The $4.7bn global syndicated lending market has been high on the list of potential applications for blockchain technology for over two years, but a flurry of announcements about trials in 2017 indicate that implementation is definitely planned for next year.
Alliances plan to place some smaller loan transactions, where participating banks are the agent, onto distributed ledger platforms, using smart contracts that will, for example, prevent borrowers from using collateral if they miss payments and alert participants to ownership changes.
Who is involved?
Several groups are working to the same end. First, a working strategic alliance that blends blockchain alliance R3 (which uses the Corda platform), blockchain expertise from FinTech firm FInastra, and a grouping of global banks, including BNP Paribas, HSBC, ING, BNY Mellon and State Street. The claim is that 10% of the syndicated market will be covered by the resultant ‘Fusion LenderComm’ by at least the end of 2018.
Credit Suisse is likewise planning market entry, albeit in a smaller joint venture, Synaps Loans, which is an alliance between smart contract vendor Symbiont, private equity-backed Ipreo’s loan settlement platform, fund managers and agent banks. These are not the only two projects expected to come to fruition next year, as Lendhaus in the UK is planning to use real estate lending syndication blockchain platform Othera to transfer at least part of its book onto distributed ledger systems.
Who will benefit?
Participating banks – over seventy in R3 alone – as well as service providers and fund managers will certainly benefit. The detail is covered in blockchain training, but the basics at least are now well known. The cost of regulatory compliance and agent-to-lender administration will fall, as although each bank in the syndicate will have different regulations, KYC, AML and data protection and privacy procedures and laws to follow, which have pushed up costs in recent times, all can potentially access data, audit trails and successfully completed compliance simultaneously in the same customer block instead of the current costly and relatively slow manual distribution system. All syndicating banks will be able to integrate their rolling accrual balances and regional drawdowns, compute precise interest rates, fees and charges across the entire system, and get greater assurance on asset ownership through key-enabled multi-stakeholder document access, including transaction records and ownership registers, as well as the monitoring of assets through the IoT allowed for in smart contracts.
Effect on the market
The market has never been as transparent as participants – except lead arrangers – have wanted, and the blockchain will alleviate these concerns. Proponents also believe that the new technology will cut delays in settling loan trades, – one estimate suggests from 20 days down to 7, at least initially, with great speed to follow. Thomson Reuters believes that faster also equals less risk from a cybersecurity and operations standpoint. For all of these reasons, proponents believe that the market may gain liquidity - proponents suggest that investors, for example mutual funds and institutional asset managers, may be inclined to join where, until now, delay, lack of transparency and cost have been sufficient deterrents.
There are, however, three great potential advantages which even blockchain advocates have been cautious to promote. The first is that there may be improvements in asset liquidity in the secondary market, as it becomes more easily accessible through the creation of ‘smart securities’ and due diligence. Secondly, syndicating banks will be able to place actual transactions and asset monitoring into their global risk management systems in real-time. And thirdly, flowing from this, if AI is integrated into distributed ledgers as promised by the blockchain innovators, then automatic position changes to optimise loan portfolios in response to macroeconomic or transaction-specific events will become a reality.
Potential issues and threats remain, which are up for analysis in blockchain training courses. Compliance regulations for blockchain syndicated lending have not been released, for one, so that the ability to data mine may be restricted. The same applies for borrowers: the lenders may be ahead of their own clients’ ability to conform with the new technology, whether in data provision or IoT. Real-time access to positions may bring problems in its wake, too – syndicated lending has always been attractive for banks that are constrained by capital-asset ratios to join loans to larger borrowers, but if they are operating at the margin of their allowed ratios, the threat of real-time changes in asset values could damp their enthusiasm.
Claims that spreads might rise seem misguided, too, as easier compliance will draw more and smaller banks into the syndication space, a development specifically invited by the blockchain developers and alliances themselves, in a market that is already very definitely mature. Fees for syndicated lending are already falling – down 17% in 2016, for example, according to Thomson Reuters, and the blockchain could well push them down further.
What the future holds
Greater transparency may even reduce the pool of lead loan arrangers – whether this happens will be seen as early as next year when the market opens up. The largest risk, though, might be success itself. Syndicated lending has been claimed as a potential use for open source Linux based Hyperledger Fabric too, so ultimately, despite the initial appeal to major lenders, P2P structures in syndicated lending might be enabled by the likes of Finastra and Othera. The banks have little choice but to join a journey with a very uncertain eventual destination, however attractive the scenery on the way.