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Race for first European blockchain bond nears finish line

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By Lewis McLellan
17 Aug 2017

A new platform expects to host the first European bonds to be issued on a blockchain in September.

BlockEx, which was founded in 2014, launched a cryptocurrency trading platform this week, allowing investors to trade Bitcoin and Ethereum. 

Unlike most such platforms, users of BlockEx will have to go through the same know-your-customer (KYC) and anti-money laundering (AML) procedure as they would if they wished to trade any regulated instrument.

However, it is working on providing a host of other financial instruments via blockchain and, in September, will execute the first genuine primary issuance of a bond to take place on the blockchain. The debut issue is likely to be small in size, and semi-private in distribution — but will deliver real financing to a borrower that needs the money.

Other platforms, including SIX Swiss Exchange, Commonwealth Bank of Australia and LBBW have issued fixed income instruments using the technology, but these have been proof-of-concept issues, rather than real financings.

Blockchain, or distributed ledger technology, is a form of computer network in which all information is stored on each computer (or node) within the network, rather than on a central server.

Blockchains are transparent and immutable, meaning that users (and crucially regulators) will be able to see the complete history of each transaction that takes place on the network.

James Godfrey, a former head of credit trading at Mizuho and Nomura, has worked at BlockEx for seven months as managing director of capital markets.

While distributed ledger technology and cryptocurrencies remain all but unregulated for the moment, BlockEx works within the UK FCA’s 'sandbox' for fintech firms and functions as a point of reference for the regulator. 

This means that BlockEx is able to anticipate to some degree the requirements that the regulator is likely to impose. “We’ve got an idea of where things should be going and are working within that,” said Godfrey. “We’re the first people to build a platform from scratch that treats the cryptoproducts as regulated instruments.”

BlockEx will operate a private blockchain, rather than a public one (like BitCoin) that allows anyone access.

By issuing bonds on blockchain, borrowers will, according to Godfrey, save a great deal of time and money. BlockEx provides an automated service for producing documentation, allowing potential borrowers to tailor a standardised format to meet their needs, although Godfrey acknowledges that the system cannot cover every variable.

The docs are then submitted to BlockEx and checked by a legal team.

Investors then buy the bond through a blockchain or distributed ledger. Settlement takes place almost immediately, rather than after the customary five day period. Godfrey believes that this system negates counter-party risk. “Trades cannot take place without both the cash and the asset on the system,” said Godfrey.

Payment flows on the blockchain will be executed by "smart contracts", computer protocols that execute provisions of the documentation. 

Formalising documentation, particularly in a form that can be executed by smart contracts, is an immense challenge, though Godfrey believes that BlockEx has “done all the donkey work” and is “weeks, not months” away from adding other instruments including syndicated loans and commercial paper.

ISDA and Linklaters published a paper at the beginning of August, discussing the challenges to formalising derivatives documentation in a way that could be executed by smart contracts. Lawyers agreed that the derivatives market was ideal for introducing smart contracts because it already makes use of ISDA’s shared documentation and definitions, unlike the bond market, which has a plethora of contractual legal forms dependent on various market conventions.

BlockEx will charge £70,000 to issue a £10m two year bond, plus an annual subscription charge of £5,000.

Godfrey says there are already a number of trades in the works.

Cryptocurrency trading and bond issuance are merely the first stages of BlockEx’s ambition. It intends to offer a derivatives trading platform and a platform for initial coin offerings to be launched.

Initial coin offerings (ICOs) have enjoyed a remarkable boom in popularity. Tech start-ups create a run of tokens registered on a blockchain, then sell them to investors. The Securities and Exchange Commission published in late July a report indicating that tokens sold in a May 2016 ICO should have been registered as securities under the Howey Test.

BlockEx is apparently working on structures for hosting ICOs that will be compliant with regulatory guidelines. Filecoin, which was sold on Coinlist last week, demonstrated one possible route by restricting the sale to accredited investors. This meant, under Reg D 506, that it did not have to be registered as a security.

Godfrey believes that BlockEx will ease the road for smaller borrowers to access capital market funding.

BlockEx is not intended to cut out intermediaries. Investment banks will be able to bring issuers and investors together, performing their advisory and origination roles but execute the transaction on BlockEx’s platform. 

“Syndicate desks will still have a role with BlockEx, albeit a slightly different one,” said Godfrey.

BlockEx will soon be offering 10% of its equity for £20m.

By Lewis McLellan
17 Aug 2017