In our previous articles in this series we argued that banks can create new markets for themselves in trade finance by providing digitised letters of credit or trade finance instruments for the movement of both digital and physical goods using blockchain. We also highlighted the fact that Barclays, together with the Israeli start-up Wave, may have been the first organisations to execute a global trade and finance transaction using blockchain technology. Since then others have followed in quick succession, all proclaiming blockchain transactional success.
Our Uber continues to move and to disrupt. Its target is the entire process from origination of a syndicated loan, through its primary or secondary sell down, to its settlement in the secondary markets. This entire process of origination, sale and settlement can be reconciled, matched, recorded, verified, tracked and managed on the distributed ledger, which will provide immutable evidence of the completed transactions. This will eliminate the need to verify data points through manual or even electronic means because everyone in the network accessing the distributed ledger would be working off the exact same data on the ledger.
Welcoming the era of ‘Smart Loans’
We would expect that the sale and settlement of these loans (whether in the primary or secondary market) will be coupled with a self-executing contract, known as a ‘Smart Contract’. This formidable combination welcomes in the era of the loans termed ‘Smart Loans’. In other words, as soon as all the conditions to sale and settlement of a Smart Loan are fulfilled, and this data is communicated to the purchaser/payor/guarantor through the blockchain system, payment of the purchase price of the loan is triggered automatically.
Financial institutions are likely to prefer a ‘permissioned’ distributed ledger.
Buyers and sellers of syndicated loans will typically be part of a closed or ‘permissioned’ group of players, likely to be open only to an approved set of participants. Financial institutions are likely to prefer the structure of such a ‘permissioned’ distributed ledger where the data would be open to only an approved set of participants, because financial institutions must abide a host of rules and regulations, particularly the constraints imposed by the need to protect client confidentiality, to process counterparties for FICA and to vet counterparties for credit, sanctions and environmental compliance.
How do the syndicated and secondary loan markets work?
What typically happens in this instance is that the major financial institutions, in their role as primary lenders, take up a loan opportunity to fund, by way of example, an infrastructure project or an acquisition.
Thereafter, the primary lender may either hold, or sell off the loan or a portion, to a market participant who will accede to the loan as a primary co-lender or ‘sell’* to a market participant under the terms of a funded participation agreement in the form of a secondary market trade.
Thereafter, further secondary market trades may occur between this market participant and subsequent market participants, either in relation to the whole or a portion of, the loan purchased.
All of these downstream trades can be reconciled, matched, recorded, verified, tracked and managed on one, single distributed ledger to which all participants have access.
The advantage of Smart Loans using blockchain technology is that the process can be expedited.
Processes employed today to manage these trades are slow and hamper the ability of the financial institutions to sell down debt in a timely manner. The advantage of Smart Loans using blockchain technology is that the payment and settlement process for the sale and purchase of loans can be expedited, and financial institutions will be able to comply more easily and quickly with their applicable liquidity requirements.
*Where a sale of a loan is referred to in the context of a Loan Market Association Funded Participation Agreement, the ‘sale’ is not a sale of the loan itself but rather the sale of a bundle of rights as will constitute a relationship of debtor and creditor between, respectively, the Grantor (or seller) (as the debtor) and the Participant (or purchaser) (as the creditor).