In February Hong Kong issued its first tokenized green bond, a HK$ 800 million issuance using the Goldman Sachs Digital Asset Platform (GS DAP). Today the Hong Kong Monetary Authority (HKMA) published a report that expands on the blockchain bond issuance, Project Evergreen, and explores the potential for tokenized bonds more broadly in Hong Kong.
While the benefits of tokenization are covered in the report, its objective is to move things forward, so it explains some of the frictions and areas that need further work at a market level.
In the foreword of the report, Eddie Yue, CEO of the HKMA said the bond issuance demonstrated how DLT can “enhance efficiency, liquidity and transparency in bond markets.”
Referring to the proliferation of DLT bond issuance platforms he stated “it will be crucial to consider how different solutions can connect and interact with each other as well as conventional systems to avoid fragmentation.”
As an example of the necessity of integration, a section of the report explores how easy it is for custodians dealing with conventional bonds using straight through processing (STP). In contrast, with new platforms, the accounts on the digital platform are also recorded on the off-chain custody system and manually reconciled.
We’d observe this isn’t particular to DLT, it’s a feature of migrating to any new technology or platform. There’s a bit of upfront pain in order to have the long term gain.
The report mentions the potential for the central securities depositary (CSD) to help with the integration role. The SIX Digital Exchange (SDX) was the first to do this by integrating its conventional CSD with the DLT-based CSD, enabling broader access to digital bonds from those custodians who are not yet up to speed with blockchain.
Hong Kong is DLT-ready from a legal perspective
However, in the case of SDX, the bond issuances were native. That was not the case for Project Evergreen where there is a conventional registry.
CMU, the Hong Kong CSD, played a leading role in the project. It recorded all the registry details off-chain as well as managing the on-chain registry where it minted the bond. CMU also acted as the gatekeeper for tokenizing cash used for settlement.
For a first digital government bond it makes sense to take the conservative path of involving the CSD.
The report clarifies that by clearing and settling through the CSD it ensured settlement finality. However, any licensed clearing and settlement system (CSS) can also ensure finality as well as the benefits of the protections of Hong Kong bankruptcy laws. So one alternative route is for the DLT platform operator to register as a CSS. Another path is to contractually agree to adopt these laws.
Our reading is the regulations in Hong Kong are supportive of digital bonds, although Mr. Yue stated there may need to be fine tuning.
Finally, the report outlined six future areas of exploration ranging from different DLT platforms and a variety of currencies to tokenizing repo transactions and retail use cases. There have already been multiple retail government bond offerings in Asia that leveraged DLT, including in Thailand and the Philippines.