OPINION: Blockchain in Commercial Finance

Blockchain, FinTech, Innovation, Investing, News, Regulation | June 15, 2017 By:

Ed Snow is a commercial finance partner at Burr & Forman (Atlanta). He counsels banks, finance companies, funds and borrowers.

It’s no secret that commercial banks have been very interested in blockchain technology in recent years. JPMorgan Chase, in particular, has garnered significant press coverage for constructing its own in-house blockchain application called “Quorum” that is built on the Ethereum platform (see JPMorgan’s press releases and white paper on Quorum at https://www.jpmorgan.com/country/US/EN/Quorum).

Several of these financial institutions have been forming – and sometimes leaving – consortiums of similarly situated financial institutions and related service providers seeking agreement on the necessary shared standards and governing principles for rolling out a distributed ledger technology (DLT) that will replicate for more general banking transactions the benefits enjoyed by more specialized cryptocurrency transactions, namely:

  • The promise of greatly reduced transactions costs;
  • Enhanced data security and verification of transaction histories;
  • Provider and user convenience; and
  • Near real time settlement speeds

Reminiscent of the early competition of videotape formats among manufacturers of VHS, Betamax and Laserdisc technologies, financial institutions are on a path to adopt and use several different DLT systems and leave to the marketplace the convergence of agreement or consensus on what commercial finance DLT structures will eventually look like and the resolution of interoperability and other issues. As recently noted by Morgan Stanley, financial institutions and blockchain are “firmly in the middle of the proof-of-concept phase of development” (see Bruce Haring, “Morgan Stanley: ‘Blockchain Still Hasn’t Had A True Test,’” Blockchain, FinTech, Innovation, Investing, Regulation, June 14, 2017, available at http://blocktribune.com/morgan-stanley-blockchain-still-hasnt-true-test/).

The syndicated loan market, in which major financial institutions participate as arrangers, agents and lenders for lines of credit and term loans to corporate borrowers, is recognized as one of the most promising candidates for the use of blockchain technology. The secondary trading market for these syndicated loans – financial assets that are purchased, sold and maintained on different centralized intermediaries’ books and records or registries – are potentially the most Bitcoin-like of any commercial finance product or asset. The trading process is typically paper and time intensive, tying up capital and resulting in longer-than-desired trading and settlement cycles, with trades occurring between seven to twenty days.

The prospects for a DLT platform that will revolutionize the trading process for syndicated loans is so promising that over the last year this industry’s trade organization, the Loan Syndications and Trading Association (LSTA), has been publishing articles and videos to educate its membership on blockchain and its potential for their market (see the interview by Bridget Marsh, deputy general counsel of LSTA, with Josias Dewey, a partner at Holland & Knight, featured as the article “Introduction to Blockchain” in the 2017 LSTA Loan Market Chronicle, pp. 46-48 and the video of such interview available at www.lsta.org).

Interest rate swaps (among other financial derivatives) are yet another promising commercial finance market product that could likely benefit from blockchain applications. A typical interest rate swap is a contractual arrangement whereby two parties “swap” certain payment streams with each other, for their mutual benefit, and allows, in particular, the party that has borrowed debt to hedge against interest rate fluctuations. The market for this product is enormous, with many commercial banks requiring their borrowers to obtain interest rate swap contracts as protections against such rate fluctuations. However, as with syndicated loans, trading in this market is primarily paper based with similar settlement efficiency issues. Here’s a video of an example of how such a financial derivative product could benefit from a DLT platform: “Blockchain CryptoSwap – A Total Return Swap Demo using Ethereum on Azure Blockchain as a Service,” https://www.youtube.com/watch?v=Jl_R9ZndeNs&feature=youtu.be.

Finally, the sale and financing of certain intangible assets such as trade receivables and chattel paper (a term referring to loans and leases secured by tangible property), might benefit from blockchain platforms whereby settlement times, security, ownership status and other efficiencies could be obtained.

Of course, with the buzz surrounding the possible use of blockchain applications for commercial finance, an extra dose of caution is warranted, especially when parties begin to free-associate smart contract remedies that might be embedded as code and become self-effectuating in the legal documentation for these financial transactions. Gideon Greenspan’s cautionary notes should always be kept in mind (see Gideon Greenspan, “Why Many Smart Contract Use Cases Are Simply Impossible,” available at http://www.coindesk.com/three-smart-contract-misconceptions/):

  • The use of external services to create smart contract effects is limited by the consensus that is required to sustain a blockchain, and the use of “oracles” to inform a blockchain’s state may diminish the value of decentralization that is presupposed by a blockchain; and
  • The enforcement of payments on the blockchain requires that a cryptocurrency be deposited and reside on the blockchain so that payments as a result of remedy enforcement are guaranteed, thereby limiting the use of the funds that must be converted to a cryptocurrency and tied up on a blockchain.

In conclusion, blockchain should be useful for commercial finance transactions involving token-like financial assets (such as syndicated loans, receivables and derivatives) that can be traded on a registry. More than this, at least in the foreseeable future, seems unlikely, and even the implementation of such a “commercial finance-lite” will not be widely possible until more uniform standards and platforms are adopted.