Interview on SDX’s recent digital bond issuance, why this was the world’s first and what the future might bring for the digital asset space.
As Product Head for Fixed Income, Stefan Bosshard is responsible for building and running the fixed income offering of the digital exchange. Between 2013 and 2019, Stefan was product manager for the fixed income segment at SDX’s “mother house”, the Swiss Stock Exchange. Prior to that, he was a bond trader at UBS, so he also understands the fixed income space from the “other side”, giving him greater insight into SDX’s client needs.
Stefan’s role at SDX has involved both building and now running the fixed income segment of the digital exchange, bringing innovation to the market, and encouraging market participants to embrace, onboard, and trade using SDX’s innovative platform and products.
Hi Stefan! Can you tell us more about SDX’s recent digital bond issuance and why / how this was a world first?
What we’ve done is put a digital bond issuance onto a fully regulated, DLT-based exchange and central securities depository (CSD) environment in a way that’s not only replicable but also open to a range of eligible investors. We did not invent digital bonds – they’ve been around for quite some time – but we have brought them to a new, regulated level. It’s the first digital bond in a fully regulated environment, and this gave investors a real taste of the future. It allowed them to gain exposure to digital assets in a reduced-risk environment. The investors include insurance companies, pension funds and asset managers, and demand was so high that the original allocation of CHF 100m – for the digital component of the bond issuance – was oversubscribed.
What benefits can digitalization of bonds – and fixed income as an asset class – bring?
Our digital bond issuance has a secondary market, with liquidity, both OTC as well as on the exchange in a regulated environment, which is also a world first. Investors can choose – and switch between – holding the digital and traditional forms of the asset, which helps create liquidity for the asset and provides a safety net for the investor. From the issuer’s perspective, it’s about inviting both traditional and digital investors, and giving them the possibility to choose their preferred form of the asset. This helps the whole market, and it helps transition the market towards digital assets as well. Digital bonds are structured and work similarly to traditional bonds, but on a different technology. This technology, however, enables atomic settlement, which can lead to greater settlement efficiencies. It also enables greater automation in the issuance process and the ongoing lifecycle management of the bond, which can introduce more efficiency to the market.
What can we do with digital assets/tokenization in the Fixed Income space that we cannot do with traditional assets?
A traditional bond can be supported by up to 700 pages of complex legal documentation on its structure and lifecycle events. With digital bonds, we are gradually bringing more of this legal complexity into the smart contracts that govern the bond. Smart contracts can reflect all the possibilities and details in a prospectus, which opens up a range of possibilities, particularly for ESG. For example, we could have a green bond issuance, where the issuer ties the bond to reduce CO2 output. That CO2 output can be automatically measured and tracked via a data token, linked to or included in the asset token, meaning that the investor can always see if the issuer is fulfilling its undertakings in the prospectus. We could even take this further and say that if these performance targets are not met, the asset might automatically increase compensation to the investor, penalizing the issuer by increasing the coupon by a predefined amount. These are all technically possible things, although they require more work to achieve!
What do we need to see for the digital asset market to evolve further?
I see the introduction of central bank digital currency (CBDC), particularly wholesale CBDC, as an essential prerequisite to enable the atomic settlement of digital assets using risk-free central bank money. We have a great interim solution at SDX, which allows market participants to transact using tokenized cash, and that has been accepted by Swiss banks and counterparties. However, to realize all the benefits of the technology without adding counterparty risk from SDX or other tokenized cash issuers, we need CBDC.
What work is SDX doing to support the development of digital asset markets, particularly with respect to Fixed Income?
Creating a new market for digital assets is a collective effort, so we are very much involved with industry initiatives and standards committees. Standardization has a considerable role to play. Equity markets are already highly efficient and liquid, which is largely due to the standardization of contracts, instruments, and data. In the bond world, we are still very manual and paper-based. A bond may be described by two market data vendors in two very different ways, both again differing from the way an exchange describes the same bond. The core details are the same, but the terminology is different. We need a common way to describe bonds before converting them to code and tokenizing them at scale. To help develop this standardization, we work with groups such as the Global Blockchain Business Council and the International Capital Markets Association, which have their own bond standardization initiatives.
Looking into the future, how do you see the market evolving over the next few years? What is the role that you see SDX playing?
I think we will see steady growth. There’s a tendency in the blockchain / DLT industry to expect growth rates of 1000%.; however, this is not entirely what I believe in. We have a significant pipeline of issuers who see the technology’s benefits and clients waiting to be onboarded. Our growth needs to be steady and controlled to maintain our high regulatory standards and market integrity. Ultimately, SDX is an infrastructure provider, and I see us as the orchestrators of the digital markets of the future, taking the financial market on a journey with us.