The digitalization of capital markets and boosting bond market efficiencies
Managing Director and World Bank Group Chief Financial Officer
This post originally appeared on CSI.co
Since its creation in 1944, the World Bank has issued bonds to raise funds from private investors that have mobilized close to $1tn for sustainable development projects and programs in middle-income countries.
But while both the World Bank and the banking industry have changed over the past several decades — a period that has included a technology boom our founders could never have imagined — the process for issuing, settling, and servicing bonds has stubbornly remained the same.
Two separate but interconnected developments that have emerged over the past decade have the potential to change that. Distributed ledger technology (DLT) and central bank digital currencies (CBDCs) could mean a huge improvement in access to finance for our member countries through increased efficiency, lower costs, and reduced operational and credit risks — and bring the bond industry squarely into the 21st Century.
At the World Bank, we have been researching and experimenting in this space for several years. DLT is already in use in several projects to better record, track, and maintain data in fields ranging from health to education and agriculture supply chain. CBDCs are in various stages of research, development, pilot, and launch in more than 100 countries.
These technologies hold great promise, for many reasons. The processing of bond payments today is complex and can take several hours, especially in the case of cross-border payments. Consider the case of a bond investor who does not see their account credited with the expected interest amount. Even if the issuer has taken the necessary steps in a timely manner, problems at any of the intermediary parties — the issuer’s correspondent bank, the paying agent, the clearing system, the custodian, or the correspondent bank of the investor — could create a bottleneck in the entire payment process.
It can be difficult for any single party to know which step in the payment chain is causing delays, and resolution requires continuous follow-up with each of the many stakeholders. The use of CBDCs can potentially cut down processing times for domestic and cross-border payments, leading to faster settlement and reducing credit risk in the markets.
All of this has applications for the World Bank’s middle- and low-income member countries. Very few developing countries have well-functioning debt capital markets because of the market infrastructure required : the establishment of central clearing systems, securities custodians, calculation agents, rating agencies, and the development of a securities-trading and risk-taking culture at local banks.
Digitalization could enable developing countries to leapfrog some of this and make strong debt capital markets a reality. The use of CBDCs can enable faster payments at lower cost with tangible benefits in cross-border remittances and can facilitate payments in conflict situations.
As with any new technology, digitalization in the capital markets and payments space carries risks that require detailed analysis and mitigation. As many of these center around technological and legal issues, any solutions must comply with domestic and cross-border legal and regulatory standards. Several governments and central banks are currently researching, reviewing, and piloting projects to develop relevant laws and policies.
Digitalization in the bond markets appears inevitable — and there are signs of increased momentum. The World Bank’s successful issuance, servicing, and redemption of a 2018-2020 blockchain-backed Australian-dollar bond spurred many other issuers to experiment with the technology to demonstrate proof of concept. A common challenge identified across many of these issuances has been that they required significant investment of time, money, and effort to create one-off platforms.
At the World Bank, we have long believed that it is important for these efforts to be replicable and scalable. Our latest inaugural issuance of a €100m fixed-rate digital bond on Euroclear’s Digital Financial Market Infrastructure (DFMI) is an important and innovative first step in that direction. A pre-eminent International Central Securities Depository (ICSD) system, Euroclear provides critical financial market infrastructure for issuers and investors across the globe. This first issuance paves the way for other capital markets participants to reap the rewards of digitalization.
The World Bank has long been at the forefront of innovation in capital markets — as the first issuer of a global bond and a green bond, and through our issuance of outcome bonds. Through this first issuance of a digital bond on Euroclear’s DFMI, we are excited about the prospect of digitalization in capital markets and the many benefits it offers for our member countries.