Blockchain Series: How to overcome these challenges to implement a Blockchain solution for Secondary Market Assets?

 

 

In the last blog post What are the problems to implement Blockchain solutions for Secondary Market Assets?”, we discussed five problems to an effective Blockchain implementation. This post offers solutions for each of them.

Problem #1 – Multiple Discounted Systems

Solution: Bridge to Blockchain

The promised benefit of migrating to the Blockchain is perceived to be substantial, from reduced operating costs, greater asset transparency and velocity and reduced regulatory risks. However, given the complexity of these challenges described above, the diversity of the Secondary Market participants (from originators, servicers, asset managers and deal managers) and their need to focus on this quarter’s financial results, it is unrealistic to think the required changes to internal systems and comprehensive systems integrations is the likely path to implementing a Blockchainsolution.  So how will the migration happen? Standard setting bodies work very slowly and comprehensive solutions don’t stick at a time of rapid innovation. What is needed is a “bridge to blockchain” that enables incumbents to continue to use their legacy systems and operating processes while enjoying the benefits of Blockchain today. Is this possible today? Yes, as discussed below.

 

Problem #2 – Documents and Data

Solution: Systematic Verification of Assets 

There are two paths to get Secondary Market Assets on the Blockchain: first, wait until originators migrate their origination systems to be able to publish blockchain compliant Assets, or second, implement a comprehensive asset assembly and verification process to ensure that all loan tape data and loan files are verified for accuracy and completeness with the Asset metadata and an audit trail published to the Blockchain. In other words, make legacy assets Blockchain compliant with a small incremental change to current Secondary Market processes.  Once these Asset metadata is published to the Blockchain it can be  “linked” back to the source document to enable participants to instantly retrieve the complete audited Asset file.

 

Problem #3 – Mosaic of Assets

Solution: Simple Data Models for Deals

The key to resolving this problem to adoption is to develop for each asset class, a data library of key data elements, which will enable easy movement of loan data among participants. This can be divided into two projects and implementation periods. Initially, the data library would be limited to the key data elements for each Asset class required by warehouse lenders and Asset securitization transaction participants. Second, the larger data library for each asset class can be developed by appropriate trade associations. For instance, Commercial Real Estate Finance Council (CREFC) has a comprehensive data model for Commercial Mortgage Back Securities (CMBS) Deals, while Structured Finance Industry Group (SFIG) has published a data library for Marketplace Lending.

 

Problem #4 – Operating Rules Buried in Legal Complexity

Solution: Extract and Link Rules to Legal Documents.

Legal documents for managing Secondary Market Assets are complex, highly negotiated, bound by tradition and must be supported by a series of legal opinions before the money will flow. Injecting into this complexity the new requirements to embed code seems challenging and will delay the benefits of Blockchain. So how to overcome this problem? By deconstruct the legal documents to find the “if then” commands, create a business rule layer to explain how the legal requirement is implemented in a Secondary Market Asset system, then write the code to implement the business rule and have a complete audit history showing how the code applied the business rule derived from the legal requirement. In other words, don’t make the attorneys embed the code in the document, rather link the document to the code and monitor its application in a Secondary Market Asset system. This will enable smart contracts to be implemented immediately to realize the promised benefits of Blockchain.

 

Problem #5 – Current Service Providers Lack Technology Expertise

Solution: Provide turn key platform and systems support to Incumbent Service Providers.

The capital markets have historically wanted rated and recognized counter parties to act as agents, trustees, and custodians for Secondary Market Assets for compliance and legal protection. However, these corporate trust departments of large banks or independent trust service providers lack the technology expertise to execute such complex solutions. Those service providers who believe they can build such complex solutions in house will be sorely surprised at the cost, complexity and time commitment to build technology that is secure, flexible for multiple asset classes and deal types and scalable. The answer is to outsource the design, development and administration of Secondary Market Asset Systems (“SMA System”) to technology companies and provide trust and other agency services. For instance, the Trustee would execute a certificate confirming certain transactions programmed by the Smart Contract embedded in the Secondary Market Asset System had occurred.

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