This is part of a blog series Can Blockchain Save Our Financial System?
This blog post examines structured finance, the possibilities offered by open ledger instruments and how the open ledger is being applied to create new financial ecosystems around the world.
To read the previous blog post about the benefits of loan securitization using smart contracts, click here.
To learn about how Bloxable is building the most advanced debt platform using blockchain and smart contracts, visit us here.
The rapid developments in digital technology have opened up economic avenues in many industries. The potential of blockchain allows faster and more accessible transfer of data over a secure network. This has great potential for the financial industry which heavily relies on information sharing to make decisions.
In this piece, we will review how the open ledger system can improve the creation of structured finance and aid the processing of financial instruments.
Structured Finance
Structured finance is a complex security instrument used in the finance industry by banks and institutions. Structured finance activities involve pooling economic assets together, dividing them into specific categories based on risks/return characteristics and then packaging them into securities.
The structured securities that are backed by mortgage or collateral are called mortgage backed securities (MBS), asset backed securities (ABS) and collateralized debt obligations (CDO).
These securities are issued a rating based on the risks associated with them. The highest rated securities are rated “AAA” which are the least risky (i.e. have the lowest loan default rates), but usually provide a very low return on investment. Lower ranked securities provide a higher return but have higher loan default rates, in general.
Examples of Structured finance
Structured finance can be created from a variety of loans. It usually takes the shape of CDOs, credit-linked notes and asset backed securities.
The objective of structured finance instruments is to promote liquidity for long-term debt obligations. A lender does not need to hold on to the debtor’s account. They can simply sell the loan obligation off to a third party and free the capital that was originally invested into the loan.
Open Ledger Structured Instruments
Open ledgers make it much easier to deal with money and transferring assets. For instance, if someone needs to transfer money from one part of the world to another, they would need to get in touch with a bank or money transfer company. Then, they would need to pay this agent a fee and wait for days before the transaction is processed.
With open ledger technology, the transfer fee can be close to zero and transfers are completed immediately. An open ledger is a publicly accessible platform which adds much transparency to the system. Also, investors will be able to trade and sell off their securities easily. The open ledger protocol will also allow buyers to view the history of transactions on the security that they are looking to buy. Open ledgers are very transparent with the entire record of transactions available for review.
Application of Open Ledger Technology
In October 2017, seven leading banks from the UK and Canada started a collaboration to create an online marketplace for the syndicated loan market. The joint venture was meant to reduce the operational cost and time it took to process loans. It was also meant to increase transparency and add speed in accessing critical data positions.
The signatories to the open ledger platform included BNP Paribas, BNY Mellon, HSBC, Finastra, ING and State Street.
Apart from being easily accessible, quick and transparent, open ledgers are also more secure than a single-server based ledger. Data is transferred securely over an open ledger network. Every transaction must be authenticated by a distributed network of nodes, spread around the world.
This makes it practically impossible to manipulate or hack into the system.
Open Ledger: The Future of Structured Finance
IBM and Google are already working with a number of financial institutes and banks to create blockchain based ledger systems. One solution has been put forward by IBM Blockchain that can process live transactions for 12 currencies across the Pacific Islands, Australia, New Zealand and the UK. Similar open ledgers are in development that will augment clearance and settlement of financial transactions across the globe.
Given the advantages offered by blockchain, it won’t be long before we see a complete transformation of our financial services into open ledger systems.
To read the next blog post in our series, about trading of structured finance products on the blockchain, click here.
