Blockchain bonds- when the world is not enough

On 24th August the International Bank for Reconstruction and Development or IBRD, an arm of the World Bank, issued a small tranche of AUD 110m bonds or notes (i.e. short term bonds), governed by New South Wales law, under its long standing Global Debt Issuance Facility. Given its massive c.50+ billion USD annual debt issuance appetite, this was a relatively small amount for the World Bank to raise. However, as the “world’s first bond to be created, allocated, transferred and managed through its lifecycle using distributed ledger technology” i.e. using block-chain, this is also arguably one of the most significant bond issuances by the World Bank, and one of the most important foreign currency bonds issued since Autostrade’s pioneering first fixed rate Eurobond in 1963. 

This is a great achievement for the World Bank and its broader team, and potentially ushers in a new era of publicly traded blockchain bonds and related financial instruments, that may well become the normal approach, as technology and software progress.

The World Bank had already signalled its interest in applying blockchain technology to help reduce costs and increase efficiency across the spectrum of its development activities, in various in-house publications and by setting up its own blockchain research lab. Similarly the Commonwealth Bank of Australia (CBA), which was a driving force as arranger of the bonds, has been experimenting with blockchain for some time at its Sydney Innovation Lab and Blockchain Centre of Excellence. In fact the CBA had already tested its blockchain platform for a 2017 prototype non-tradeable “cryptobond” (akin to an experimental cryptocurrency) for Australian state issuer the Queensland Treasury Corporation, using a private Ethereum blockchain system, and  in particular testing the cryptobond’s book-building process before issue.

The Final Terms for the new World Bank "Kangaroo" (AUD) “BONDI” bond (i.e. “Blockchain Operated New Debt Instrument”)  were for short-term 2 year maturity notes, denomination size AUD 1000 per note, paying 2.2% interest per year semi-annually. This would mean a small number of payments, 4 interest payments and 1 principal payment  to each note holder over its life. 

Similarly, the bond seems to have been designed for sale to a small number of sophisticated institutional investors rather than for the broader retail market, limiting the expected number of holdings and transactions over the bond's lifetime. 

The Final Terms included a number of additional blockchain-related Risk Factors that “distributed ledger technology is comparatively new and untested” and  brought new but known risks such as cyber-attack, denial of service attack, potential software errors, theft, loss or compromise of the underlying Platform for the distributed ledger, as well as “completely new forms of risks” or blockchain unknown-unknowns.

To mitigate the impact such risks could have, the Register of Notes was restricted to be only the “records held by CBA in its Sydney office in its capacity as Registrar” and other “Recordings in the Ledger” would “not constitute any legal entitlement to the Notes” although of course they might have very high evidential value and credibility, given blockchain verification technology, in any subsequent legal dispute.

Review of the Final Terms suggests the following system design:

• CBA would set up and maintain a “Platform” for a distributed, shared “Ledger”, (also implemented using an Ethereum private blockchain system) to assist CBA as Registrar in maintaining its Register of Holdings of the BONDI bonds
• All transactions in the bonds including issuance, transfer and redemption  would be recorded in the Ledger
• Each investor in the BONDI bonds, and certain other “Contributors”,  would have to participate in the Ledger in accordance with the official “Platform Rules and Procedures”, probably including maintaining all their correct information in the Ledger and recording their transactions and transaction prices in the Ledger
• The Ledger would be shared between the Contributors who would perform regular reconciliations with each other. 
• (N.B. This exploits the adding-up constraints, that all the individual holdings of bonds have to add up to the total holding of the bonds, and all the bond purchase transactions have to match all the bond sale transactions, each pair of bond purchase and sale transactions have to match out, and each pair of transaction counter-party pairs and transaction prices also have to match out. However given the relatively small issue size and expected small number of discrete bond holdings, the rate of transactions and events to be reconciled on the Ledger would also be expected to be relatively small and infrequent.)
• After reconciliation each individual transaction would have to be “validated” by both the counterparties and the whole group of Contributors
• Such validated transactions would then be “taken to be recorded in the Ledger and then as requests for changes in the Register”
• The Registrar, CBA, would just use its records for its Register of the Notes
• To help maintain the Register of Notes, the Registrar CBA would use “only the form of the Ledger maintained by the Registrar on the Platform from time to time”
• This might give the Registrar the option to use different information from that held in the Ledger, or Contributors copies of the Ledger, for its Register of Notes, if it had good reason
• There is also a fall-back provision for CBA not to use and not to require Contributors to use the Platform and Ledger e.g. in the case of Platform problems.
• Payments of principal and interest by CBA would be still only made in AUD currency and not say digital tokens which could incur additional Australian Goods and Sales Tax (GST)

This World Bank Kangaroo BONDI bond represents a quantum leap forwards in bond issuing and processing technology and “proof of concept” for blockchain bonds. The question now is how easily and quickly this experiment can be scaled up to much larger bond issues, with much larger and more flexible and transient investor bases, more frequent transactions, needing public distributed ledger technology and including direct smart contracting for automated payments and mismatch resolution. 

If this can be done, then the same technology can probably be applied to a raft of other existing and potential tradable instruments across both developed and currently undeveloped global financial markets.

(Rupert Macey-Dare is a commercial barrister and PhD-economist. Rupert gratefully acknowledges helpful comments from Chris Barratt, Brin Rajurathai, Alison Grady and Josh Critchlow. These are discussion points of the author and do not necessarily reflect the views of any other individuals or organizations, and do not constitute legal or economic or other advice.)