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If politicians’ talk is to be believed, the UK is a hotbed of financial innovation. Since 2010, British ministers have made it a hub for renminbi trading, sukuk issuance, green finance and the crypto industry. But that enthusiasm is masked by worry about being left behind by smaller, nimbler rivals. Fomo is now fueling the new government’s reported enthusiasm for using blockchain to issue gilts.
So far, there are relatively few examples of this use of distributed ledger technology, which allows transaction details to be recorded in multiple locations. In 2022, digital bonds raised just 0.02% of the $7.3 billion raised by traditional versions, according to S&P.
But some countries, notably Luxembourg, Switzerland and Singapore, have been enthusiastic pioneers. Institutions such as the European Investment Bank and the World Bank want to show that this technology can be a cheaper, faster and more efficient way to issue debt. The latter is fully aware that developing countries do not have the market infrastructure necessary for an efficient debt market. Digitalization could allow them to overcome these obstacles.
Yet there are significant barriers to adoption of this technology. For issuers, this may seem like a distraction from their primary task of issuing bonds. The UK Debt Management Office cannot, for example, claim that it is improving the functioning of the gilt market or reducing costs. The potential benefits for investors have also not been exploited. Platforms developed by market participants are often incompatible, reducing liquidity and limiting the growth of secondary markets.
Breaking the status quo will be an uphill battle. Start-ups will struggle to gain a foothold in a heavily regulated market, while incumbents may be reluctant to invest in technology that could disintermediate them. There is also a chicken-and-egg problem when it comes to integrating digital bonds into banks’ existing processes. Costs can only be justified with sufficient emission volume. But until systems are fully integrated, the savings may be too small to encourage large-scale emissions.
Moody’s also highlights the risks of incidents when integrating blockchain technology into existing systems. The Australian Stock Exchange’s ambitious efforts to upgrade its clearing and settlement systems to blockchain technology were scrapped in 2022, with A$250 million ($171 million) in costs wiped out.
To be sure, there are also risks to staying away. The City of London would lose out if banks developed their technical solutions elsewhere. This means that the UK government’s willingness to consider issuing digital bonds is reasonable. But history shows that even superior technologies can face insurmountable obstacles. Blockchain gilts could prove to be another symbolic gesture towards financial innovation in the UK.
vanessa.houlder@ft.com
