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Blockchain Solution for the Global Bond Markets

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The global bond market is in a stage where returns are muted and any efficiency will be a huge plus. While regulatory costs, transaction costs and issuance costs eat away a part of the meagre returns, continuous credit risk monitoring and lack of liquidity have been major concerns. The presentation looks at the nature of processes involved in the issuance and trading of bonds and identifies the pain points of the market participants. Then it discusses how we may come up with a solution for solving the bond market’s pain points by maintaining the market on an ecosystem of blockchains. A possible blockchain design for the market is described and the roles that the participants may play in the new ecosystem is elaborated. Blockchain’s inherent services help in
(1) Streamlining the issuance where all participants work in real time on common datasets and
(2) Trading of bonds by eliminating duplicative steps & shrinking the settlement cycle
The reduction in issuance time and settlement time, in turn, reduces market participant’s costs, risks and capital locked up. This solution design may have other positive side effects like improving liquidity, more transparency and easier asset servicing. The presentation concludes by looking at the evolving landscape and strategies that market players may adopt to stay in the forefront.

Published in: Technology
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Blockchain Solution for the Global Bond Markets

  1. 1. Presented by Prajeesh Jayaram in November 2016 BLOCKCHAIN SOLUTION FOR THE GLOBAL BOND MARKETS ISSUANCE AND TRADING OF BONDS ON DECENTRALISED PERMISSIONED LEDGERS PRESENTED AT FINANCIAL INNOVATION SUMMIT 2016, MUMBAI, INDIA AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA
  2. 2. Use cases in Financial Services  Payments & remittances  Issuance, ownership & transfer of securities  Audit trail, AML & regulatory reporting  KYC & other aggregations 2 BLOCKCHAIN Services provided  Consensus  Uniqueness  Validity  Immutability  Authentication Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM A transaction database that is replicated, immutable, encrypted and edited by consensus driven collaboration Technologies coming together  P2P Networks  Cryptography – Hashing, Digital Signatures, Encryption  Distributed Systems and Consensus Use Cases Models  Financial systems  Provenance tracking  Record keeping  Multi-party aggregation
  3. 3. Present Processes and Pain Points Possible Solution and the Future Issuing and Trading on Blockchain Benefits and Adoption Strategy AGENDA Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 3
  4. 4. BOND ISSUANCE PROCESS  Mutually-untrusting stakeholders playing specialized roles  Consensus, information sharing, negotiation and authorization  A shared repository of information, documentation  Issue Post Launch - Intermediaries’ services throughout the life  Depositories, Registrars, Custodians - record keeping and reconciliation Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 4 Comments reporting ISIN Issuer Investors Rating Agency Merchant Banker Trustee Depository Exchange Back Office / Custodian Registrar Regulator Escrow Bank A/C Bond Prospectus Business, financial info Credit rating Security / collateral details Term-sheet Favourable Terms Consensus terms Favourable terms Due diligence Instructions Legal Counsel Vetting/compliance check Application form & bidding Application money ISIN creation Allotment Charge Favourable terms Allotment Marketing Involves creating, sharing, reviewing and approving information and documentation between multiple mutually- untrusting stakeholders
  5. 5. BOND MARKET TRANSACTION  Trading: Mature, secure and efficient process using the best in technology  OTC broker or a Order Matching System  Clearing: Central Counterparty manages DVP and counterparty risk;  Custodian, Clearing Bank, Depository, Registrar - revenue of $40 billion in 2013^  Settlement: Netting of obligations and T+2 settlement (mostly)  Capital is tied up, ticketing charges, IT overheads and staff costs Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 5 Buyer Seller DepositoryBack Office Regulator Term-sheet Instructions Funds Blocked Buy Exchange Back Office Broker Broker Registrar Central Counterparty Custodian Custodian Buy Sell Sell Instructions Confirm Confirmation Confirm Securities Blocked Affirmation Transfer Funds Credited Funds CreditedSecurities Credited Securities Credited Pre-trade evaluation Pre-trade evaluation Clearing Bank Issuer Investor Servicing Multiple copies of the same transaction information separately maintained and reconciled by intermediaries ^ Source: Oliver Wyman Research
  6. 6. PAIN POINTS IN BOND MARKETS Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 6 Costs • Transaction costs - $26 billion for US bonds in 2015 • Regulatory costs - $12 billion for KYC/AML in 2013 • Issuance costs and asset servicing costs Risks • Monitoring credit risk continuously; trusting ratings • Liquidity - Fragmented market and capital constraints • Counterparty risk and op risk – settlement errors & disputes Delayed Settlement
  7. 7. Pain Points and Present Processes Possible Solution and the Future AGENDA Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 7
  8. 8. Check Appropriateness Bond TradingBond Issuance APPROPRIATE SOLUTION? Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 8 creating, sharing, reviewing and approving information between multiple mutually-untrusting stakeholders multiple copies of the same transaction information separately maintained and reconciled by intermediaries • Shared Repository? • Multiple Writers? • Mutually Untrusting? • Avoid Central Intermediary? • Interacting Transactions?
  9. 9. APPROPRIATE SOLUTION.. Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 9 The Asks Hygiene factors Security Scalability Confidentiality Performance Regulatory Compliance
  10. 10. APPROPRIATE SOLUTION…  Regulated permissioned replicated ledger for each bond issue  All info from pre-issue to maturity maintained as chained transaction blocks  Identifiable digital bond tokens  Denominated in on-chain currency Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 10 Issuance Ownership Risk Monitoring Trading Servicing Reporting The Design Comprehensive shared information and value ledger Market Participants are part of multiple blockchains Issuer Investors Intermediaries Regulator Bond Blockchain 1 Bond Blockchain 2 Market Infra Blockchain
  11. 11. Shared Databases BUILDING THE BOND MARKET Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 11  Network Layer - nodes, shared data and communication protocols  Separate permissioned blockchains for each bond  Market Infrastructure networks / blockchains; Gatekeepers  Apps used by market participants Exchange Bond 1 Bond 2KYC Bond 3 Network Layer Issuer Investor Intermediaries Regulator Bond Market Building Blocks Payment Applications Asset Servicing Watchlist Wallet KYC CheckSupervisory
  12. 12. Genesis Issuer creates permissioned private consortium blockchain for a new bond issue. Regulator as supervisor by default Pre-Issue Issuer adds intermediaries (Banks, rating agencies, trustees, Legal etc.) for pre- issue process, documentation, authoring digital bond and issuance IssueLaunch Regulator approves documentation and digital bond, private blockchain becomes permissioned and open for subscription Trading Intermediaries participating in transaction processing execute transactions and store the information on the blockchain AssetServicing The blockchain may have logic to execute fund transfers for coupon payment and redemptions. Bondholding can be derived from the blockchain Archiving Blockchain archived on maturity, conversion or bankruptcy of the issuer. This archive includes all the information about the bond and its transactions BUILDING THE BOND BLOCKCHAIN Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 12 Issuer InvestorsIntermediariesRegulator A blockchain to record the bond’s entire life
  13. 13. THE MARKET INFRASTRUCTURE Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 13 Issuer Investors Gatekeepers Regulator Intermediaries Bond BlockchainExchange Payment Network Purpose Bond For issuance and trading of a bond KYC For Gatekeepers to share KYC data Exchange To share price info & trade commit Payment For inter-Gatekeeper payments Blockchains / Networks KYC • KYC / Payment networks may be blockchains • Trustees and rating agencies – multiparty aggregators • Some of these networks can be combined without losing functionality and efficiency
  14. 14. PARTICIPANTS AND ECONOMICS Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 14 Node Actions Expense / Revenue Issuer Genesis, Minting, Asset Servicing Intermediary Fees, Regulatory Fees Regulator Reverse Tx, Node Additions Regulatory Fees Intermediary Creating Documentation, Consensus Intermediary Fees, Transaction Fees Gatekeeper Investor Node Additions, Consensus Intermediary Fees, Transaction Fees Investor Transaction / Info Request Transaction Fees Properly aligning incentives of market participants → blockchain adoption IssuerInvestors IntermediariesRegulator
  15. 15. APPLICATION LAYER Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 15 Used by Investor to Hold AssetsWallet • Functionality for exercising options, voting and other investor privileges • Options to communicate intent to trade Used by Issuer / Gatekeeper for Client verification / servicingKYC Check • Admission to the Bond Blockchain restricted by KYC • Other Gatekeepers can pay and get this info with investor’s consent Used by Issuer for Servicing InvestorAsset Servicing • Acts as a registry service for the issuer • Servicing - issuer authorized or automated as the case maybe Used by the Regulator for Supervision and DisputesRegulatory Oversight • Check the trade details of a particular investor • Movement of a security across trades - market rigging or manipulation
  16. 16. Present Processes and Pain Points Possible Solution and the Future Issuing and Trading on Blockchain AGENDA Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 16
  17. 17. ISSUANCE ON BLOCKCHAIN Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 17 Issuer Investors Gatekeepers Regulator Intermediaries Bond BlockchainExchange KYC Participants work in real time on common datasets Regulator’s oversight and immutability → Transparency Issuer’s Wallet Investor’s Wallet Minted Bonds On-chain Money Allotment All participants maintain multi-asset wallets On-chain money convertible to fiat currency Pre Issue • Hash of all transaction documents • Issuer creates unique bond tokens with unique Asset ID Issue Opens • Issue opens & investors join after KYC check • Investors fund wallet for subscription Issue Closed • Issuer’s wallet funded with subscription amount • Some intermediaries leave
  18. 18. TRADING ON BLOCKCHAIN  Available For Sale / Purchase flag  RFQ trading in bond blockchain  Gatekeepers may show trades in similar bonds Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 18 IssuerInvestors Gatekeepers Regulator Intermediaries Bond BlockchainExchange KYC Exchanges add value in anonymity, order matching and price- info dissemination Seller’s Wallet On-chain Money Bonds Settlement True gross instantaneous settlement of bonds Buyer’s Wallet Blockchain anchoring Committed on bond blockchain Exchange OMS Order request to bond blockchain Price: Exchange Watchlist
  19. 19.  Securely store and manage identity  Reconcile on-chain and off-chain ownership  Member in market infra networks  Authorize participation of traders  Consensus formation in blockchains THE GATEKEEPERS Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 19 Bank They maintain investor/trader’ s wallet = Bank a/c + Demat a/c convert between on- chain Money and off-chain currencies They maintain KYC data of investor / trader They move the assets between wallet’s May make market in the bonds they are members of
  20. 20. Present Processes and Pain Points Possible Solution and the Future Issuing and Trading on Blockchain Benefits and Adoption Strategy AGENDA Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 20
  21. 21. Cost Savings • Lower Regulatory Costs: Transparency and clearer order trail • Lower Transaction Costs: Simplified market will lower back office costs, lower margin postings • Fewer Market Intermediaries: Eliminating the need for replication and duplication Risk Management • Risk Reduction: Reduced operational risk and counterparty risk • Liquidity Risk: Avoiding market fragmentation and provides liquidity • Credit Risk: Amortized incentives for rating agencies, risk scores and risk analytics across securities Benefits of Early Adoption • Reap returns on blockchain investments – rush to file patents • Employees and partners get used to working with shared ledgers upfront ADDRESSING PAIN POINTS Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 21
  22. 22. BENEFITS FOR THE MARKET Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 22 Regulators • Market oversight - transparency and clearer order trail • Real-time monitoring of financial activity – asset bubble etc • Eliminates risk of single point of failure Investors • Real time settlement and capital freed up • Significant reduction in disputes and certainty in settlement • More equitable and accessible market Issuers • Efficient investor servicing due to automation and no need of a registrar • Price discovery even if trades not executed
  23. 23. ENABLERS AND POSSIBILITIES  KYC: Digital system for storing identity attributes  Real-time Risk Monitoring: Real time accounting; granular credit scores  Repos and Pledging: Very essential functionalities for bond markets  Smart Property: Contracts interacting with tangible real-world assets → enforcement Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 23 Other ProspectsEnablers Overcoming institutional inertia with regulatory leadership Legal framework for digitization, validity and enforcement Collective standardization for an all-inclusive single solution Value and trust improves with the quality and stability of the systems
  24. 24. CORPORATE STRATEGY Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 24 Iterate, Enhance, integrate Enterprise Awareness Understand Landscape Form Partnerships Solve Pain Point Evaluate Benefits An evolutionary process, that can be communicated as beneficial, by focusing on solving specific pain points
  25. 25. PROJECTS AND LANDSCAPE Digital Security Issuances  tØ: Overstock issued crypto-bond on private placement basis  Digital Asset Holdings: A portion of Pivit’s funding issued using distributed ledger technology  NASDAQ Linq: Trading & tracking of shares in private companies using Open Assets Protocol Testing by Bank Consortiums  R3: Tested trading bonds using technology by Ethereum, Chain, Eris Industries, IBM and Intel Capital Market Blockchain Projects  Chain: Open source blockchain protocol helping banks to deploy and operate scalable blockchains  SETL: A multi-asset institutional payment and settlement platform  Counterparty: Financial tools built on top of the Bitcoin blockchain  Clearmatics: Decentralized clearing network to settle trades and automatize financial contracts  Symbiont: Distributed technology platform for institutional financial markets Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 25
  26. 26.  Global bond market - muted returns and poor liquidity  Any efficiency will be a huge plus  Blockchain characteristics help in streamlining issuance and consolidating liquidity (trading)  Solution for these problems may be a blockchain ecosystem  Separate blockchains for each bond / each issuer? Single blockchain?  Entire life from genesis to maturity and two phase commit  Design is an use case specific, iterative process  Scalable, secure, confidential, reliable and compliant  Partnerships / investments to learn the evolving industry standards – open source SUMMARY Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM 26
  27. 27. 27Friday, November 11, 2016 BLOCKCHAIN SOLUTION FOR BOND MARKETS BY PRAJEESH JAYARAM BLOCKCHAIN TECHNOLOGY WILL FUNDAMENTALLY ALTER THE WAY FINANCIAL INSTITUTIONS DO BUSINESS ACCORDING TO A WORLD ECONOMIC FORUM REPORT pramax@gmail.com https://www.linkedin.com/in/pramax

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