For a small but growing group of pioneers, there is a common vision for the future of European bond markets: to operate entirely on distributed ledger technology (DLT) – or blockchain. And with each incremental step towards that goal, industry interest also increases.
Allen Law Firm & Overy counts many of its partners among these pioneers. Over the past year, the company has taken the initiative to facilitate the issuance of historic bonds on a public blockchain – obtaining mandates to work on new projects in several European capitals in the process – while playing a leading role in the rewriting of laws in two European countries. states.
“Endgame is a very ambitious question, which is to create integrated capital markets where everything is recorded in the blockchain and settlement occurs almost automatically,” says Salvador Ruiz Bachs, partner at A&OMadrid office. “Even bonds are governed by smart contracts.”
This market view would mean reduced back-office and settlement costs, as well as increased legal certainty that would come from all parties having a “single source of truth”, instead of the need to enter values in individual systems internally before trying to reconcile an understanding of the market.
The goal is still far away, but A&O contributed to these first steps by advising the three main banks – Goldman Sachs, Santander and Société Générale – on the legal basis for the first issue by the European Investment Bank of a bond of 100 million euros (112 million dollars) on the public Ethereum blockchain network.
To issue the bonds, the joint lead managers converted investors’ cash into central bank digital currency (CBDC) created by the Banque de France. the CBDC was credited to EIBwhich he then issued as securities on Ethereum, converting the CBDC revert to the euro later in the day.
This is not the first bond the law firm has helped issue on a public blockchain – an earlier experimental deal, in which Santander acted as both issuer and investor, was issued in September 2019 – but the EIB the transaction took several additional steps, including the involvement of several dealers as well as secondary investors and the first use of a CBDC.
By launching the EIB obligations, A&O had to overcome unprecedented legal hurdles.
“It’s not just about adding a thin veneer to what we already have in the capital markets. You have to deconstruct how a bond works and everything you know about how a conventional bond works in European markets,” says Daniel Fletcher, a London-based partner at the firm.
“The minute you have to go back to basics and think: does it work the same way? Is the legal basis and legal analysis the same in a new obligation? Sometimes the answer is yes, sometimes no. And, sometimes, the answer is a gray area.
A&O first undertook a jurisdictional analysis to advise the best applicable law under which to issue the securities. The choice fell on French law, which has the advantage of recognizing the dematerialized form and the representation of bonds in a blockchain format, explains Ruiz Bachs – a fact which brings legal certainty to the constitution, issuance, registration and transfer of digital bonds.
The company then undertook a regulatory analysis of the show’s compliance with several European regulatory frameworks, which included establishing clear red lines.
One of these lines was that the securities could not be admitted to trading on a regulated trading platform. According to the European Union (EU) Central Securities Depositories Regulations, securities admitted to trading must be registered with a central securities depository, which means that they cannot be registered on a blockchain.
A major regulatory hurdle A&O had to navigate the process was to ensure that the securities would not be used to launder money. The co-managers had to set up a whitelisting process for investors registering for the initial subscription with the registrar named Societe Generale to ensure that the securities do not go to bad actors in the market. secondary.
In French civil law, the issuer – the EIB in this case – is responsible for compliance with sanctions if it uses an agent, explains Hervé Ekué, managing partner of A&Othe Paris office. To resolve these legal issues, the firm was forced to draft bespoke documentation.
“We needed to be quite detailed about the duties of this agent [on] how the reports would work and ensure compliance with the legislation,” explains Ekué. “We also needed to distinguish between the functions the entity would perform as agent for the issuer and the function it would perform to facilitate the overall transaction, which it would perform as principal.”
Having done this work, the law firm now has its own manual for future transactions. The analysis defines the questions asked by partners working on DLT Bond issuances should respond within a jurisdiction’s regulatory framework, says Ekué.
“We [now] have our own internal reference and we hope that it will become, in one way or another, a reference for the market”, says Ekué.
This playbook and the company’s experience are helping it facilitate other shows: partners are now working on blockchain deals in other jurisdictions, including Luxembourg and Spain.
Another striking aspect of A&Owork on the EIB link is that it brought together partners from London, Luxembourg, Madrid and Paris working as a unit. As London-based firm partner Emma Dwyer points out, her bench “is not London-centric” and highlights the firm’s “global nature”.
Corn A&OThe contribution to this nascent vision does not stop there: it has also found itself influencing legislation in Europe.
“Everyone wants a piece of it,” says Ekué, referring to DLT bond issue. “Everyone sees this as something interesting, intellectually stimulating and potentially future-proof, so there is a friendly competition between different states to make this happen.
The law firm was one of many participants who helped the Luxembourg Ministry of Finance draft amendments to its laws to facilitate the issuance of DLTbased on titles.
“The idea is really to open up Luxembourg as an attractive center allowing different entities to structure their emissions”, explains Philippe Noeltner, senior employee of A&Ofrom the Luxembourg office. “[And for] various service providers to act in this capacity and facilitate the issuance of these securities.
Enacted in January this year, the legislation amends the definitions and mechanism of the law to allow DLT be used as a record for an issued security, as well as to allow any EU credit institution or investment firm to become a central account holder – responsible for verifying that the number of securities in circulation does not exceed the total number issued – without needing to be authorized in Luxembourg to perform the service.
Noeltner points out that A&O was not the only firm to hold the pen for changing the law, but claims to have taken the lead on certain aspects, such as answering questions from industry working groups and promoting the law during a phase of consultation.
The company is also helping France change its laws. Ekué leads a sub-working group under the supervision of the Haut Comité juridique des marchés financiers in Paris, which has been commissioned by the French Treasury to identify legal obstacles that could slow the development of bonds on DLT. The working group looked into the loopholes in French law and the imitations of German, Luxembourg and Swiss laws which provide a favorable environment for issuing DLTbond-based.
Ekué expects a report to be published in the first quarter of 2022 and that there will be more clarity on a potential change in French law after this year’s presidential election, for which the first round of voting will take place. place on April 10.
In a separate initiative from the EIB bond issue, the firm also advised a consortium that plans to lay the foundations for a DLTbased on the bond market for over a year now.
Fletcher says the company is looking at what messaging parties, infrastructure and protocols might look like, as well as the legal and regulatory framework. “I think it is [a] very challenging and very ambitious project, but we’re using all the knowledge and experience we’ve gained from the deals we’ve worked on and really trying to engage with the wider community to see what the future of this capital market infrastructure,” he says.
The era of the pioneer is not over.