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WHAT DISTRIBUTED LEDGER

TECHNOLOGY CAN DO
FOR CAPITAL MARKETS
by Glen Fest

To understand why theres been so much excitement about so-called blockchain technology,
consider the drastic change coming this spring
to the nearly $600 billion secondary market for
leveraged loans. The Loan Syndications and Trading Association plans to enact new rules on how
investors and sellers in non-distressed loans are
compensated for late-settling trades sometime
in the second quarter. Bearing the brunt of the
changes will be buyers, who will lose out on collecting loan interest payments that are made
between a loan trades purchase agreement and
ultimate settlement. That period averages three
weeks.
Rather than being automatically entitled to
the spread on a loan during that period, buyers
will have to bring funds and documents to the table to close the transaction within seven days or
forfeit the so-called delayed compensation. While
sell-side firms do collect their own delayed comp
in carry-forward charges from buyers during the
period of delay, the loans trades are holding up
capital on their books while waiting to clear.
For the LSTA, the delayed comp changes are
an overdue correction to a slow settlement practice that provided investors with no-risk income
as they waited for a deal to close. You could
argue the buyer wouldnt do all the things they
need to do to close that trade in a timely fashion

because they are getting free delayed compensation here, says Ted Basta, the trade groups senior vice president of market data and analysis.
The directive by the LSTA has spurred complaints by investors, however that they are being
punished for the tortoise-paced settlement practice in loans. Loan buyers argue the delays are
caused by the lack of automated processing of
trades, rather than any incentive for them to sit
on their thumbs while collecting free money.
They have a point.
The processing regime behind loan settlements is notoriously anachronistic, with agent
banks often ferrying faxes and e-mails between
buyers and sellers to close loan trades. Trades are
often held back by exceptions that must be manually fixed such as having to determine a traders compliance with know-your-customer regulations, or whether a buyer is permitted to obtain
the loan under borrowers consent clauses in the
original credit agreement.
The delayed comp dilemma is among many of
the sludgy settlement and processing practices in
the capital markets. For many proponents of modernization and more efficiency in the loan, bond,
swaps, and private placement fields, its well past
time to put investors, banks, brokers and borrowers on the same technological page.
Or, perhaps, the same chain.

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COVER STORY

Over the past two years, a buzz has

been building over the potential for the
use of blockchain technology in financial
services and markets. The original blockchain is the distributed ledger behind
Bitcoin, providing a constantly updated,
public record of the history and ownership of each unit of the virtual currency.
But most of the financial industrys recent
flirtation has been with blockchain systems that are unconnected to Bitcoin, or
any digital token for that matter.
What has financial markets intrigued
about blockchain is the potential to offer
the same shared ledgers across multiple
users to perform financial transactions
or back-office functions in a manner
that delivers real-time data to all parties
involved. Instead of data, documents or
other information rolling out from a central database to users private systems, the
ledger is viewable and usable at once
by any and all nodes on a distributed network (either private or public).
Its both automation and sharing the
automation, said Preston Byrne, the chief
operating officer and co-founder of Eris
Industries, a startup blockchain company
based in London whose open-source platform is used for developing shared ledgers
tied to syndicated loan origination and
issuance.
You can automate anything on a Microsoft SQL server platform, said Byrne.
That was doable 10 years ago. But what
you cant do is automate something at the
same time in two different places with an
SQL server.
Many of the exact case uses of blockchain technology remain theoretical, or
in the back-office development of institutions, but many emerging case studies
from startup vendors like Eris or Digital
Asset headed by former JPMorgan executive Blythe Masters are converging on
the capital markets.

Accenture will be the preferred sysAt a conference last summer hosted

by American Banker, a SourceMedia sister tems integrator, implementing the tools
from Digital Asset. Both
publication like Asset Secucompanies are founding
ritization Report, Masters
members of the Linux
spoke of the need for imHyperledger Project that
proving settlement latency
involves banks, clearingin the back office. She nothouses (like the Depositoed the delays of days, weeks
ry Trust & Clearing Corp.)
or months in back-end
and tech companies collabprocessing, and the ineffiorating on potential soluciencies in record-keeping
tions.
(and the related hazards in
According to a blockregulation and compliance)
chain industry report last
and settlement, which can
Blythe Masters
fall, Digital Asset is one
take days or even months
of the most widely foto complete.
cused vendors in its plans
The industry is under
to produce blockchain
enormous pressure to recapital markets solutions.
duce its operational costs,
Digital Asset is developing
she said, and blockchain
tools that would handle
tech has the potential to
workflow in origination/
solve this problem. I beissuance, middle-office aulieve that [blockchain] techtomation and clearing/setnology has the potential to
tlement across loans, OTC
truly change the way the
and listed derivatives, fixed
financial world operates,
income, private equity, prito reduce costs, improve
vate placement and trade
efficiency, reduce risks and
Preston
Byrne
finance.
ultimately provide better
While not working on
customer service, which
settlement solutions, Eris
ultimately is what financialhas been focused on the
ly services needs to be all
handling of the origination
about, Masters said at the
and issuance of syndication
conference.
loans. The company has
Digital Asset has been
its own alliance with PwC,
one of the most watched
and several bulge-bracket
firms in the blockchain
banks have adopted Eris
space. In February, Masopen-source software to
ters firm announced a
handle lifecycle managepartnership to help form
ment of debt instruments,
a blockchain practice unit
according to Byrne.
within Accenture, PriceGabriel Wang
Few
details
have
waterhouseCoopers and
emerged about specific
Broadridge to assess and
implement blockchain solutions for cli- uses that financial institutions are planning to develop with blockchain technolents.

12 Asset Securitization Report // March 2016

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COVER STORY

ogy. That seems less a trade secret than the

reality that banks arent sure how blockchain-based protocols will evolve, according to Gabriel Wang, a buyside analyst on
institutional securities and investments
for technology research firm Aite Group.
The mechanism that many point to as
a means of delivering blockchains promise is the use of smart contracts applications within the blockchain format that
carry instructions on how information or
data is to be carried out. For example, according to Wang, a smart contract could
automate a business process (such as a
title transfer) when certain conditions or

negotiations could take days and settlement times can be weeks. Thats why a lot
of blockchain vendors in the space have
looked at syndicated loans, corporate
bonds and ABS as a focus in their area.
In looking at efficiency gains, the potential changes to existing practices and
transaction structure in capital markets
are expansive. Eris Byrne sees a host
of new realities that could govern how
transactions are conducted and managed
through blockchain automation.
Lets say its a note or bond, Byrne
said. Do you need a registrar anymore
if the software is keeping track of who

out, there is a market pricing function

to exchanges and clearing houses that
cant be replaced or replicated in a direct blockchain connection. Bitcoin was
trading among a closed group of participants that needed perfect transparency,
said Byrne. With trading in the financial
markets, you dont want perfect transparency. You want your affairs and your
holdings to be opaque.
The blockchain is a big blank slate
and will do exactly what the bank tells it
what to do, Bryne said. Its really up to
them what those problems are.
In a recent white paper, the DTCC

You can automate anything on a Microsoft SQL server platform. You could do that 10 years ago. But what you cant do is
automate something at the same time in two different places.
trigger events are met in a trade.
But of the all the financial sectors,
capital markets are the most conducive to
blockchains structures. Capital markets
deals tend to be large-value, low-volume
deals that fit into a blockchains limited
scalability and speed of execution; they
also carry high clearing and settlement
risks mired in paper-based workflows and
have a finite number of market participants that a blockchain could expand to
include.
If you are trying to use this in U.S. equity markets, where you have high speed
trading, algorithms, and the ticket sizes
are pretty small, blockchain is not very
suitable for markets like that, said Wang.
For syndicated loans and ABS, you
have this really large notional amount of
volume to trade, he continued. They
are made over the phones, in which trade

owns what? Do you need a clearing system if all of the software that is managing the lifecycle is not only tracking who
owns what, but also all the transfers that
[can] become legally valid once someone
has submitted an instruction to transfer
them?
And can you then take all those roles
and collapse them into the lead manager
or the arranger/agent, whoever is sitting
at the top of these transactions?
One of the first successful tests of a
blockchain technology taking on a traditional role was Decembers announcement by NASDAQ OMX Group that a
client had used its Linq blockchain ledger technology to conduct a shares transfer to a private investor all without the
benefit of a middle man clearing house.
That may be a bridge too far in some areas of capital markets. As Byrne pointed

noted that distributed ledger technology

had key platform challenges to overcome,
including a lack of coordination on standards and the ability for improvements
in settlement time that wont need mass
blockchain adoption.
Importantly, while there has been
a great deal of discussion around implementing real-time settlement using distributed ledger technology, the current
U.S. equity market convention of T+3
is based on laws and market structures,
the report stated. Modernizing current
practices and laws to enable real-time settlement are not dependent on the use of
blockchain technologies.
However, the DTCC did single out
syndicated loans as an area where blockchain could fill the gap that has not been
filled by proprietary automated workflow
solutions.

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