BlockChain Technology and Collateralized Securities Loans
Collateralized securities loans are one component of a broader securities lending market that has experienced exponential growth since the 2008 recession. Regulators, securities exchanges, and central banks are embracing securities lending as an important financing avenue for companies and individuals that have been locked out of other financing sources.
In late 2019, the Malaysia Stock Exchange increased its support for securities lending when it announced its proof-of-concept development of a blockchain-powered securities lending solution that is intended to expand the capacity of the lending pool for stocks traded on Bursa Malaysia. Recent worldwide economic events will likely delay further implementation of this solution, but it nonetheless marks a critical milestone in the expansion of securities lending as a critical tool that individuals and small- to mid-size businesses can use as a source of capital and liquidity.
At its most fundamental level, blockchain technology provides a decentralized, ledger of transactions. Information and data in the ledger are distributed across many platforms and servers. Any attempt to retroactively alter any transaction in the chain will alter all subsequent blocks. In the securities lending industry, blockchain technology gives borrowers and lenders unprecedented access to information that will facilitate and expedite loan transactions while allowing for more efficient administration of those loans.
The immediate effects of blockchain technology in securities lending will be felt when securities that are part of a loan transaction are transferred among the parties to that transaction. Currently, the transfer and verification of receipt can take two to three days. By recording and storing all information in a manner that cannot be altered, blockchain can facilitate an almost instantaneous transaction. This speed and efficiency will reduce administrative costs for all participants in a securities lending transaction and move securities lending more to the forefront of debt financing options.
Several months or years may elapse before markets recover from the coronavirus shock. Blockchain technology will likely be a critical component of that recovery as businesses look for quick ways to raise capital. The technology will offer the greatest benefits to the securities lending transactions that are structured by large investment and merchant banks that borrow securities from owners in exchange for cash collateral.
The benefits of blockchain technology will later flow to individual cash borrowers that pledge their stock for unrestricted loans. Blockchain ledgers will expedite a lender’s underwriting of stock loans and will give the borrower faster access to loan funds.
Lenders will be watching the Malaysian blockchain experiment closely to determine how that technology will lower their lending costs and enable them to implement more competitive loans to their clients. In many ways, securities lending and collateralized stock loans are still a nascent industry that has not yet been encumbered by older lending practices and traditional business models. Blockchain has the potential to transform the industry into a primary source of debt financing that businesses and individuals can use to unlock the cash value and liquidity that id hidden in their equity holdings. Even if that transformation increases overall leverage in the market, blockchain and other technology innovation swill give lenders a better opportunity to control leverage and to avoid problems that have crippled overleveraged markets in the past.