Overview and background
On 16 February 2023, the Hong Kong Monetary Authority (“HKMA”) which acts as its de facto central bank assisted the Hong Kong Government in issuing a tokenised green bond in a principal amount of HKD 800 million under the Government Green Bond Programme (the “Tokenised Green Bond”), effectively the first tokenised green bond issued by a government anywhere in the world. This one-year, HKD-denominated Tokenised Green Bond was priced at 4.05% at issuance, and was distributed by a four-bank syndicate, made up of Bank of China (Hong Kong), Crédit Agricole, Goldman Sachs and HSBC. The Tokenised Green Bond itself is lodged with the HKMA’s Central Moneymarkets Unit (“CMU”). Goldman Sach’s tokenisation platform, GS DAP, is used to settle the securities tokens (representing beneficial interests in the bond) for cash tokens (representing fiat cash against the HKMA), with all payments and redemptions conducted on a distributed ledger technology (“DLT”) platform. This issuance builds on HKMA’s collaboration with the Bank of International Settlements Innovation Hub Hong Kong in 2021 known as Project Genesis.
The Financial Stability Board describes tokenisation of assets as the creation of a digital representation (i.e. a token) of a real asset using digitalised DLT. Beneficial ownership of tokenised securities can be recorded on a blockchain using DLT, potentially applying smart contracts and automation. The Tokenised Green Bond offering combines the benefits from traditional issuance and DLT, resulting in significant operational efficiencies due to automation and disintermediation. Proceeds generated from the issuance of the Tokenised Green Bond will be used to finance or refinance projects that fall under one or more of the “Eligible Categories” set out in the Hong Kong Government’s Green Bond Framework, such as renewable energy, pollution prevention and control, green buildings, and climate change adaptation, placing it firmly within the “green bond” and ESG cannon.
The Financial Secretary, Paul Chan, expressed his excitement at this breakthrough, stressing that it is an important milestone which showcases Hong Kong’s strength in sustainable finance, bond markets, green and financial technologies, and its ability to combine them together in a single instrument.
How do the Tokenised Green Bonds work?
As briefly mentioned above, security tokenisation involves the conversion of rights to a real asset into a digital token. The utilisation of the DLT platform potentially facilitates a streamlined bond documentation preparation process, real-time bond subscription and allocation, and shortened delivery versus payment (“DvP”) settlement.
The steps involved in a traditional conventional bond issuance are as follows:
- a paper note is first deposited with the CMU;
- book entries are then made in the CMU with respect to holdings in, and transfers of, the bond;
- the DvP process will then happen, which is signified by the synchronized transfer of payment for the bond transaction made through the real-time gross settlement system and transfer of ownership of the bond to the investor,
the aforementioned processes can involve lengthier timelines, operational costs and exposure to human error compared to tokenised issuance.
The Tokenised Green Bond combines elements of conventional issuance and security tokenisation. First of all, despite the fact that tokenisation allows a "digitally native" issuance of the security on the DLT platform itself, the Tokenised Green Bond is "born" in the traditional way upon lodgement with the CMU before tokenisation. The tokenised security is then open to institutional investors for subscription. Upon review of the term sheet of the Tokenised Green Bond, investors may directly place their orders for the tokenised security (which resides on the blockchain) on the system, which applications shall then be validated simultaneously. Valid orders are then coded on the distributed ledger and enforced by way of a computer program. DvP settlement is then triggered using on-chain cash tokens issued by the HKMA, which represent claims against the HKMA for HKD fiat cash. During this process, stakeholders are given real-time visibility as to the transfer of the beneficial ownership of the tokenised security, which is automatically recorded on the DLT platform. The operational enhancement is evident from the shortened DvP settlement period from five business days in conventional bond issuances to just one day, or even approaching real-time.
Furthermore, the full lifecycle processes of the Tokenised Green Bond could potentially be automated and performed using self-executing smart contracts. For example, steps from order placement to trade matching and execution in a secondary market trading could be fully smart contract-driven. As the digital asset resides on the blockchain, the segregated order books originally managed by multiple banks and brokers are now connected. This enables investors to place their buy-sell orders through smart contracts, and enables stakeholders access to real-time data (including order status) while eliminating duplicative processing. Orders then may be matched automatically and seamlessly settled on-chain. Corporate actions processing the multiplication involved in coupon payments and maturity redemptions can be potentially eliminated: calculations will be automatically processed and payments will be automatically made on-ledger between accounts via smart contracts. The simultaneous settlement mechanism and the use of smart contracts simplify complex business processes and ensure scheduled events happen in a timely and efficient manner. However, whether smart contracts can be written in a way that allows them to process more complex actions which involve determination of whether certain events have actually taken place in the contractually prescribed manner remains to be seen e.g. coupons that are stepped up on the happening of certain events.
Where Digital Assets meet ESG
In recent years, environment, social and governance (“ESG”) concerns have become a major focus for multinational corporations in many jurisdictions, while many countries or regions have been shifting their priorities and putting greater resources and assets into developing green debt and capital markets. As an international financial center, Hong Kong has also emphasised the importance of business sustainability through promoting ESG as a way of attracting ESG-focused companies to set up or expand their presences here. Please click here to read our ESG Guide – Hong Kong for a summary of the regulatory regime underpinning ESG and government-led initiatives in the city.
In parallel, there has been a notable increase in global investors’ appetite for digital assets. This has facilitated the reshaping of the global financial ecosystem with increasing integration of digital assets with traditional finance, and a fast evolving regulatory environment in the area. Please click here to read our Virtual Asset Snapshot – Hong Kong for further details on regulation of virtual assets in Hong Kong.
Stepping back a little, the broader aim of the Tokenised Green Bond issuance was to demonstrate the Hong Kong Government’s ability to bring together its traditional strength in fintech with green and sustainable finance, and to demonstrate that the city remains a flexible and competitive international finance hub with ambitions in both the digital asset space and with respect to ESG objectives. On a policy level it also ticked all the right boxes, being consistent with the Hong Kong Government’s strategies and initiatives to foster innovation and facilitate the development of the city into an international center for green technology and finance, as announced in its 2023-2024 Budget.
Is Tokenisation the Future of Capital Markets?
The use of tokenised securities can potentially decentralize capital markets away from traditional financial intermediaries, allowing tokenised securities to be sold and transferred digitally with ease. For example, the full lifecycle of the Tokenised Green Bond, from coupon payment, settlement of secondary trading, to maturity redemption, will be digitalised and performed on the private blockchain network, and could potentially be performed using self-executing smart contracts. This leads to operational efficiencies through automation and disintermediation, while supporting impact investments where investors may seek to generate economic returns through investment in projects with a positive ESG impact. In practice, investors often have limited access to reliable and timely data when monitoring the performance of their green investments and it is often hard for them to determine whether a bond issuer has in fact generated the positive green impact that the issuer promised at issuance. The use of digitalised platforms allows investors to track green performance in real-time. There are also potential benefits in limiting the scope for putting a human or intermediary “gloss” on the data, which increases auditability due to having direct access to raw data.
On the other hand, tokenised securities also have their limitations. In particular, world-wide adoption of DLT is technologically and politically challenging, given the differing regulatory approaches to blockchain, even between Mainland China and Hong Kong which are part of the same country but have different legal systems under the “One Country, Two Systems” formulation, for example. Compatibility across different tokenisation platforms that have emerged in the market over the recent years remains a challenge, as each platform will have its own technical parameters and features and characteristics which may not be compatible with other platforms. In the meantime, there is an ongoing debate among market participants as to whether these digital bonds should be issued using enterprise private permissioned blockchains like GS DAP, or public blockchains. Private blockchains ensure privacy between participants, while public blockchains offer improved market participation and transparency as to transactions. Which option will ultimately be favoured by the market remains to be seen.
Furthermore, this market is relatively new to Hong Kong, and it will take some time for potential investors to embrace the new technology and build confidence in digitalised and tokenised securities, which, it should not be forgotten, give rise to ownership rights in an underlying security backed by actual assets. They are a quite distinct asset class from cryptocurrencies. While this is a first, the Hong Kong Government will be motivated to encourage further similar issuances and to develop and encourage asset tokenisation to reinforce its global positioning as an innovation hub with green financing and ESG at its core. However, it is important to take a step back and see this development in its proper context: firstly, only the tokenised element is actually new. Second, the short tenor of the Tokenised Green Bond suggests that this was more of a trial balloon with the additional benefit of being able to claim a “world first”. It remains to be seen whether this will set a trend for future issuances.
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Authored by Andrew McGinty, Vanessa Kwok and Joshua Lee.
