KfW spearheads digitalisation in securities issuance

At the end of 2022, German development bank KfW became the first issuer to launch a digital fixed-income bond in the form of central register security following a change in legislation. In mid-2021, the government passed the German Electronic Securities Act, allowing for the dematerialisation of paper securities. Instead of issuing a physical security, transaction data is recorded on an official electronic registration platform.

“The German sovereign bond has been electronic and KfW is a government-like issuer, so it is astonishing that we still settle physical notes, which is inefficient and increases risk,” says Petra Wehlert, head of capital markets at KfW. “It is a natural step to be able to settle bonds electronically, like the government.”

In December 2022, KfW issued a €20m electronic bond (e-bond) with a term of two years and a coupon of 2.381% for general funding purposes. Melanie Kehr, member of the executive board of KfW Group, said in a statement at the time: “As one of the world’s largest capital market issuers, innovation in the area of our refinancing is important to us in order to improve efficiency and reduce operating risks and transaction costs.”

The development bank has a close relationship with the lead manager, Deutsche Bank, whose own treasury was also interested in buying an e-bond. Ms Wehlert adds: “We needed partners to run some tests who were quite open-minded about new products and Deutsche Bank was one of those houses.”

Other partners were legal adviser Hengeler Mueller and Deutsche Börse’s international central securities depository, Clearstream, who carried out the issue on its D7 digital post-trade platform. Ms Wehlert explains that the electronic process only makes sense for KfW if it can use a public infrastructure capable of processing large volumes, because the development bank raises about €85bn annually from around 300 bonds.

Steps forward

KfW has used an electronic book-building process for many years and the e-bond was similar to a normal issue with 300 investors and the same liquidity, but the process between pricing and settlement was much more efficient. Data from the bond’s term sheet was uploaded to D7; however, the current process is too complicated and manual, according to Ms Wehlert.

While the e-bond raised €20m, which is more akin to a private placement, KfW would like to issue larger benchmark bonds electronically. She says: “Once the data-uploading process has developed, it will be a small step to use e-bonds for the whole business.”

KfW mainly issues in euros because that achieves the best funding results, according to Ms Wehlert. KfW issues a liquid dollar bond once per quarter, and the bank has also been active in sterling and Australian dollars. However, she says rising rates, inflation and volatility have decreased overall investor demand, adding: “We have a variety of products that we offer and our average duration is five to six years. Longer duration issues are probably more tricky than [they were] last year.”

The development bank hopes to issue another e-bond in the second half of this year, and if it works well it will have the capacity to use the process for much larger volumes. Importantly, other e-bonds have been issued in Germany following KfW’s deal. Ms Wehlert says: “Issuers tend to wait for KfW to use new processes first as this will tend to be the direction for the development of the whole market.”

Blockchain potential

Ms Wehlert argues that an e-bond is just the first step in making issuance more efficient. The second step is a digital bond that investors can potentially trade on a blockchain in a digital currency. She describes an e-bond as an efficiency improvement for an existing product, while blockchain-based digital bonds are a new product group that will need new infrastructure for both issuers and investors.

In February 2023, technology company Siemens became one of the first companies in Germany to issue a digital bond. Siemens’ €60m one-year bond was issued on a blockchain allowing the transaction to be completed in two days. The European Investment Bank issued its first blockchain bond in 2021, and subsequently issued the first sterling-denominated digital bond in January 2023, raising £50m. However, Ms Wehlert observes that they have less liquidity, which is a definite hurdle in the secondary market.

KfW is waiting for more investors to be interested in settling on a blockchain, which Ms Wehlert believes is not that far away. As a result, the development bank intends to progress towards making all of its bond issues electronic in parallel with developing blockchain-based digital bonds.

“Digital bonds are meant to reduce risk, but if you cannot settle on-chain and have to use an intermediary, then you run an additional risk,” she adds. “This will be a niche product at the beginning, but perhaps will become mainstream in the same way as green bonds.”

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