Next stop: a bond that pays coupons by the second
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People and MarketsCommentP&M Notebook

Next stop: a bond that pays coupons by the second

The simple way to turn on a light

The pace of technological change in the bond market is picking up

Tech evangelists within banks have some grandiose ideas about what new innovations such as distributed ledgers will be able to achieve in the bond market, such as automated securities that react in real time to external data.

Even a debt capital markets banker with no idea how blockchains work should be able to grasp the implications of such a feature. Imagine a bond where the coupon adjusts instantaneously in response to a credit rating upgrade or downgrade, a shift in a company’s leverage ratio, a sustainability metric or even a weather forecast.

But while there is clearly something cool about these possibilities, they are also somewhat mind-boggling.

A reassuring thing about a fixed coupon is that, assuming the issuer remains in a position to meet its obligations, a bondholder knows in advance exactly what a bond will return. Why introduce more uncertainty?

And yet, long before the advent of programmable securities, there were already notes with step-ups, step-downs, waterfalls, cash sweeps, payment-in-kind toggles and other whizzy bits and bobs triggered by specific events. There is an appetite for this kind of innovation in some corners of the market.

At the very least, automated bonds will call into question the role of trustee and administration service providers, calculation agents, paying agents and so on who typically handle the mechanics. Eventually, this may extend to bookrunners, too.

'Crunchy' capital markets

If this all sounds a bit overwhelming, DCM professionals can take solace in the fact that they are working in a field that has historically been resistant to change. As some tech promoters frustratedly point out, the way bonds are sold has changed very little since the invention of email. Raja Palaniappan, co-founder and CEO of the fintech firm Origin Markets, has put it down to the “crunchy” nature of capital markets.

In the first instance, this can be explained with reference to the kind of regulatory friction that is still holding back the sustainability-linked bond market in certain areas of bank capital. But even when a new kind of security is given the green light, it needs to gain broader acceptance in the market, especially among the investors who will be expected to buy it, which is no cake walk.

So bonds that pay their coupons on a second-by-second basis are probably still a way off.

Nevertheless, the banks, always looking for a competitive advantage, are working hard to find one, knowing that when the brave new world finally appears, it will pay to have brought your own map. Better yet, they could help to shape the landscape as it emerges.

Lab work

That’s why banks like Santander and NatWest are performing experiments with emerging technologies like Fnality International’s distributed ledger payment system.

Santander has been toying with blockchain since 2016, when it hired cryptocurrency expert John Whelan to run its blockchain lab from Madrid. The Spanish firm has been involved in many digital capital markets milestones. NatWest created a new digital capital markets team this year and put head of flow credit, Chris Agathangelou, in charge of it.

But sources in the world of fintech say that banks' innovation teams are not all created equal, suggesting that some may be window dressing.

In this respect, technological innovation has a lot in common with sustainability. In both cases, industry sources say that whether bankers treat the issue seriously or purely as a marketing ploy depends on the attitude of the leadership at the top of the firm.

Perhaps it is therefore telling that Ana Botín, the executive chair of Santander, wrote a personal message on LinkedIn after last week's test of the Fnality system, affirming that distributed ledger technology was “indeed interesting”.

“[L]ots of people have been thinking about how it could be used to make finance more ‘efficient’, faster, cheaper and involving fewer intermediaries. Particularly here at Santander,” she wrote. “It should not be surprising that we were also the first to conduct an end-to-end bond issuance on a public blockchain two years ago.”

As in innovation, so in ESG: leaders can't expect the rank and file to do all the heavy lifting spontaneously, but should take an active interest.

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