Standard Chartered says a group of investors has bought up $500 million worth of tokenized trade-finance assets that it posted to the public Ethereum blockchain.
Steven Hu, Singapore-based head of digital assets for trade and working capital at the bank, says “about ten” institutional investors oversubscribed the two tranches of asset-backed debt. “Strong demand shows we can achieve liquidity in tokenized assets,” he told DigFin.
He added that this is the first time a bank has tokenized real-world assets on a public blockchain.
The pilot scheme for tokenizing trade-finance receivables is part of Project Guardian, an effort by the Monetary Authority of Singapore and the Bank of International Settlements to develop standards for financial applications on blockchain. The goal is to promote compatible systems and broader participation, and to avoid market fragmentation.
Standard Chartered partnered with Chinese supply-chain fintech Linklogis, which provided the technical platform, and with SGX, which listed the tokens. Standard Chartered has a stake in Linklogis.
Going public
StanChart chose to use Ethereum because investors can use it to directly access the tokenized assets in primary and secondary markets.
Ethereum also offers transparency and traceability of the tokens and therefore provides real-time updates related to the underlying asset, in this case, trade-finance receivables.
In effect, the bank is using Ethereum to securitize the working capital of large importers and exporters. Trade receivables are an obscure asset class to most investors. Only the biggest, most specialized private-credit funds would know how to play in this space.
The bank is using distributed-ledger technology to transform these into fixed-income securities that can be packaged into varying tranches of risk and return. This makes it easier for investors to analyze, acquire, and trade, and creates a secondary market for the underlying asset.
In addition, Hu says the use of smart contracts makes the process of issuing and distributing these assets much cheaper and more efficient. Hu declined to detail the underlying asset or its pricing, but says these benefits in theory should lead to better yields for investors.
Transparent and traceable
Pricing is also determined by the potential for trading these assets in a secondary market. So far that has not taken place, but with ten institutional investors involved in the pilot, a secondary market may emerge. Unlike bond markets, which are usually over the counter, these tokens are listed on SGX, so this new market structure has some equity-like facets.
Transparency is another aspect of this pilot that is meant to be an improvement upon paper-based asset-backed securitization (ABS). A problem with ABS instruments is what the industry calls ‘information asymmetry’. This means the investor has little to no visibility about the underlying assets: they are loans or other instruments packaged by an investment bank into securities.
The 2008 financial crisis was triggered by this mismatch in the form of US subprime mortgages that had been sliced and diced and put into securitized tranches by Wall Street investment banks. These instruments, called collateralized debt obligations (CDOs), were then assigned credit ratings, and investors largely bought them on faith.
In the case of StanChart’s pilot, disclosure of certain information is embedded in the token, and can be updated simultaneously across the network. This is intended to boost investor confidence about what they’re buying and help grow demand for tokenized assets.
Privacy and security
But transparency cuts two ways. Issuers don’t want to release private details about their loans, including pricing information. Investors may not wish to disclose details of their holdings.
“We’re using this pilot to learn how we can manage data protection, for issuers and for investors,” said James Li, CEO at Linklogis International in Hong Kong. “If successful, this will enable the bank to be more efficient, securitize loans more quickly, and distribute more. It can have a big impact.”
There are other challenges related to using public Ethereum. One is governance. Financial institutions are minor players in maintaining the blockchain, which relies on proof-of-stake consensus. That means they have little say if developers want to fork the protocol, or defend the network against possible attack.
In the wake of Ethereum’s transition to PoS last September, analytics company Nansen reported that of the 4,653 active nodes maintaining the network, 64 percent of staked Eth was held by just five accounts, including Coinbase – and a majority was held by two accounts, including AWS.
This undermines the idea that public Ethereum is fully decentralized (in contrast to Bitcoin).
Hu says asset tokenization requires a further degree of centralization. “We can’t fully decentralize trade finance. The token is connected to the real world.”
This creates the need for an independent third party to validate the status of the underlying asset. Hu says the bank is still vetting potential custodians to serve this function. (StanChart has a stake in one, Zodia; Hu declined to say if it’s on his shortlist.)
Who does what
The pilot is creating a new set of roles.
The financial institution several things. Like an investment bank securitizing mortgages, the FI here repurposes the underlying trade-finance assets as non-fungible tokens. These NFTs represent each piece of underlying paper.
Then the bank creates its native ABS token on Ethereum that represent tranches of those NFTs – in this case, a senior and a junior debt tranche. These are what it can distribute to investors. It also manages the fiat cash leg settlement.
Here it relies on its partners for certain functions. Linklogis develops the ABS token’s smart contracts, enables their transfer and settlement, and registers them on-chain. SGX approves the token offering and publishes information about it as one of several digital bond listings on its books.
Another role of the FI is to serve as a “trust anchor”, which screens counterparties (issuers and investors), validates their identity, runs KYC/AML checks, and grants them the credentials to participate.
Public Ethereum can be accessed as both a permissionless blockchain (anyone can run a node), which is what makes it convenient and able to gather liquidity. But the trust anchor determines which addresses it wishes to include in the initial token offering as well as for secondary trades.
Waiting on custody
The custodian should play two roles. For now, investors must practice self-custody. That’s okay for a pilot but institutional investors are usually required by law to use third-party custodians to safekeep assets. A bank-appointed custodian could provide that service as well (although investors can choose their own).
Secondly the custodian should process trades. In the traditional world, this involves a lot of paperwork and reconciliation. In this case, it’s about ensuring the assets are what the issuer says they are – and conducts a price, similar to cutting a NAV for a mutual fund.
This is the hard part, though, which may be why it is taking Standard Chartered time to select a custodian. Pricing is sensitive information and it has to be done right and with trust. Thus an independent party is crucial, and why it would not be a good look for Standard Chartered to do this if it’s already serving as the asset originator or arranger.
This also helps provide some privacy in balance with the transparency and traceability of a public blockchain. The ABS token provides provenance and auditability of the underlying asset. But the pricing information is kept separately by the custodian.
