DMI News 04/22/2024——

The tokenization process of conventional capital markets is advancing globally. From the perspective of the digital bond market, according to incomplete statistics, successful issuances of digital bonds worldwide have totaled more than $5 billion USD. Participating institutions include the World Bank, the European Investment Bank, Societe Generale, and others. Notably, the Hong Kong SAR government's successful digital bond issuances in 2023 and 2024 serve as pilot approaches.

As a data and service platform for the Asian bond market, DMI closely monitors the tokenization process in the credit market. The international law firm Ashurst participated in both approaches to digital green bond issuances by the HKSAR government, serving as legal counsel for the institutional-grade DLT platforms (Goldman Sachs GS DAP™ and HSBC Orion). Ashurst also received the DMI 2023 "Best Digital Bond Issuance" award for its outstanding contributions in this field. DMI News invited Ben Hammond, the managing partner of Ashurst's Hong Kong office and a partner in Ashurst’s financial services regulatory group, to provide insightful interpretations of the performance and future of the digital assets market in Hong Kong, as well as the journey behind digital bond issuance.

Before delving into the details of the conversation, let's briefly review the key elements of the two digital bond issuances by the Hong Kong government:

The outstanding amount of the two digital green bonds issued by the Hong Kong SAR government was HKD 800 million and HKD 6 billion, respectively, marking the world's first sovereign entity to successfully issue digital green bonds and setting a world record for multi-currency digital bond issuance. These innovative practices align with Hong Kong's vision to promote the development of the fintech sector and represent significant milestones following the publication of the "Policy Statement on the Development of Virtual Assets in Hong Kong.”

Through the conversation with Ben Hammond, significant progress and breakthroughs have been noted between the two issuances in terms of entitlement, digitally native format, existing market infrastructure, and green document tracking.

In the interview, Ben Hammond gave the view that a digital form of legal tender such as CBDC, digital currency, stablecoin, or tokenised deposit would be fundamental to unlocking the potential of DLT platforms in the digital bond markets. He believes that the full benefits of tokenisation would be realised when the technology is gradually used for more types of financial instruments. Ben Hammond said,“It is the beginning of that change coming into the traditional wholesale financial markets.” 

Ben Hammond considers Hong Kong as innovative and world leading in this area and is willing to be part of it. Speaking of Ashurst’s business offering in digital asset market, digitalisation is one of the key strategic areas of focus for Ashurst globally.  

Here are the interview records:

DMI News：Could you introduce Ashurst’s experience participating in the Hong Kong digital green bond project, as well as its past experience and expertise in the digital asset field?

Ben Hammond: From a strategy perspective, one of the areas that Ashurst has been focused on is digitalisation as a megatrend. That’s a global area of focus for Ashurst and the way we came to this project is within a global team. Ashurst has been advising clients particularly in Europe for years. My colleagues in Europe advised on the first use of a digital assets platform for digital bonds in Luxembourg.

Our expertise in cross-jurisdictional regulatory advice led us to be involved in this project. The technology developed in other jurisdictions is now being utilised globally. Our established relationship with Goldman Sachs brought us to the project when they introduced their platform in Hong Kong in 2022. This reflects our commitment to digital transformation and our investment in expertise. Our involvement in this project is driven by our recognised expertise in digitalisation. For example, last summer,  I spoke at a digital assets symposium with the Bank of England and the Financial Stability Board in London. We also have partners in London who are members of various regulatory committees, which aligns well with our bank clients. Additionally, the Basel Committee's international banking standards have led to several projects in Hong Kong involving major banks like Goldman Sachs and HSBC.

The Hong Kong government itself, as well as the Hong Kong Monetary Authority (HKMA), has been focusing on showcasing the feasibility of digital securities issuances in Hong Kong. This initiative aims to encourage the adoption of technology in the financial sector and demonstrate the adaptability of Hong Kong's legal system. With strong banking relationships and expertise in the banking space, we quite often engage in discussions related to these projects..

In Luxembourg, there is a particular new law that allows digital securities to be issued. As a result, a number of different projects and issuances have taken place there. Both HSBC and Goldman Sachs have used that platform in Luxembourg. I think many banks have been closely looking at other jurisdictions as well, and Hong Kong is favourable in this regard.

DMI News: What are the challenges and benefits of digital bonds insurance?

Ben Hammond: We were deeply involved in both projects as the platform legal counsel for Goldman Sachs's digital asset platform (GSDAPTM) in the first case and HSBC's Orion platform in the most recent one. Our role encompassed all aspects of the bond issuance processes. The first challenge we faced, which is common in many jurisdictions including Hong Kong, is the absence of specific laws providing rules for digital bond or digital securities.

One of the initial challenges was to provide certainty to clients, regulators, and the market regarding the legality and consistency of digital bonds. These bonds are raising a substantial amount of capital to fund Hong Kong's balance sheet, necessitating investors' confidence and legal clarity.

Digital assets without traditional certificates raise concerns about rights enforcement, defaults, market liquidity, and cyber risks. This poses challenges in communication and instilling confidence in the market to assert that the bonds are reliable investments with legal protections. In the latest issuance, digital bonds are listed and allow investors to be held in traditional settlement systems, available in Euroclear and Clearstream. Investors therefore can hold these bonds directly but also have the ability to hold them in normal custody chains.

Digital bonds come with significant advantages despite initial challenges. Directly holding the legal title offers greater control and digital bonds can be immediately (and "atomically") settlemed, a stark improvement from traditional bond settlement processes that take days. 

Furthermore, the Central Moneymarkets Unit (CMU) provides a system that adds further certainty for investors, protecting them from challenges in case of insolvency. CMU, designated under Hong Kong's Payment Systems and Stored Value Facilities Ordinance, ensures that transfers under its system are not challenged by typical insolvency law principles.

Looking ahead, digital bonds may require fewer intermediaries and potentially reduce costs for issuers. The full benefits of tokenisation would only be realised when the technology is gradually used for other types of asset classes, equities, and other types of instruments. It is the beginning of that change coming into the traditional wholesale financial markets.

DMI News: What benefits can tokenisation bring in contrast to conventional green bonds? What can tokenisation bring to green finance and ESG?

Ben Hammond: Green bonds are typically structured based on specific green investment criteria. They share similarities with traditional bonds, but what distinguishes green bonds is the allocation of funds to environmentally friendly projects. I believe that reporting on green bonds should be transparent for investors. Digital bonds provide the opportunity for direct reporting on investment performance and compliance with criteria. This allows investors to verify where their funds are allocated and how they are performing. I think this combination of green and digital bonds makes sense and is likely to become more common in the future.

For green finance and ESG, offering an attractive and competitive product to the market increases the chances of a successful issuance, especially if it aligns with green finance goals. The ability to report transparently is a key benefit, as it allows for greater transparency in meeting ESG targets and showcasing investment performance. This link between transparency, investment performance, and ESG criteria provides significant advantages.

DMI News: The first offering has been called “tokenised green bond”, while the latest one named “digital green bond”. Why there are different titles and why the second one has been described as “digitally native”?

Ben Hammond: Part of the reason lies in differences in terminology. The key distinction between the two platforms concerns entitlement. On the Goldman Sachs digital asset platform, as it was offered in the context of the 2023 issuance, participants hold beneficial titles recorded on a distributed ledger, while legal title is held by a trustee. However, on the HSBC Orion system in the context of the 2024 issuance, both legal and beneficial titles are held directly on the system without a trustee. This is because the bond exists solely on the blockchain without physical existence, making it digitally native.

It's worth noting that the Goldman Sachs digital asset platform is also capable of this. This difference is not due to technological limitations but rather the setup of arrangements.

DMI News: Are there any other differences between the above two DLT platforms? What are the reasons behind choosing different platforms for the two approaches?

Ben Hammond: What we are seeing is exploration in the market of different solutions, including different parties working together in various ways, and exploring what technology can do in those cases.

The issuance of the tokenised green bond in February 2023, which Goldman Sachs's platform was involved in, was the first sovereign issuance and was groundbreaking globally. The Hong Kong Monetary Authority issued a paper last summer about lessons from that first transaction and what they might do in the second transaction. And they pushed it further this time.

We are seeing the market getting comfortable with the changing and updated technologies. On the other hand, there have been legal and regulatory developments in the interim. For example, Hong Kong introduced a new virtual asset trading provider licensing regime. Besides, there were also new rules around holding virtual assets and developments globally as well, leading to a more developed legal framework.

Since the first one was a success, investors have shown interest in the second one. I think there was not any fundamental change in the capability of the underlying technology but the full realization of its potential is emerging over time.

DMI News: From the viewpoint of legal advisors of DLT platforms, what changes have taken place in the two approaches during the past year?

Ben Hammond: I think the nature of our role has encompassed more aspects, with more rules emerging.

Moreover, there are changes thriving globally. Hong Kong law is rooted in an English common law tradition, which is similar to other common law jurisdictions. One of the fundamental developments over the years has been the amount of legal developments in all those other jurisdictions.

There was a significant project in England and Wales by the Law Commission which looked at property law last year, and explored the need to recognise a new category of personal property that would include digital assets. It is necessary to consider the conclusions of the Law Commission's report and how Hong Kong law will develop, and whether Hong Kong law will take the same view.

Furthermore, advisors need to understand the technology and be able to advise on it. Understanding how the technology works is part of the legal analysis.

On the HSBC Orion system, a direct participant can hold legal title and transfer interests of bonds directly to someone who is not a participant of the platform or an indirect holder. It means that the legal title needs to move to one place, and the beneficial title needs to move to another place. The beneficial title becomes split in the transfer. This is an example of the legal issues that arise because of what the technology can do, and therefore understanding the technology is essential.

DMI News: Throughout the entire lifecycle of the two digital bonds, which stages and phases did the DLT platform play a role in and participate?

Ben Hammond: In some ways, all of them.

DLT (Distributed Ledger Technology) involves a distributed ledger recording ownership of bonds. At the moment the bond comes into existence, or when anyone wants to transfer the bond, or when the bond is ultimately redeemed, the ledger needs to be amended again. Only through the updating of the ledger does the transfer literally occur. So I suppose distributed ledger technology is there the whole way through. DLT allows for transfer, settlement, and also allows people to assert their rights to make claims.

The other angle here to think about is that it depends on which technology you use. The above two approaches are based on private networks. But when using a public network, there are other aspects about IT security. It is required to think about the risks that come with it throughout the life cycle, securing it to make sure it is safe.

DMI News: Would you mind outlining the roles as legal advisor of DLT platforms in the above two cases?

Ben Hammond: Ashurst has been working with DLT technology projects for years.

Instead of questioning the technology, a lawyer is required to translate it into rules from a legal perspective that users need to follow in practical terms, allowing them to use the technology and understand its limitations and risks.

If the law requires a document or record to be produced for stamping or production to the government or to tax authorities, lawyers need to know that and make sure technology can solve these problems. The key tasks here were to ensure legal and regulatory compliance for those involved, and to write the rule books for people to follow and the risk factors for the bond documents.  This is in addition to advising the range of legal issues that arise in a traditional transaction. 

The last area is advising on the legal requirements for distribution. There are additional disclosures that need to be made to promote a digital bond.

DMI News: Could you illustrate the potential of the DLT platform to be unlocked in the future?

Ben Hammond: This is something that is changing over time. I believe we will see more participants holding bonds' legal title directly. Currently, investors can hold them directly through banks that are CMU (Central Money-markets Unit) members participating on the platform. Alternatively, banks that are CMU members outside of the DLT platform may also play a role.

One area with ongoing changes is settlement. A significant development would be having a digital form of legal tender for immediate and real-time transfers while CBDC digital currency, stablecoin, or tokenised deposits are currently not fully available for use in this context in Hong Kong. 

The third element is more private issuances. There could be private digital bond issuances entering the market. The last element is applying the DLT platform in other financial instrument markets when it's ready.

DMI News: Have you observed any changes in the roles of intermediary agents as the adoption of DLT platforms grows?

Ben Hammond: Yes and no. 

At the moment, most of the parties are still there, but it may be about to change. Various roles are no longer necessary, including the lodging agent since there's nothing to lodge. And not as many trustees and custodians are required since investors are directly holding legal title to bonds.

While issuers may still need certain intermediaries, because issuers probably need a paying agent to administer payments; or a trustee to avoid facing investors directly. It is not the case that agents are redundant, but there are more options for individual issuers.

DMI News: Could you outline Ashurst’s business layout in the digital asset market, especially in Hong Kong?

Ben Hammond: Ashurst is really pleased to be involved and has achieved solid performances in this area.

Digitalisation is one of the key areas of strategic focus for Ashurst. We have a strong team with considerable experience in the digitalisation space worldwide, including tokenised deposits and payment space projects. We were also involved in various aspects of Project Guardian in Singapore.

Ashurst is equipped with an excellent market-leading team across all aspects of financial markets, from banking to capital market structured products, and from derivatives to the equity capital markets. All of these areas are changing because of digitalisation, and our clients want us to advise on all aspects being changed by this.

We are delighted to be doing these projects in Hong Kong because it is innovative and world-leading, and we are part of what is happening here in Hong Kong. Speaking of our business strategy in the digital asset market, 'Do more of it'."

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