Tokenisation of Bonds in Hong Kong: a recap on lessons learned

Following on from that pilot project, known as Project Evergreen, we worked with the Hong Kong Monetary Authority (the HKMA)  on its report, ‘Tokenisation of Bonds in Hong Kong’, which discusses the design and issuance considerations, including platform design, deal structuring, and legal and regulatory regimes.

Project Evergreen showed the potential for DLT to generate various efficiencies for bond issuance, including paperless creation that removes the need for a physical global certificate, and easier interactions between parties on a common DLT platform.

Here we explain certain key points and summarise lessons learned by applying the technology to a real transaction. 

Settlement

In Project Evergreen, DLT was used throughout the bond lifecycle, including in primary issuance, settlement of secondary trading and coupon payment, and it will be adopted for maturity redemption as well.

Settlement can be done instantly and simultaneously on an atomic DvP basis, reducing settlement delay and settlement risks associated with conventional bond issuances, while the use of end-to-end DLT across the bond lifecycle substantially reduces multiple manual processing, lowers servicing time and costs, and removes the need for synchronisation between different channels.

Technology and platform design

There are various options set out in the report in respect of technology and platform design, which interested issuers may take into consideration. These include identifying the appropriate network type, participation model and data visibility of transactions and holdings, and the performance and scalability of the DLT network.

Deal structuring considerations

The deal structuring considerations associated with digital bonds for potential corporate issuers fall into four categories: securities leg, payment leg, settlement finality, and other considerations. These are covered in detail in the report, but we will highlight a few important matters:

• In relation to the securities leg, the type of issuer will affect the analysis. A potential issuer that is a corporate incorporated in Hong Kong would be subject to various requirements under the Companies Ordinance. The corporate would need to consider issues such as requirements to keep a register and to take precautions to guard against falsification if the register is not kept in a bound book.
• In a digital bond issuance, the bonds can be issued directly on the DLT platform in a ‘native’ issuance, or first issued off-platform and then tokenised in a ‘non-native’ issuance. Project Evergreen adopted the non-native approach, but there are different implications depending on which approach is taken.
• Turning to the payment leg, payments can be made on the DLT platform or off-platform with fiat cash. Again, the two approaches have different implications, with the traditional fiat payment process offering advantages such as stability and familiarity, while payment in the form of central bank digital currency, or a digital token, could offer a faster and simpler process.

Other considerations will include custody arrangements. Options include holding the digital bonds through self-custody, which offers investors more direct control, autonomy and privacy over their digital bonds and tokens, or holding through traditional custodians, which may provide more convenience and familiarity.

Finally, having a business continuity plan in place is important to address the potential risks of the digital platform, specifying the steps to be taken by the platform operator and other parties in the event of a DLT platform disruption or failure.

Unlocking the potential of DLT

There is a clear conclusion in the report that tokenisation could significantly improve efficiency and transparency in bond markets, and Project Evergreen has successfully demonstrated the potential for deploying DLT to real capital market transactions under the existing Hong Kong legal and regulatory framework.

It will now be interesting to explore the applicability of the learnings from this pilot to different platforms, currencies, issuance formats and asset classes. Allen & Overy has already been looking into different tokenisation structures across different jurisdictions and we look forward to continuing to develop new and innovative solutions with our clients.