Intelligent Blockchain for Asset Securitisation

Enhanced Liquidity and Reduced Risk in Securitisation to address the crisis with Non Banking Finance Companies (NBFCs) in India

Siddhartha and Gary Miller

Context

“Securitisation market records 50% growth in Q1[i],” reads an Economic Times headline quoting an ICRA report. What is even more interesting is that the growth in Pass Through Certificates is 95% (Direct Assignments growing at 32%). This is on the back of a 100% growth in FY 19[ii], making India, arguably, the fastest growing securitisation market in the world.

Still, at a projected 200 Lakh Cr INR($29B), India’s securitisation market is one-eightieth (1/80) the size of the US’ ABS and MBS market[iii][iv], making India a rather nascent market given that the size of its economy is about one-eight (1/8) that of the US. For the first half of this decade, the US securitization market was still recovering from the impact of the financial crisis while high savings rate countries like India never substantially depended on securitisation to finance credit growth. In India, a perfect storm of Non Performing Assets (NPAs), Asset Liability Mismatch (ALM) and a related, but compounding, phenomenon of non-deposit taking entities (most NBFCs) getting a larger share of the credit market has resulted in the need for a fresh look at the need for capital of lending institutions.

If you think of securitisation simply as a risk-mitigated means to funding, say, someone’s home loan through someone else’s pension investments, it makes sense beyond short term triggers like GST rates and holding periods etc. But given all the issues we have faced, just linking the two words ‘loan’ and ‘pensions’ sounds scary as well. Hence, we need to go to first principles and focus on a process that enables lenders’ objectives of availability and cost of capital and investors’ requirements for the best risk-adjusted return.

Going to the first principles, thinking of securitisation as facilitating one person’s investment as another person’s borrowing

Recently at a conference in the US, Gary asked the audience why they thought most frequent ABS issuers issue quarterly? ‘Because it takes a quarter to do a deal,’ he explained. Simply put, current securitisation processes are inefficient. The time and cost involved would still be worth it if they were substantially reducing risk, yet that isn’t really the case either. Ultimately, securitisation participants are actually creating layers of cost and layers of opacity in the securitisation cycle.

All that needs fixing in the Securitisation process -lessons from the US

Figure 2. All that needs fixing in the Securitisation process -lessons from the US[v]

Blockchain for Securitisation

With the advent of blockchain technology and the evolution of Artificial Intelligence technologies, it is now possible to address many of these challenges with Securitization through a combination of AI and Blockchain, or using our coinage, Intelligent Blockchains.

In a report for the Structured Finance Industry Group and Chamber of Digital Commerce, Deloitte and Touche, LLP lists various advantages of the Securitisation process moving to a blockchain[vi]:

One Version of Truth — Services, Issuer, Investor (and Credit Derivatives market makers) all have exactly the same view of every single loan in the portfolio, eliminating any inter-entity or inter-system reconciliation requirement.

Comprehensive, Tamper-proof Audit Trail — Every transaction on a Blockchain is immutable, thus providing a comprehensive, tamper-proof audit trail for regulators and auditors, as well as each subsequent investor.

Efficient Market — Better Valuation & Price Discovery — Transparency ensures more efficient market where ‘mark to model’ isn’t a poor substitute for ‘mark to market’ due to lack of liquidity and information asymmetry.

Speed and Certainty — Integrated platform and execution of contracts through smart contracts ensures near real-time transactions.

Gary, writing for International Business Times, noted that the first step to implementing blockchain or distributed ledgers technologies (DLT) to benefit the securitization process is to simply show that a transaction’s data and calculations can be run and automated using DLT[vii]. Blockchain’s connectivity and consensus mechanisms will provide trust, provide automation and efficiency, immutability, and eliminate or reduce human error. While further benefits can be achieved with the advent of digital title to assets and issuing digital securities, there is lot that can be achieved without waiting for that future.

Othera in Australia and Figure Technologies in the US have built platforms to put both the origination and the securitisation process on a blockchain. Intain has taken a different approach so that any originator can benefit from a blockchain-based securitisation process, even without originating loans “on blockchain” or issuing digital tokens for the ABS securities. Beyond the benefits of blockchain, Intain has used artificial intelligence to automate the due diligence process and also uses machine learning to forecast the pool and tranche quality for the investor — think of this as a credit quality “ticker” based on near real-time data!

Risks and Mitigation

S&P Global has talked to market participants and, while listing the benefits of blockchain for securitisation, it has highlighted potential risks[viii]. Both the authors had the opportunity to discuss the benefits and the concerns with S&P in the context of this report. Some of these risks like Key Technology Partner (KTP) risks can be addressed through appropriate contractual and governance mechanisms. Interoperability between different platforms and system compatibility remains a challenge that the blockchain industry is addressing in different ways[ix]. One such approach, adopted by Intain, is to use DLT to an extent that it brings the benefits of immutability, auditability and transparency while working with existing systems and processes as the technology evolution for a completely blockchain-centered securitisation process evolves over time.

Future

While the benefits of securitisation on blockchain are obvious, we see it is an evolution rather than a revolution. This evolution would cover three facets that may characterise phases of this evolution:

1. Blockchain as the Information Rails: Intain is currently piloting a securitisation transaction for about 20,000 payday loans on a blockchain platform in India working with a leading issuer. The Originator, Issuer (SPV), Investor and potentially, the Rating Agency, working of the same blockchain with real-time availability of loan level data is something that the industry can benefit from now. We see a wider adoption in six to twelve months where reconciliation and reporting gets automated and all participants and the regulator benefit from auditability of the transactions.

2. Digital Assets and Digital Securities: A ‘dematerialised’ loan contract and a digital security based on the units of a securitised tranche almost like a mutual fund unit is already a possibility in terms of technology but needs an enabling legal and regulatory framework. We should also look at the concept of immutable loan records (something akin to an Aadhar of each loan) as built by Global Debt Registry (https://gdr.co/ ).

3. Securitisation Marketplace: One or a few industry platforms where issuers can get a lower cost of capital in return for the additional transparency offered and an efficient price discovery mechanism is what we should aim for. It will also bring in smaller originators to the market facilitating financial inclusion. For the large originators, it will allow smaller issuances at much shorter time intervals. On the other side, with even boutique, city-based investment advisory firms achieving few hundred crores (billions, 1B Rupees = 14M USD) in AuMs, a new set of investors could enter the market.

Siddhartha has held executive leadership and board positions in Financial Services operations and technology. He is the Founder and CEO of Intain

Gary Miller is a veteran securitisation banker who has lived the impact of the financial crisis and has been a leading proponent of securitisation on blockchain. He is the President of Intain Inc.

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Siddhartha Siddhartha

Written by

Founder of www.intainft.com and www.in-d.ai , background in financial services operations, working on building financial systems combining blockchain and AI

The Startup

Get smarter at building your thing. Follow to join The Startup’s +8 million monthly readers & +792K followers.

Siddhartha Siddhartha

Written by

Founder of www.intainft.com and www.in-d.ai , background in financial services operations, working on building financial systems combining blockchain and AI

The Startup

Get smarter at building your thing. Follow to join The Startup’s +8 million monthly readers & +792K followers.

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