Mar 13th 2023 | 06:32 | 3 min read
Blockchain is the next-gen technology that has the power to transform every aspect of the financial sector. From establishing decentralized finance (Defi) to Fintech, blockchain envisions creating a decentralized, transparent, secure and efficient financial system.
Blockchain facilitates fast, secure, and cheaper transactions while ensuring data integrity, privacy, and accountability. All these are achievable due to the elimination of central authorities & unnecessary middlemen, programmability, and automation.
One more area where blockchain can be used to reduce reporting costs, increase transparency, and speed up transactions is structured finance.
From asset origination to secondary market trading, blockchain ensures security, reduce regulative inefficiencies, eliminate time lags, streamline payment flows and mitigate fraud from the entire securitization process.
Since 2020, Vanguard, a leading investment management firm in the US, has made substantial investments in developing blockchain securitization solutions. Then, in June, Vanguard launched a blockchain pilot that aims at digitizing the issuance of asset-backed securities in collaboration with Symbiont, BNY Mellon, Citi, and State Street.
The successful execution of the entire transaction, from origination to servicing, financing, and sales, on the blockchain has further strengthened the case for the widespread adoption of blockchain securitization.
Let us understand how blockchain can transform the securitization lifecycle?
Blockchain and Securitization
The blockchain’s ability to streamline processes, reduce costs, enhance security, improve transparency and speed up transactions proves fruitful in the securitization lifecycle.
Every participant in the securitization lifecycle is affected by the innovative capabilities of the blockchain. The affected participants include originators, sponsors, guarantors, servicers, rating offices, trustees, financial experts, and controllers.
The benefits of blockchain technology for securitisation are:
- Firstly, blockchain will help to reduce regulatory inefficiencies in the securitisation process.
- Secondly, it will reduce the burden of due diligence and improve data security.
- Lastly, the enhancement in accuracy and speed helps to mitigate frauds, and counterparty risks, free up capital and lower the come threshold for the benefit of the investors.
- Most importantly, blockchain’s capability to sustain data immutability while ensuring secure transactions is highly crucial for securitization where data integrity is paramount.
How Blockchain Securitisation Works?
Blockchain technology is rapidly evolving as its adoption is growing across major sectors exponentially.
In the finance sector, blockchain offers a secure and transparent way of carrying out transactions without the need for intermediaries. By removing the middlemen, blockchain speeds up transactions and reduces costs.
Blockchain in finance levels up security and accountability by creating an immutable ledger to store all the transaction data. Further, blockchain redefines the financial structure by automating complex financial processes through smart contracts.
But there are many versions of blockchain which are used by businesses to resolve their inefficiencies. Out of all the versions of blockchain, permissioned blockchain is best suited for enhancing the securitisation process.
Permissionless blockchain is used for Bitcoin and other cryptocurrencies. In a permissionless blockchain, you don’t need the authorisation to join, view or participate in the activities of the blockchain.
However, in the permissioned blockchain network, you need the authorisation to join the network and perform a specific activity. Permissioned blockchain network is not available to the public and is mostly used in companies or institutions.
Administrators of the permissioned blockchain network can control the read and write access to data. They get to decide who gets access to read/write specific data.
Therefore, it allows stakeholders to feed proprietary information about the transaction and ensure that only authorized parties have the access to view the data.
In simple words, it means that the information available to the investors will differ from what is available to the creditors, regulators, credit rating agencies and others.
Therefore, the ability to authorise the permission to read and write data of the permissioned blockchain makes it a perfect fit for securitisation.
Blockchain Securitisation Lifecycle: Step-by-Step Explained
The lifecycle of securitisation is divided into 4 stages. They are:
- Asset origination
- Issuance and sale of securities
- Cashflow management
- Secondary market trading
Let us now discuss each step in detail and the role of blockchain in these securitisation steps.
The tokenisation of real-world assets involves creating digital representations that can be stored on a blockchain, which is commonly used in the securitisation market. This offers the advantage of simplifying and facilitating the transfer of ownership, as opposed to relying on traditional paper documentation.
The blockchain platform can record and transfer assets from the originator to the issuer within minutes, rather than days.
Furthermore, compliance with regulatory obligations is made easier through instantaneous data sharing under regulatory requirements.
The securitisation structure can include eligibility criteria, which can be automatically matched against the asset portfolio. Additionally, each asset can be tagged through the tokenisation process to prevent it from being double-pledged to another pool.
Issuance And Sale Of Securities
By originating assets on the blockchain or tokenising them, the structurer can easily access reliable information about the asset pool in real-time.
If transaction documents are executed as smart contracts, each party can have access to the same set of terms that can be updated instantly. This could eliminate or significantly reduce the need for circulating multiple rounds of documents.
Standardisation of smart contracts could enable the development of a uniform calculation model, allowing transaction parties to rely on one reliable source of data to build a model.
Therefore, the continuous updating of smart contracts with data on the credit quality of the asset portfolio can improve document management, reduce costs, and expedite the transaction timeline.
Tokenising or originating assets on the blockchain enables transaction parties to monitor the asset portfolio in real time, from issuance to maturity, and receive instantaneous updates. Moreover, the transparent nature of blockchain technology can potentially reduce fraudulent modifications.
In theory, the need for reconciliation can be eliminated if blockchain technology is used to collect and distribute payments. Further, data on pre-payments, defaults, and recoveries can be automatically linked to each tranche of securities issued.
Credit rating agencies can easily monitor the credit quality of the underlying assets and related securities, while investors can expect to receive payments in hours instead of weeks. The secure and verifiable transaction history provided by blockchain technology enables transaction parties to precisely monitor the security’s performance.
Secondary Market Trading
Blockchain technology’s ability to facilitate easy asset transfers between parties can have a significant impact on clearing and settlement, potentially increasing the liquidity of securities on the secondary market.
The instantaneous nature of transfers can potentially reduce counterparty credit risk. Additionally, the verifiable nature of the blockchain ensures that digital assets cannot be double-pledged.
How Securitization Can Benefit from Blockchain Technology?
Better Quality Loan Originations
Blockchain technology in securitization offers a multitude of benefits to all players involved, including originators, issuers, servicers, and investors. By developing a set of smart contract templates for securitization, loan originations and asset pools can be enhanced.
With blockchain, the asset pool can be quickly created and the underlying securities issued. This allows for larger homogeneous asset pools, resulting in improved statistical analysis and asset diversification. Investors also benefit from greater credit enhancement as economic stress is reduced on them.
Effective Transaction with Accurate Analysis
All cash flows between the parties engaged in the securitization process are tracked on the blockchain, leading to quicker and more accurate cashflow reporting, as well as increased execution transparency.
The technology’s wider array of analytics enables more robust statistical inference, improving the predictability of results. Below is a list of many banking procedures that could utilize blockchain in the securitization process, along with existing rates of blockchain adoption in banking.
Implementing Finance Frameworks
Securitization has been criticized for its intricate transactional frameworks, which contributed to the 2008 financial crisis.
Blockchain securitization would streamline these processes and give regulators, auditors, and other outside parties access to transparent information. This would lead to a rise in the demand for securitization-led structured finance solutions globally, increased originations for investors, and a wider range of structured finance products available to borrowers.
Future of Blockchain Securitisation
In 2020, Figure Technologies announced the issuance of the first securitisation backed by loans on the blockchain. According to the company, the blockchain securitisation model will help transactions save up to 100 basis points. The parties in the transaction referred to Figure as the originator, Jefferies Group as the structuring agent and a large asset manager as the senior note buyer.
Another firm, Bank Frick and Cadeia issued the first end-to-end blockchain securitisation in December 2021. The corporate loans were tokenised as assets and the entire cashflow management system was automated with smart contracts. Further, the securities were privately placed Swiss Franc asset-backed tokens. Their main goal was to reduce settlement time and cost while improving coordination and asset monitoring for auditors and regulators.
Though there are a few prominent examples of blockchain securitisation, its use in the financial market will take some time.
To achieve exponential growth in blockchain securitization, it is essential to approach the topic from a global perspective, which involves the standardization of international laws and ensuring strong technology compatibility. The key driving forces behind this growth would be the availability of necessary support and the positive attitudes of all stakeholders involved.
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