Blockchain and cryptocurrency are making their presence felt across capital markets. Frédéric Dalibard, Head of Digital at Corporate & Investment Banking and Global Blockchain Coordinator, and Thierry Redon, Blockchain Project Manager at Natixis, consider recent developments and where the technology might go from here.
The likely impact of blockchain across the banking sector has been widely discussed since the middle of this decade. However, now that real use cases have emerged and the more challenging applications have been put on hold the hype has given way to a more measured assessment of the technology’s potential.
There is a clear trend among the regulatory community to make local regulations more crypto or token-friendly in order to facilitate the emergence of the tokenised economy.
We are seeing a high level of interest from originators and borrowers looking to see how they can tap into this market. There is also considerable interest from investors who want to know how they will be able to access the tokenised market more easily and with less friction – for example, asset managers wondering how they could maintain positions in their funds in a more efficient way.
This is particularly relevant for asset classes that are relatively illiquid, such as real estate, for which the tokenisation of assets could provide investors with greater ease of access.
For distributed ledger technology to be fully utilised, the monetary counterparts of these trades also have to be tokenised. To date, central banks have been reluctant to issue digital currencies, but this is changing and these institutions are now talking about the need for cryptocurrencies that are linked to fiat currencies.
The deputy director of the People’s Bank of China’s plan payments department told a China Finance 40 Forum in August that it had been working on a cryptocurrency since 2018 and that the new digital currency would replace cash in circulation as well as supporting the internationalisation of the yuan.
We believe Facebook’s Libra project has been a catalyst for this trend. Libra has made a concept that was previously hypothetical real and there is a sense from central banks and regulators that if they don’t do something, they could lose their grasp on a large chunk of the money flows within their economies.
Loss of sovereignty is a huge concern for senior economists such as France’s finance minister, who has raised concerns about a cryptocurrency with huge amounts of power but no governing rules or obligations and recently dismissed suggestions that Libra could become a sovereign currency.
In June, France revealed plans to establish a G7 taskforce on ‘stable coin’ projects led by European Central Bank board member Benoit Coeure (stable coins are cryptocurrencies that are pegged to a stable asset such as gold or the US dollar).
Bank of France Governor Francois Villeroy de Galhau said Libra would have to respect anti-money laundering regulations and seek banking licences if it were to offer banking services.
These moves by Facebook and the People’s Bank of China point to the likelihood of an acceleration in the issuance and trading of assets in tokenised form. This will happen first in non-regulated markets because of regulations around central securities depositories and we can expect to see activity in areas such as private equity.
There are already a number of initiatives in the commercial paper market and the repo market, most notably HQLAX, a blockchain solution for collateral swaps in the securities lending market designed to facilitate more efficient collateral management of high quality liquid assets.
Under the HQLAX operating model there is no movement of securities between custodians. Instead, a digital collateral registry is used to record ownership of baskets of securities, whilst the underlying securities remain static in the custody location of the collateral giver.
This model is designed to enable platform participants to seamlessly execute capital efficient securities lending transactions for enhanced balance sheet optimisation. We also see crypto assets being looked at as alternative asset classes. The SEC has pushed back strongly against crypto-related funds but various attempts have been made to bring funds to market.
In July, VanEck CEO Jan van Eck and the firm’s director of digital assets strategy Gabor Gurbacs wrote a post in which they suggested stable coins would strengthen the cryptocurrency ecosystem. They stated that Bitcoin and digital assets are already a part of many investor portfolios - just not in traditional brokerage accounts – and may play a bigger role with appropriately regulated, insured and liquid access vehicles, such as ETFs.
Earlier this month, VanEck and SolidX announced that the VanEck SolidX Bitcoin Trust would issue shares in accordance with Rule 144A under the Securities Act of 1933, as amended. These shares will provide institutional investors access to a physically-backed bitcoin product that is tradeable through traditional and prime brokerage accounts and are described as the first institutional quality, cleared product providing exposure to bitcoin and enabling a standard ETF creation-and-redemption process.
We also have projects in the trade finance space that are coming to production, such as Komgo. Natixis is one of the 15 institutions behind the Komgo blockchain platform for commodity trade finance which now facilitates standby letters of credit and receivables discounting as well as letter of credit and KYC.
Trade finance is the ideal use case for blockchain given the limited regulation of document exchange and the involvement of multiple counterparties.
Going to production has been challenging for many blockchain initiatives, but Komgo has progressed to this point successfully. Having a prototype is one thing, but going to production in a banking environment is difficult – there are IT security issues, decisions over where to host the solution, how to price the service, etc.
There remains work to do with all the parties involved in trade finance transactions, but we are confident that things are moving in the right direction.
Given that regulators are moving at different speeds, we are fortunate that the regulator in France has been helpful. This has also been the case in countries such as Switzerland, where SIX has been building the SIX Digital Exchange (SDX), the world’s first fully integrated infrastructure for the trading, settlement and custody of digital assets.
The plan in Switzerland is to port an entire portion of its market into a purely digital exchange, which is a game changer. We think this is where the market is going, although some regulators will have a lot of catching up to do.
Another interesting project in the blockchain space is Finastra’s Fusion LenderComm syndicated lending market solution. Designed to streamline information exchange between agent banks and lenders, it enables financial institutions acting as agents to publish loan data to the ledger and extend self service capabilities to lenders.
Through their own portal, agents can define and then publish lender specific deal position data to Fusion LenderComm, so individual lenders can drill down into the data without needing to query positions by phone, fax or email, as is typical today.
By allowing the sharing of syndicated loan position data more efficiently between loan agents and participants, the project addresses a key pain point by automating the costly manual processes traditionally involved in such sharing of information.
Connecting the agents’ recording systems to the blockchain provides a live view of what is going on with their loans.
This is just the beginning of how distributed ledger technology could be used. The process could easily be transferred to other markets where the lifecycle of assets and products can be complex in terms of initial margin requirements, computations and/or margin calls.
Our vision for the future is that transaction-based systems will become blockchain-based at the layer where all the transactions are recorded. Vendors are already looking at how they can synchronise the various counterparties of a trade using a blockchain backbone.
It is easy to envisage a future where the database where all these systems record their transactions is blockchainbased and the resulting automation in the lifecycle of these trades would produce considerable operational benefits.
Given that the cost of doing business is a major concern to the banking industry, this could underpin the future sustainability of banks.