April 5th, 2017 by jja_fr

How can blockchain and smart contracts benefit securitization?

We will explore in detail how potential benefits could play out at the different stages of the securitization lifecycle, but for now, here are some common themes to keep in mind:

One version of the truth. Blockchain enables a single, consistent source of information for all participants in the network. In an industry that currently faces inefficiencies around the storage, reconciliation, transfer, and transparency of data across multiple independent entities, this feature could be highly beneficial.

A complete, immutable, and traceable audit trail. From loan origination to primary issuance, servicing, and changes in ownership in the secondary market, blockchain can create a chronological and immutable audit trail of all transactions. With this capability, regulators and auditors could finally get a systemic view of the ownership of the underlying securitized assets. An issue that troubled the industry during the global financial crisis—determining who owned the title to some underlying assets—could be more easily resolved.

Better valuation and price discovery. The transparency facilitated by blockchain could reduce the information asymmetry and network disadvantages that some entities, especially smaller ones, currently face in the securitization industry. The resulting market efficiency could raise the investment appeal of securitized assets and deepen the potential pool of investors.

Speed and certainty. Blockchain, through its disintermediation and simultaneous recording of information across the system, can virtually eliminate time lags in information and payment flows throughout the securitization process, including in the secondary market. This increase in speed and certainty could significantly reduce counterparty risk, release capital, and reduce the return thresholds that investors demand.

Security. Blockchain’s capacity to increase the security of transactions and data, and mitigate fraud could be appealing to the securitization industry, where integrity of data is paramount. Blockchain’s immutable audit trail, for example, could permit every asset (and every transaction involving that asset) to be linked to a particular security, facilitating asset perfection and eliminating the risk of double-pledging assets.

The combined impact of all the above advantages—greater efficiency, speed, transparency, and safety for data and transactions—could lower risks in the securitization market as a whole and lead to greater investor interest. This in turn could improve prices, volume, and spreads. With better and more transparent information, regulatory compliance could also be simplified and market failures could become less likely.

With these general points in mind, we will now take a more detailed look at the specific places where blockchain could impact the securitization process, ranging from loan origination and loan servicing through the structuring, review, and initial sale of the security, to the servicing of the security, ongoing ratings monitoring, and secondary market trading. At each stage, we will look at some inefficiencies in the current process, then explore how blockchain is likely to change how the industry handles certain questions around its core functions and obligations, including data recording and dissemination, transaction execution, receiving and making payments, and regulatory compliance.

We will also look at why, despite the likely advantages, implementing a blockchain in the securitization industry may be challenging. We will conclude with a vision of a possible future state and with ideas about possible next steps.

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