The first blockchain-based Pfandbrief successfully settled on Tuesday after Berlin Hyp’s €100m three year mortgage Pfandbrief created a buzz around the possibilities of crypto securities in the covered bond market, a development that promises greater efficiency once challenges are overcome.

The German bank announced the planned issuance on 22 July and priced the new issue last Friday (2 August) at 15bp over mid-swaps. Those involved in the transaction said that issuance into an otherwise quiet summer market – and ahead of this week’s volatility – helped the pioneering trade garner attention.

DekaBank and Berlin Hyp parent LBBW were lead managers, will act as custodian banks, and DekaBank will manage the crypto securities register. Metzler Bank was pre-announced as an anchor investor, and White & Case advised Berlin Hyp in relation to the offering.

The Pfandbrief is the first issued under the German Electronic Securities Act (eWPG), which came into force three years ago. German agency KfW issued the first syndicated bond under the legislation a month ago – a €100m 18 month deal sold after some eight weeks of marketing – and Berlin Hyp’s is only the second.

While the new issue follows and builds on digital innovations and tests in recent years across the bond markets, initially in covered bonds by Société Générale, Berlin Hyp’s trade is the first to address a specificity of the Pfandbrief market, namely that the cover pool monitor hitherto had to manually certify compliance with cover requirements. An amendment to the Pfandbrief Act allowing this to be done digitally was passed in conjunction with the eWPG and Berlin Hyp’s transaction is the first to take advantage of this possibility.

“For us, the main goal was to contribute to the development of the market,” Bodo Winkler-Viti, head of funding and investor relations at Berlin Hyp (pictured), told The CBR. “The amendment to the Pfandbrief Act allowing digital issuance is almost three years old and nobody had issued yet, so it was about time to take this step.

“This was not about having the biggest size, the tightest spread, the most investors, or anything like that,” he added. “It was about engaging with investors to convince them that it’s worthwhile doing the necessary work to be ready to invest in these kinds of electronic assets, because in the medium to longer term, this is clearly the future.”

A pair of investor calls attracted interest from around 135 market participants, taking in institutions from small to large, and especially members of Germany’s Savings Bank Finance Group. The final number of investors who were allocated bonds was not disclosed, but extended beyond Metzler, although a key takeaway from Berlin Hyp’s deal – like KfW’s – was that many accounts needed much longer to complete new product processes.

“After KfW’s trade, Berlin Hyp’s transaction motivated more people to take the internal steps to be ready,” said Florian Rathgeber, FIG and SSA syndicate at LBBW, which was involved in both issues. “We got a very good response from investors looking at the new issue but also at potential secondary involvement in the coming weeks.”

The two leads are market-makers for Berlin Hyp’s deal and Winkler-Viti said he is confident that the first secondary trades will occur soon.

Although the digital issuance is a standard Berlin Hyp mortgage Pfandbrief, the €100m size means that it is not LCR-eligible, while a lack of ECB eligibility and listing were cited as further impediments to greater investor involvement.

The use of a private Blockchain – Swiat, in which the two leads have stakes – means that the risk weighting is comparable to conventional issuance. The deal was the first syndicated bond to use a private Blockchain, with KfW’s having been issued on a public Blockchain, which under Basel rules means that it carries a higher risk weight than the agency’s conventional issuance. A potential relaxation of this treatment next year is understood to have contributed to KfW’s choice of an 18 month maturity, while the expected stability of the treatment of Berlin Hyp’s issuance contributed to a more standard, three year maturity being chosen.

Proponents of such Blockchain-based issuance envisage T+0 settlement to be possible, but Berlin Hyp opted for T+2, erring on the side of caution for the pioneering trade.

“We were amazed at how easily and smoothly settlement went,” said Winkler-Viti. “It was technically perfect and that was the most important thing.

“And then we could find out what is lacking in order to get more attention – ECB treatment, admission to regulated segments at the stock exchanges, and 100% certainty on risk weights.”

Should the risk weighting of Berlin Hyp’s Blockchain Pfandbrief change for regulatory reasons, the issuer will convert it into a conventional Pfandbrief.

The mortgage Pfandbrief was – like Berlin Hyp’s conventional issuance – assigned a Aaa rating by Moody’s, which cited its covered bond rating methodology, but also noted technology-related risks, saying that these had been effectively mitigated or were equivalent to those of a traditional issuance.

While KfW’s new issue was priced at 10bp over its conventional benchmark issuance, Berlin Hyp’s was issued at a similar level to its conventional Pfandbriefe. Although Winkler-Viti said that achieving a tight spread was not a goal of the transaction, he noted that not paying up significantly to issue the new security – which involved additional costs for Berlin Hyp – was also important. LBBW’s Rathgeber said this matched the stance of interested investors.

“Price was not the main motivation for anyone here,” he said. “The motivation is basically the same for everyone: investors want to learn, gain expertise, and be first-movers in what they see as part of the future of bond placement.

“If you don’t have that mindset, it doesn’t matter if you get a pick-up of 2bp or 10bp, because that won’t compensate for the amount of work you need to invest internally.”

Metzler cited such considerations as contributing to its involvement as an anchor investor.

“The proactive regulatory framework, as well as the latest practical tests relating to the digital euro that were conducted by the European Central Bank, have served to strengthen the digital assets ecosystem and have led to increased investment in such assets by institutional investors,” said Mario Mattera, member of the executive board of B Metzler seel. Sohn & Co. “In this dynamic environment, we can already see the capital market of tomorrow approaching us at a fast pace.

“We at Metzler Bank therefore believe it’s crucial that we understand just how important this future capital market will be in terms of how it will affect our processes and products.”

Although issuance of such crypto securities is yet to gain critical mass, Patrick Seifert, head of primary markets and global syndicate at LBBW, said the execution of Berlin Hyp’s trade following KfW’s recent deal showed the segment to be maturing.

“It’s very encouraging to see market participants ready and able to deal internally with all this issuance next to the regular business,” he added. “Questions remain as to how and when the conventional market can migrate into a token market, but bear in mind that regulation is moving along.

“There are the ECB trials that could provide a missing part of the puzzle by enabling cash settlement in tokenized form, and once you get there, you will basically be able to deliver the entire value chain in digital format.”