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To go by politicians’ rhetoric, the UK is a hotbed of financial innovation. Since 2010, British ministers have variously plugged it as a hub for renminbi trading, sukuk issuances, green finance and the crypto industry. But the enthusiasm is hedged with anxiety about being left behind by smaller, more nimble rivals. Fomo is now fuelling the new government’s reported enthusiasm for using the blockchain to issue gilts.
As yet, there have been relatively few examples of this use of the distributed ledger technology, which allows transaction details to be recorded in multiple places. In 2022, digital bonds raised just 0.02 per cent of the $7.3tn 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 are keen to show the technology can be a cheaper, faster and more efficient way to issue debt. The latter is acutely aware that developing countries lack the market infrastructure required for effective debt markets. Digitalisation could allow them to leapfrog those obstacles.
Yet there are significant obstacles to the take-up of the technology. For issuers, it may seem a distraction from the core task of issuing bonds. The UK’s Debt Management Office cannot, for example, argue that it improves the functioning of the gilt market or reduces costs. Nor have the potential benefits for investors been realised. The platforms developed by market participants are often incompatible, reducing liquidity and limiting the growth of secondary markets.
Disrupting the status quo will be a struggle. Start-ups will find it hard to get established in a heavily regulated market, while incumbents may be reluctant to invest in a technology that may disintermediate them. There is also a chicken-and-egg problem when it comes to integrating digital bonds into banks’ legacy processes. The costs can only be justified with a sufficient volume of issuance. But until the systems are fully integrated, the savings may be too small to incentivise large-scale issuance.
Moody’s also points to the scope for mishaps when integrating blockchain technology into legacy systems. Ambitious efforts by Australia’s stock exchange to upgrade its clearing and settlement systems to blockchain technology were abandoned in 2022, with the write-off of A$250mn ($171mn) in costs.
To be sure, there are also risks in sitting on the sidelines. The City of London would lose out if banks developed their technical solutions elsewhere. That means the UK government’s willingness to consider digital bond issuance is sensible. But history shows that even superior technologies can face insurmountable barriers. Blockchain gilts may prove to be another token gesture towards UK financial innovation.
vanessa.houlder@ft.com
