By Konstantin Vasilev Member of the Board of Directors of Cbonds, Ph.D. in Economics
Updated August 06, 2023
What is a bearer bond?
A bearer bond is a type of fixed-income security that differs from registered bonds in terms of ownership. Instead of having a designated registered owner, bearer bonds are owned by the person who physically possesses them, known as the bearer. The bond includes attached coupons representing interest payments, which must be presented to a bank or financial institution in order to receive the interest payments. Additionally, upon reaching the maturity date, the bondholder can redeem the physical certificate to collect the principal amount. A registered bond is a type of bond where the owner’s name and contact details are officially recorded with the issuing entity.
Similar to registered bonds, bearer bonds are negotiable instruments with a specified maturity date and a coupon interest rate.
However, such bonds have become virtually extinct in the United States and other countries for several reasons. One of the main reasons is that the lack of registration made them attractive for illicit activities such as money laundering and tax evasion, facilitating various underhanded transactions. Moreover, their physical nature makes them vulnerable to theft and loss.
Bearer bonds used to be a common form of debt security, but their physical bond certificate has been replaced by more modern alternatives, such as book-entry forms or electronically recorded versions. Bearer bonds have significantly declined, and investment banking has shifted towards registered bonds and other securities for raising capital.
In modern finance, bearer bonds are not recommended due to their security issues and the potential for misuse in terrorist financing or dishonest individuals. Most countries have moved towards registered securities, where ownership is recorded digitally» or «where ownership is digitally recorded» or «where ownership is recorded online, reducing the risk associated with physical possession and enhancing market transparency.
In summary, while bearer bonds were once a prevalent instrument, their use has diminished due to security concerns and the availability of more secure and transparent alternatives.
How do bearer bonds work?
Bearer bonds work in a way that differs from registered bonds in terms of ownership and anonymity. Here’s how bearer bonds work:
Purchase. Individuals can purchase bearer bonds without registering their personal information with any authority. The bonds are not tied to any specific owner’s name, which allows the buyer to remain anonymous.
Ownership. The individual who physically possesses the bearer bond is considered the rightful owner. There is no central record or registry of ownership, as is the case with registered bonds.
Interest Payments. Bearer bonds come with attached coupons representing periodic interest payments. The bondholder must present these coupons to a designated bank or financial institution to receive the interest.
Anonymity. The lack of registration makes bearer bonds attractive to those who wish to maintain their anonymity. Since there is no official record of ownership, it becomes challenging for authorities to trace the true owner of the bonds.
Disappearance. Bearer bonds have become rare and are almost non-existent in the US and several other countries. The reason for this disappearance is mainly due to the risk they pose for illicit activities, such as money laundering and tax evasion, which are facilitated by the anonymity they offer.
Vulnerability to Theft. Bearer bonds are significantly more vulnerable to theft than registered bonds. If the physical bond is stolen or lost, the holder may face difficulties in claiming the value of the bond, as there is no record to verify ownership.
Advantages and disadvantages of bearer bonds
Advantages of bearer bonds
Anonymity. Bearer bonds do not have registered owners’ names, providing a level of anonymity to the bondholder. This can be beneficial for individuals who prefer to keep their financial affairs private.
Easy Transferability. Bearer bonds are easily transferable between individuals. The bondholder can physically hand over the bond to another person to transfer ownership, simplifying the process.
No Recordkeeping. Since bearer bonds don’t require registration, there is no need for detailed recordkeeping of bondholders. This reduces administrative burdens for both issuers and investors.
Disadvantages of bearer bonds
Risk of Loss or Theft. Bearer bonds are negotiable instruments, which means whoever physically possesses the bond is considered the owner. If lost or stolen, it can be challenging to prove ownership, and the bondholder may face a total loss.
Lack of Identification. Unlike registered bonds, bearer bonds do not have records of bondholders. This makes it difficult for issuers to communicate with bondholders or make interest payments if the bond is lost or forgotten.
Limited Market Access. Bearer bonds may have limited marketability due to the anonymity of ownership. Some financial institutions may be hesitant to accept or trade them, potentially leading to lower liquidity.
Potential for Misuse. Bearer bonds can be used for illegal activities like money laundering or tax evasion since their ownership is not easily traceable.
It’s important to note that many countries have moved away from issuing bearer bonds due to the associated risks and potential for misuse. Instead, most modern bonds are issued in registered form to enhance transparency and security.
Examples of bearer bonds
Bearer bondholders typically store the physical certificates in a secure safe deposit box at a bank or a safe location at home. When the bond reaches maturity, it must be physically delivered to a bank either in person or through courier service for redemption.
Receiving interest payments can also pose challenges, as the coupons may get lost in the mail.
The use of bearer bonds can create complications for the heirs of the bondholders. Proper documentation should be attached to the owner’s will to avoid such issues.
Security issues associated with bearer bonds
Here are some bearer bond security issues:
Anonymity and Money Laundering. Bearer bonds allow individuals to purchase and hold them without revealing their identity. Criminals can exploit this anonymity for illicit activities such as money laundering and tax evasion. The 2009 case involving UBS illustrates how bearer bonds were used to help American citizens evade taxes.
Limited Tracing and Ownership Disputes. Since bearer bonds are not registered in the owner’s name, there is no official record of ownership. The custodians cannot identify the true owner if the physical certificate is stolen. This lack of bond registration can create difficulties in proving ownership and may lead to ownership disputes.
Reduced Accountability and Reporting. The lack of registration hampers proper accountability and reporting mechanisms. Since no records are maintained of bondholders, it becomes challenging for authorities to track ownership and transactions, potentially making it easier to engage in fraudulent activities.
Potential for Counterfeiting. The anonymity of bearer bonds can make them attractive targets for counterfeiters. The absence of a centralized database or record-keeping system makes it harder to detect counterfeit bonds, posing a risk to investors.
Tax Compliance and Reporting. Bearer bonds can make it more difficult for tax authorities to monitor interest income and ensure tax compliance. The lack of a paper trail or registered owners can facilitate tax evasion by individuals who fail to report interest income.
Risk of Loss or Theft. The physical nature of bearer bonds means they can be easily lost, stolen, or damaged. If the bondholder loses the physical certificate, there may be no way to recover the investment, leading to a total loss.
Limited Market Access and Liquidity. Bearer bonds
’anonymity and potential security concerns can deter financial institutions from accepting or trading them. This reduced market access can result in lower liquidity and make it challenging for bondholders to sell their investments when needed.
Efforts to combat illegal activities
Phasing Out Bearer Bonds. Many countries, recognizing the potential for abuse and security concerns, have discontinued the issuance of bearer bonds. Instead, they have transitioned to registered securities with transparent ownership records.
Enhanced Regulatory Oversight. Financial regulatory authorities have increased scrutiny of financial transactions involving bearer bonds. Stringent monitoring and reporting mechanisms have been put in place to identify and deter illegal activities, such as money laundering and tax evasion.
Know Your Customer (KYC) Requirements. Financial institutions are required to follow strict KYC procedures when dealing with customers to ensure they have a clear understanding of their clients’ identities, sources of funds, and purposes of transactions. This helps prevent the anonymous use of financial instruments for illicit purposes.
Anti-Money Laundering (AML) Measures. AML regulations have been strengthened to identify and prevent money laundering activities facilitated through bearer bonds. Financial institutions are obligated to report suspicious transactions and conduct due diligence on customers.
International Cooperation. Countries and financial institutions work together to share information and intelligence regarding suspicious transactions involving bearer bonds. International cooperation helps identify cross-border criminal activities and improves the effectiveness of anti-illegal activity measures.
Promotion of Digital Securities. The adoption of digital securities and blockchain technology provides a more transparent and traceable alternative to traditional bearer bonds. Digital securities allow for secure ownership records and seamless tracking of transactions, reducing the potential for fraudulent activities.
Awareness and Education. Raising awareness about the risks associated with bearer bonds and illegal activities is essential. Educating the public, financial institutions and law enforcement agencies can help them promptly identify and report suspicious activities.
Legal Penalties and Enforcement. Strict legal penalties and enforcement measures are put in place to deter individuals and organizations from engaging in illegal activities related to bearer bonds. Those found involved in unlawful activities can face severe consequences, including fines and imprisonment.
