Investor engagement and learning journey the focus of KfW’s latest digital issuance test case

Germany’s federal development bank has been an active contributor to the digitalisation of financial markets with the first steps already taken in 2017 as it simulated its first distributed ledger technology (DLT)-based money market paper, in the form of a €100,000 five-day CP issue. Between 2017 and 2021, Armbruster says KfW remained abreast of key industry developments, despite the absence of any real legal framework for blockchain-based issuance in Germany during this period.

A difference-maker was the German Electronic Securities Act (eWpG) which became law in 2021. This was a key piece of digital markets regulation in Germany as it removed a major barrier and enabled the dematerialisation of the physical security certificate and the use of DLT on a larger scale. Since the new legal framework has been in place, KfW has issued two digital bonds in form of a central register security on Clearstream via Deutsche Börse’s D7 platform. The first, a €20 million transaction with a two-year tenor was issued in December 2022. This was followed by the recent €4 billion benchmark bond priced on 25 June this year, which marks the first high-volume bond on the D7 platform.

According to Armbruster, the second issue focused on scalability, efficiency and reducing errors. “We launched our ‘minimum viable product’ for D7 in 2022 with a follow up transaction in mind,” he says. “With this second transaction, we put a focus on further automating data generation and speeding up the issuance process, thus improving scalability.”

Scalability is a key topic in capital markets digitalisation and Armbruster says KfW is dedicating extensive resources to exploring how to achieve it, including issuing large volumes in digital format.

D7’s technology enabled a further decrease in time-to-market for digital securities, from minutes to seconds. Traditionally, issuances can take several days due to cumbersome reconciliation processes and lack of system interoperability.

Most recently – just a few days after the D7 deal – KfW priced its first blockchain-based €100 million digital bond under the eWpG – with a coupon of 3.125 per cent and a tenor of approximately 18 months.

Armbruster highlights that KfW took inspiration from other DLT-based transactions, such as those issued by European Investment Bank (EIB) and German multinational, Siemens. It also factored in that some trades were issued in different jurisdictions under different laws.

EIB issued its first digital bond in 2021, in the form of a €100 million twoyear transaction that also used an experimental central bank digital currency (CBDC) token for settlement. The supranational has since sold digital bonds in various currencies, and in 2023 it raised £50 million (US$63.4 million) in a world-first sterling transaction that used a combination of public and private blockchain on HSBC’s Orion platform.

From the corporate sector, Siemens raised €60 million in 2023 in its first digital outing, a one-year bond. Payment was carried out using traditional settlement methods.

Armbruster tells KangaNews: “Being a large and dominant issuer in the SSA sector, it is our responsibility to remain in the driver’s seat of innovation and share knowledge with our peers. Digitalisation plays a crucial role in the financial industry and it is important for us to play a leading part in its development to, on the one hand stay competitive, and on the other make an active contribution to the development of the market for digital securities in Germany and Europe.”

SPREADING THE NET
For its latest bond issue, KfW placed particular emphasis on attracting as many investors as possible into its books. Armbruster says: “The issuance of our first crypto security is another important milestone on our digital learning journey. From the outset, our aim was to involve as many market participants as possible in the transaction to collectively learn new things and test the innovation facilitated by the legislator through the eWpG, together with our banking partners, our anchor investor – Union Investment – and other interested investors.”

The goal was to help educate the market, being an enabler and paving the way for future transactions of this type for other market participants.

KfW hired a syndicate of banks targeted at maximising investor participation, with the aim that each would tap into different investor bases and drive input across the buy side. DZ BANK, Deutsche Bank, LBBW and Bankhaus Metzler ran the deal. Together, these banks represent the four pillars of the German banking system.

Armbruster says the syndicate targeted investors that were ready to buy but also those testing out the technology for the first time – accounts that could take comfort in the fact that their money was being placed with the safest name in the market.

In the end, KfW attracted a considerable number of German investors such as Berliner Volksbank, DekaBank, LBBW, Solventis AG, Sparkasse Pforzheim Calw, and WI Bank, among others. Furthermore, Union Investment, as a key anchor investor, has actively supported the transaction in a collaborative manner from the beginning.

The attractiveness of conventional KfW bonds comes from the issuer’s triple-A rating and the high liquidity of its bonds, Armbruster explains. “New products like crypto securities require these features in order to be attractive for investors,” he says.

One major challenge remains the limited secondary market liquidity of crypto bonds. This is not only due to a relatively small number of issues with few 'eligible' investors. Above all, capital markets regulation requires marketable securities to be held in custody at a central securities depository, which by definition is not the case for crypto securities.

With the bond being a relatively short-dated note, investors will also be able to experience its full lifecycle including coupon payments – which Armbruster says is important for new participants in the technology. “We were able to get a feel for potential scalability by monitoring how many investors were in the book as well as understanding the motivations behind participation and, on the other side, why some names were absent and were not able to use the technology yet,” he comments.

In fact, he also emphasises that KfW did not measure success based on the number of buyers that took part. “We obtain value through the information we gather. We had enough investors on board to understand the various motivations for getting involved, and for abstaining from the book. This will prove invaluable when we return to market with our next trade.”

DIGITAL OUTLOOK
Armbruster says it will continue to be important to understand investors’ needs.
Looking ahead, KfW intends to target scalability, though Armbruster notes that the exchange of cash and bonds on blockchain remains subject to how a wholesale CBDC develops.

The European Central Bank is currently experimenting with a wholesale CBDC, which includes DLT settlement trials with central bank money. In May, a first wave of participants began testing and on 21 June the central bank revealed the second group of participants that will begin trialling in July.

The first group was dominated by German names but the second is more diverse. It includes 49 firms from across the financial sector, as well as three national central banks.

The latest phase of the project will target domestic payments in the Eurozone using a mock settlement, a range of securities use cases and foreign exchange payment-versus-payment (PvP) transactions with different central banks. Market participants believe the large number of parties involved demonstrates a strong interest in the benefits DLT could bring to wholesale finance.

FURTHER DIGITAL INITIATIVES
Aside from its two new issues, Armbruster says the bank has been striving to also optimise processes and mechanisms it relies on heavily for its core activities. “KfW is one of the world's largest and most active issuers of bonds, one of the largest European issuers of short-term debt instruments in the form of CP and one of the most intensive users of cross-currency swaps. Efficient processes and a high degree of automation in the issuance of securities are thus of strategic interest to us and we have a natural interest in any development in these markets,” Armbruster tells KangaNews. “Change affects business activities and, as Germany’s largest development bank, we have a duty to a variety of stakeholders to be an active contributor and drive innovations.”

He adds that KfW continues to feed back to the market as well as to central banks and the Ministry of Finance. “This is a foundation for further dialogue. If these innovations work for KfW, they could work for other issuers too. Noone knows which kind of digitalisation path is the one that will be scaleable – but we have learned that the earlier one starts, the better.”

In the medium term, Armbruster tells KangaNews that KfW expects to announce the launch of a further digital bond. But he also states: “Despite all my enthusiasm for crypto securities, I do not anticipate that crypto debt securities will displace traditional debt securities in the fixed-income market within the next five years. However, if crypto securities live up to their full potential, we could see a market with faster execution, lower costs and less operational risk. For investors and issuers.”