OpenLaw and the Loan Syndications and Trading Association Partner to Automate Complex Loan Agreements
OpenLaw has partnered with the Loan Syndications and Trading Association (the “LSTA”) to explore how a revolving credit facility could be automated with blockchain technology to streamline both the origination of syndicated loans and the trading of those loans.
Blockchain technology creates potential new pathways for lenders, borrowers, and banks to streamline the structuring and execution of complex lending agreements. One prime example of this capability are syndicated loans — complex lending transactions where a syndicate, or group, of lenders provides a loan facility to one or more corporate borrowers.
Today, the process of originating and administering a syndicated loan often is time-consuming, expensive, and manual, which creates the risk of error or misstep.
Leading the syndicated loan market is the LSTA, a member-based organization that develops market standards and best practices, including standards for the origination of corporate loans, the trading of corporate loans and the settlement of loan trades. Members of the LSTA include buy-side institutions (e.g., institutional investors, like insurance companies, asset managers, mutual funds and CLOs) and sell-side institutions (the banks that act as arrangers, administrative agents and dealers), as well as law firms and service providers. As part of its services, the LSTA provides and maintains form legal documents that support the primary and secondary loan market.
Overview of Syndicated Loan Automation with Blockchain
In collaboration with the LSTA, OpenLaw has developed an end-to-end prototype based on the LSTA’s form of Investment Grade Revolving Credit Facility to model how parties create a loan, execute key legal documents, automate certain interactions common to syndicates, and provide the building blocks for faster settlement of loan trades. The purpose of this prototype was to explore how syndicated loans may be impacted by blockchain technology, assuming this technology continues to mature and become incorporated into the underlying fabric of commercial life.
Through this exercise, we identified several aspects of the syndicated loan transaction that could be impacted and automated using blockchain technology and associated smart contracts. Specifically, we demonstrated that:
● The drafting of syndicated loan agreements can be automated, in part, using legal technology tools with evidence of the parties’ agreement and associated electronic signatures stored on a blockchain;
● Smart contracts can be used to automate certain aspects of loan administration, particularly responsibilities performed by the administrative agent, which in turn should potentially lower costs in the loan market;
● Blockchain technology and smart contracts can be used to hard code regulatory compliance, in the form of approved addresses that can help ensure compliance with U.S. KYC/AML requirements;
● Blockchain technology and smart contracts can be used to hard code disqualified lender lists to streamline the borrower consent process; and
● Blockchain technology can be used to digitally represent a lender’s interest in a syndicated loan, creating opportunities to shorten settlement times for syndicated loan trades.
In developing the proof of concept, we also learned that, for now, blockchain technology and associated smart contracts have certain limitations. For example, not all provisions of the LSTA Credit Facility can be converted into code-based provisions. Smart contracts can streamline the role of administrative agent, but will not entirely remove the agent from the syndicated lending process. Finally, there are practical limitations currently presented by smart contracts, because they can only interact with tokenized assets. Unless a digital asset gains widespread adoption — or there are additional services that make it easy to convert traditional fiat currency into digital assets — blockchain-based applications and services will take time to adopt.
A Deep Dive into Syndicated Loan Automation with Blockchain
Diving deeper, in this proof of concept, we digitized the LSTA’s form of Investment Grade Revolving Credit Facility (the “LSTA Credit Agreement”) using OpenLaw’s open source markup language and automated key performance provisions using blockchain-based smart contracts.
Through this approach, we demonstrated how parties to a syndicated loan transaction could conceivably gain the ability to repeatedly — and rapidly — execute complex lending agreements, potentially decreasing the time it takes to close these transactions.
We also demonstrated how a standard credit facility agreement can be electronically signed, using OpenLaw’s Sign and Store, with evidence of the final agreement and each party’s signature securely recorded to a tamper-resistant blockchain. Through this approach, electronic signatures and document record keeping functions, which today are mediated by centralized file hosting and electronic signature functions can be disintermediated, mirroring the traditional peer-to-peer nature of commercial relationships.
Smart Contract Components
Beyond automating the creation and execution of the LSTA Credit Agreement, we also automated certain performance obligations under the LSTA Credit Agreement using blockchain-based smart contracts, which were triggered once the relevant parties electronically signed the contract.
A core smart contract automated some of the functions of a syndicate’s administrative agent. This smart contract takes in customized parameters, like a loan amount, minimum draw amounts, and details related to the terms of loan.
Once set up, additional smart contracts were deployed, making it possible for parties to borrow, lend, make and receive payments, and perform other obligations under the LSTA Credit Agreement using digital assets. For example, the borrower could request either an ABR- or LIBO-based loan via a smart contract that calculated relevant interest rates using outside interest-rate based data feeds (also known as oracles).
Through the use of additional smart contracts, the entire process of accepting and approving borrowing requests was streamlined. An administrative agent can communicate to each lender its share of the borrowing request that the lender needs to fund. Once the administrative agent facilitates the borrower’s request, the arranger could transfer the funds to the borrower with a click of a button.
Compliance and Syndicated Loan Interests
To demonstrate how blockchain-based systems could be built to align with existing laws and regulations, we also prototyped and built smart contract-based tools to implement blockchain-based KYC/AML compliance tools. These tools were exemplary, and could conceivably include blockchain-based addresses verified against the Office of Foreign Asset Control (“OFAC”) SDN list.
Secondary Trading
Pushing further into the future, we also demonstrated how digitized lending interests could be seamlessly transferred using blockchain technology.
Limitations of Blockchains and Smart Contracts
Despite these benefits, the proof of concept also shows some of the limitations of blockchain technology.
First, the entire LSTA Credit Agreement was not completely transformed into a smart contract. Rather, only certain portions of the LSTA Credit Agreement could be converted into code-based provisions — those fundamentally representing provisions involving the transfer or management of the underlying loan. Other provisions that are more subjective in nature, like representations and warranties, cannot be represented as smart contracts and instead were maintained in the LSTA Credit Agreement as natural language provisions.
Second, the proof of concept and agreement are denominated in digital tokens. These tokens are not, yet, commonly used for accounting the exchange of value in a syndicate and likely will not be used in the immediate near term.
Third, the nature of the blockchain means that interactions with the blockchain are publicly known to participants, which has a number of implications. For example, if the syndicate were to be deployed on a public network, then anyone who has access to a node on the blockchain will know about interactions with the smart contracts deployed thereon. The parties may choose to deploy a private blockchain network, which is limited to only selected members, which may be limited to those parties commonly involved in syndicated loans. The network can be set up so that the transactions are not easily tracked but easily verified no matter whether conducted on a public or private blockchain network.
Despite these limitations, a new future for digital syndicated lending is beginning — one that promises to ensure greater efficiencies.
To learn more, watch the video above or send us a note at hello@openlaw.io.
About OpenLaw
OpenLaw is a blockchain-based protocol for the creation and execution of legal agreements. Using OpenLaw, lawyers can more efficiently engage in transactional work and digitally sign and store legal agreements in a highly secure manner, all while leveraging next-generation blockchain-based smart contracts. To learn more about OpenLaw, check out our site and documentation for an overview and detailed reference guide and. You can also find us at hello@openlaw.io or tune in in our community Slack channel. Follow our Medium and Twitter for further announcements, tutorials, and helpful tips over the upcoming weeks and months.
About LSTA
The LSTA has been the leading advocate for the U.S. syndicated loan market since 1995, fostering cooperation and coordination among all loan market participants, facilitating just and equitable market principles, and inspiring the highest degree of confidence among investors in corporate loan assets.
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Disclaimer. The views, information, and opinions expressed are solely those by the author above do not necessarily represent the views of Consensys AG. They are meant for informational purposes only, are not intended to serve as a recommendation or investment advice to buy or sell any securities, cryptoassets, or other financial products.
