We are at the end of another busy autumn conference season, and I have had the opportunity to speak at half a dozen events to focus on the intersection of capital markets and distributed ledger technology.
As we wind down for the holidays and plan for 2019, I wanted to reflect on the key themes and current trends in structured credit based on my interactions with leaders and innovators in the market.
This year, ABS East saw an encouraging level of DLT specialists from larger industry participants attend for the first time. The underlying technology is now a few years old, and senior leaders in the securitization industry have become increasingly familiar with the end-value state of cheaper and faster transactions with greater asset integrity.
There is now a growing consensus that the decentralized nature of DLT supports our sector’s broader digital transformation goals, and that it can help us move away from a siloed ecosystem that has not been able to realize the same common protocol benefits seen in other asset classes.
The ABS opportunity
Harmonized data standards, shared infrastructure and immutable records have the ability to transform how asset-backed securities participants interact in the ecosystem.
Everybody, myself included, is on a journey of discovery here. That journey started over three years ago with a recognition of immutable, better record-keeping. This was followed by understanding of the value of a shared system of record to ensure that all permissioned parties in a transaction to have access the same underlying loan information.
These autumn conferences focused on the next phase of on-chain digital assets. In discussing these digital assets I’ve often been asked, “Don’t we already have digital loans?”
Even within the minority of the asset-backed securities market, where the application and origination process has been digitized, a PDF of a loan document is very different from a digital asset in the efficiency and sophistication with which it can be transacted in the credit markets.
A loan as a digital asset on-chain can be transacted with the ease, speed and certainty of other digital assets like cryptocurrencies (AML/KYC permitting), while the PDF document is still dependent on the legacy model taking weeks and significant cost to execute transactions, with limited contextual asset information attached or ability to run smart contracts.
We are seeing the emergence of two paths here: asset-backed tokens (or loan-backed) and loans native to the blockchain. In the token model, the original authoritative copy of the loan document is securely locked down with an associated token representing ownership interest and core asset characteristics.
This facilitates more efficient transactions and introduces a chain of title and verification not seen before in the market. In the native model, the loan lives solely on the blockchain, cannot be copied, printed, double spent or misrepresented.
Given the majority of lending is still paper-based, we expect to see a domination of asset-backed tokens for a while. The transaction and management of both asset types in the capital markets we call Digital Structured Credit.
Current stage of adoption
It is fair to say that capital markets is over the “hype” phase of Gartner’s adoption model with DLT.
As with any new technology, many overestimate the speed of adoption, but the market underestimates equally the long-term impact. The credit market is slightly behind most electronically traded asset classes that saw low risk in applying DLT to settlement & clearing inefficiencies.
We are hearing less about new proof-of-concept projects as the marketing value of DLT subsides and the business cases demonstrate clear benefits. Building the right social constructs, standards and incentives for value to be realized across the asset-backed securities ecosystem is arguably more important than building the underlying technology.
One of the core pillars for all digital asset classes has been custody. This had been a gap for institutional players to participate, particularly with cryptocurrencies, but still applicable to all digital assets.
In 2018, we have seen significant progress with established players like Fidelity introducing market offerings that will help drive adoption. In asset-backed securities, I continue to see commercial demand for private keys to digital structured credit being held by an established, independent custodian to deliver seamless integration to the existing securities custody and value-added services that investors demand.
Most professionals are now comfortable with the scalability, security and permissioned vs public implementation options for DLT. While asset-backed securities have relatively low volumes of data and transactions in comparison to other electronically traded asset classes, we foresee the benefits of these efforts to allow greater capabilities and on-chain development for the market.
The leading capital markets projects represented at these conferences were utilizing permissioned blockchains, with the expected controls and security, and not looking to change the industry access paradigm.
Some of the most common discussions among panelists this autumn included looking back at the credit crisis and a look forward at whom will benefit from the efficiency gains.
Could DLT have prevented the credit crisis? As with any technology, it is only as good as how humans have chosen to deploy it! (Ignoring the AI debate). There were obviously many well documented factors here, but few would argue that the immutability, enhanced data integrity and, shared system of record in keeping track of assets, diligence and all economic interests would have helped reduce impact.
Who will realize the efficiency gains created by DLT in the asset-backed securities market?
The parties who control blockchain nodes, the management of assets and the ability to author smart contracts will have significant influence on how future value is distributed.
Time will tell which constituents will drive this transition.