Allen & Overy: Inside The EIB’s Landmark Digital Bond Deal

Frank Mausen, Partner, and Philippe Noeltner, Senior Associate at Allen & Overy Luxembourg (Photo: Allen & Overy Luxembourg)

On November 29, the European Investment Bank, in collaboration with Goldman Sachs Bank Europe, Santander and Société Générale, announced the issuance of the first Luxembourg law governed digitally native bond issued on a private blockchain. Frank Mausen, Partner at A&O and Senior Associate Philippe Noeltner tell us more about the importance and implications of this historic deal which they helped draft. 

What are the benefits of issuing blockchain-based bonds?

PN: It’s about innovation and efficiency. Relying on the blockchain and smart-contract protocols to issue bonds helps an issuer and its intermediaries automate certain processes. For example, in this deal, coupon payments will be automated through the use of smart contracts. The settlement will be done in real time and will be recorded directly in the blockchain. It usually takes two to seven days to settle a traditional bond, whereas the Digital Bond was settled on a T=0 basis. Other benefits of using such technology are that it can help an issuer to comply with its KYC obligations (by for example using certain smart-contract protocols) and can provide transparency when using a public blockchain to record bond transfers (as was done on the first EIB bond issuance).

This deal is important because it is taking further steps to digitise the capital markets. This will allow us to live in a world where the involvement of intermediaries can be reduced and processes would be rendered more efficient.

FM: While this creates a risk for some intermediaries, it also gives them an opportunity to reinvent themselves and find their reasons for existing. We are certain that we will see a lot of changes over the next few years and that intermediaries will come up with creative solutions.

Your press release states that you are achieving a lot of “firsts” with this deal. Which one of them do you expect to be the most impactful for the Luxembourg economy?

PN: Having two different blockchains being used and real interoperability between the two blockchains is interesting. It is also important to realise that you have government authorities using this technology which enabled the bond to be settled in central bank money. This paves the way for a CBDC (Central Bank Digital Currency) and for cross-chain settlements, which is something that’s been looked at by the market for some time as hurdles to overcome in a digital capital market environment.

FM: I think for Luxembourg it’s also important to recognize that the Luxembourg legal framework is being used by such prestigious players as the EIB and three banks (Goldman Sachs, Société Générale and Santander) which are among the leading institutions in their sector. This shows the credibility that Luxembourg law has and the certainty that exists when relying on its legal framework. It will also signal that Luxembourg is welcoming this new technology and hopefully lead to being perceived as a hub where players can establish their platform and issue securities. 

PN: HSBC has also announced the launch of its platform Orion which will rely on Luxembourg law and be operated out of Luxembourg. This will be key for the Luxembourg financial centre.

What were some of the challenges in structuring this deal?

FM: I think what was most interesting and challenging for lawyers is that we were leaving the well-trodden path. We have this new law and this new technology which we have to combine. So, we were not just dealing with in-house legal but also banks, business people and the IT guys who programmed the platform. We are now bringing the issuance of securities to the 21st century and obviously big players are always looking for certainty and security, therefore we had to analyse all the angles and ensure that there were backup plans for everything.

PN: I would say personally, the structuring of the deal so that it can be as legally robust as possible, without compromising on innovation. That really required us to have long, deep brainstorming sessions about how to (i) use our Luxembourg legal framework, interpret it and (iii) take the right legal decisions to document the issuance of the bond.

FM: Luxembourg is not resting on its laurels. There is a third blockchain law pending in Parliament that will hopefully go through soon which will provide for the possibility to take security interests over securities in blockchain. Luxembourg has adopted a full framework for issuing securities natively directly in a DLT framework to settle them in a DLT platform and take security interest – so we have an entire lifecycle that is DLT. Once the law will be adopted, it will exist nowhere else but in Luxembourg.

I like to say we in Luxembourg don’t have mountains, we don’t have the sea and we don’t have natural resources. The only thing we have is brainpower. So, I think we need to stay innovative and keep in line with our light-touch approach which allows us to reassure players and cover future technologies and market trends. If we play our cards properly, Luxembourg can become an important player in this field.

What future do you see for DLT-based bonds?

FM: I think right now market precedents are being set and Banks are testing the waters. As already mentioned, other deals are in the pipeline so now we are in a situation where we are trying to find out what works and what doesn’t, what investors like and what they don’t. Once we combine those experiences, I think ordinary issuers will also come into play. While we are not able to say that in 10 years, every transaction will be done via DLT, it will certainly become an important part of the business and play a crucial role in the capital markets.

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