Corporate Bond Market in India and Importance of Blockchain

So, what are Corporate Bonds?

Corporate bonds are debt securities issued by private and public corporations to raise funds for meeting business objectives like supporting ongoing operations, business expansions, merger & acquisitions etc. without diluting the current shareholders' equity.?With?bonds,?corporations?can often borrow at a lower interest rate than the rate available in banks. At the same time, it helps in raising long term debt, generates liquidity and also reduced burden on regular banks.

When one buys a corporate bond, one lends money to the "issuer," the company that issues the bond. In exchange, the company promises to return the money, also known as "principal," on a specified maturity date. Until that date, the company usually pays you a stated rate of interest, generally semiannually.

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Current Bond Issuance Process: This involves multiple mutually-untrusting stakeholders?playing specialized roles. These entities, which include the Issuer (Company), Merchant Bankers, Legal Counsel, Rating Agencies, Trustees, Collection Bankers, Registrars form a Consortium or a ‘Working Group’. This group works on several documents including engagement letters, consent letters, disclosure documents, due diligence certificates, issuer undertakings, escrow agreements, regulatory submissions etc. The working group members?discuss, exchange emails, negotiate, create these documents, review them, approve them?by wet-ink signing & sealing and finally submit them to the regulators for permission to issue. ?Once regulator approves the issue, it is open for subscription and then the investors subscribe.

During allotment, there are?several intermediaries who are involved in record keeping and reconciliation. ?

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Why Blockchain?

Blockchain, a distributed database that is practically immutable, maintained by decentralized Peer-to-Peer network using a consensus mechanism, cryptography and back referencing blocks to order and validate the data transactions. It offers some remarkable features like trust among users, data immutability, security, transparency & accuracy, interoperability, smart contract execution, trusted record keeping, access control, auditability etc.

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Proposed Solution

This gives a picture of how the “to be model” on a blockchain is structured to function with reference to various participants in the blockchain.

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1. New Securities are issued into the Asset Ledger by the Issuer. Origination of the asset is represented digitally by a new “Tokenized Asset’ by the issuer.

2. The issuer approaches the Investment Bank for help with the securities issuance process and the Investment Banker initiates a digital term sheet and obtains sign off from the issuer.

3. Here Lead Manager and Syndicate Members have a single view of the Master Book on a blockchain platform. This Master Book contains orders or bids from prospective investors with details as to the quantity of shares and their price.

4. The Fund Manager uses tokens to manage the investor’s holdings recorded on a fund ledger. The tokens represent cash or security based on the investor transaction. These tokens are used to determine investor portfolio value and to represent investor’s holding on the blockchain platform. These tokens will be used in case of trade settlement happening within or outside the platform.

5. Cash transfers are also represented via tokens with buy and sell facility. Tokens can also be used for representing credit and debits in corresponding Cash/Suspense accounts on the platform. These tokens are assigned to a stable price and could represent one unit of a particular currency.

6. Custodians or Banks: These participants come into play when settlement happens outside the blockchain platform. They act as keepers of tokens represented on a blockchain platform and transfer security/money to the beneficiary accounts corresponding to the tokens represented on the platform.

7. Digital Securities are credited to investor’s account (replacing the paper notes/ certificates)

8. Mandatory Corporate Events and Disbursements are executed by triggering Smart Contracts. These events are initiated by the corporation and affects all shareholders. Dividend payments, coupon payment, interest, stock splits, mergers, return of capital, bonus issue, etc. comes under mandatory corporate events and disbursements. These corporate events can be converted into smart contract which would auto-execute updating all shareholders of the asset and cash account based on the corporate event.

9. Regulatory reporting related to issuance process becomes easier as the data is now publicly accessible with complete electronic audit trail providing full transparency. Regulators could audit live data directly on the public ledger and verify the transaction history and details on the platform. we will be discussing this in coming slides

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A glimpse of Stakeholders, their roles, permissions and Income and expenses. E.g The Regulator(s), oversee the consensus formation and are part of all the blockchains. The regulator can retrieve information from any network or participant in the ecosystem. Participants can submit grievances to the regulator in case of permissioned members misbehaving or cartelizing. The regulator may punish the intermediaries by revoking licenses, monetary penalties and / or?intermediary rating?downgrades. The regulator maybe authorized to reverse transactions by putting in a transaction that is counter to an illegal transaction. If the regulator opposes a block formation, even if the blockchain has a majority consensus, it would be considered there is no consensus.

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How Blockchain Can Transform Bond Market:

It can be used to simplify various events and documentation process occurring during different stages of bond issuance like:

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Challenges Vs Benefits:

???????CHALLENGES:?speed and scalability, open source framework, Strategic architecture and unclear legal framework

???????BENEFITS: Truly real time transaction, truly distributed ledger and execution, improved regulatory effectiveness, smarter and cheaper financial services for participants, huge potential for integration with other emerging technologies such as Artificial Intelligence and Internet of Things

We are in an early stage of blockchain application-systems development and adoption as industry is still developing proof of concepts (PoCs) at individual level or in consortium to test and develop industry standards for blockchain. Future looks promising as more and more countries have started testing blockchain based solution for their capital markets. For near future, I would quote a popular line from the series- Games of Thrones “As rulers of the North, they must always be ready for anything that could happen—and eventually, something will,?WINTER IS COMING.”