creating an end-to-end digital platform to cover the entire life of a bond from the pre-mandate stage, through execution, pricing and primary settlement until final redemption.
Agora, co-founded by bond market veteran Charlie Berman, aims to connect issuers, arrangers and multiple service providers such as custodians, central securities depositories and paying agents to a single channel. This will enable them to share and distribute information during the process of issuing a bond using digital ledger technology.
“I joined Salomon just after they joint led the first global bond in late 1989, which was for the World Bank,” says Berman, chief executive of agora. “The structure was heavily driven by the issuer and I would argue that was the last time we had a significant change in the nuts and bolts of how bonds get done. It took until the mid-1990s before this huge innovation was generally accepted and adopted.
“About 18 months ago, I started to seriously think about how distributed ledger technology could be applied and make a meaningful impact on capital markets. Few front office people have had the time to immerse themselves and understand what the new tech can do. The response I have got from the Street was amazing and very positive.”
Berman says, when mapping out the process of issuing a bond, he found the market is composed of a series of linked deep subject matter experts performing critical and interdependent functions.
“Many of the functions are enshrined in statutes and extremely heavily regulated,” he says. “Its pretty pointless to try and introduce tech that bypasses the incumbents but can’t then be utilised. Our approach is to work with the existing stakeholders to develop solutions that they need and will embrace and adopt.”
In November, agora closed its initial seed funding round with contributions from a small group of individuals, including Michael Spencer, the founder and former CEO of interdealer broker Icap, which later became Nex Group.
The timeline for launch is “weeks and months, rather than months and years,” says Berman. “We are starting with SSAs as that’s where innovation begins, closely followed by banks as issuers and ultimately even less frequent issuers will benefit from the improvements.”
The private markets too are ripe for digital innovation. DZ Bank launched Ingen, a medium term note (MTN) platform in 2019.
“At the heart of InGen we have a database that we make available to investors to search through around 400,000 structured private placement opportunities from over 200 issuers in euros and dollars,” says Friedrich Luithlen, head of debt capital markets at DZ Bank in Frankfurt.
“So for example, an investor hooked to the system can input that they’re looking for a triple-A product in euros, an SSA or covered bond for ‘x’ amount with a specified schedule including call rights.”
He adds: “Then it takes half a second to bring up the top 20 picks within that criteria based on the highest yields. We have currently 30 institutional investors on board who are using the system actively. There has been nice traffic since we launched in the summer.”
Trades cannot be completed on the platform, so investors are still required to call DZ’s sales team.
DZ is also a partner in the European private placement facility (EPPF), which in 2019 was used to place the first “smart n-bond” for Bank Nederlandse Gemeenten in a move that was seen as a step towards a functioning pan-European private placement market.
The €10m three year bond pays a coupon digitally, without the exchange of paper. All documentation on the new system is fully machine-readable and standardised.
“It was the first electronically settled NSV [Namensschuldverschreibung],” says Bart van Dooren, head of funding and investor relations at BNG in The Hague “It makes life easier on the documentation side.”
Using EPPF’s platform, issues are given an Isin code like any other security. This means some investors, who previously could not buy NSVs (or Schuldscheine) owing to regulations around purchasing loans, are now able to participate.
The market will largely be used for well-rated western European borrowers, according to people familiar with the strategy.
New role for banks
As the bond market goes through a digital evolution, investment banks will find their roles redefined.
“The primary market has, relative to other parts of finance, remained a fairly manual process with some speculation that it is ripe for a digital transformation,” says Goss. “So the elephant in the room is whether there will be at some point a disintermediation of banks from the new issue process. However, the view from at least some frequent official borrowers is that for the foreseeable future there is a desire to have bank syndicates as they provide a valued range of services.”
“Issuers need the expertise from banks,” says Luithlen. “That is delivered through the syndication process. What we as syndicates are providing is greater execution certainty amid the political uncertainty from Brexit, trade wars, etc. We further bring critical flow knowledge from secondary markets and our discussions with investors to the table. Finally, we put our own skin in the game and help trades across the line if the market is underwhelming on a given day.”
BNG’s van Dooren agrees on the importance of investment banks in the syndication process.
“We are based in Hague and don’t have branches all over the globe to collect feedback from investors such as those in Asia to see what they’re after, whether that’s 10 year euros or two year dollars,” he says. “This is information we get from investment banks and therefore the role of syndicates is important.” GC