Does blockchain stand a chance in the muni market?
WASHINGTON — Blockchain technology is making headway in corporate business and some muni market participants believe issuers could reap the benefits of lower fees and faster transactions by adopting it. However, it also has skeptics who have trouble seeing it making any near-term impact in an industry historically slow to embrace change.
Years after muni market participants first began to discuss the role blockchain could play in the market, the technology's penetration of the business is close to nonexistent. At a National Association of Bond Lawyers conference earlier this month, Stevie Conlon, vice president and tax regulatory counsel at Wolters Kluwer, urged the attendees to accept some changes blockchain could bring, such as reducing underwriter and dealers’ fees and tasks. But some in attendance were skeptical.
“It seems interesting at first and interesting to knock out the middleman,” Lori Smith-Lalla, a bond lawyer in Broward County, Florida, told The Bond Buyer. "But once you get into the weeds of it and really take a look at what is going to be needed to be involved for all the players to get comfortable with something like this, both legally and disclosure wise — I think it’s going to be a while off before it becomes something very in vogue.”
Some experts say a blockchain system could allow investors to buy bonds directly, standardize documents and therefore cut fees normally paid out to lawyers and underwriters. A distributed ledger is a database where users can share information, but no one user has access or control of the information. It’s sort of like a spider web, where information is connected, but there is no one central database.
By using distributed ledgers, some think issuing and buying bonds could become easier and more cost-effective.
Smith-Lalla isn’t convinced blockchain is in the cards.
“We’re going to have so much regulation that needs to be put in place, because disclosure on this stuff is going to be ridiculous,” she said. She added that it would be hard to figure out how blockchain would apply to SEC regulations and anti-money laundering statutes.
Russ Truell, a vice president at Piper Jaffray, said some governments, like Cook County, Illinois, looked for ways to implement distributed ledgers to streamline real property transactions. In May 2017, the county released a white paper on their pilot program, which explored blockchain to secure land title registries, validate credentials, register licensed professionals and more. Truell stressed his opinions were his own, and not those of Piper Jaffray.
However, the county halted the program and said though there were compelling reasons that blockchain was a natural fit for keeping land records and streamlining documents, that it wasn’t ready yet and was looking to other Illinois counties for solutions.
Truell said Cook County was the closest he has seen any government come to implementing distributed ledger technology.
“To me, it’s kind of like at the stage where back in the late 80s or early 90s, somebody came in and if you’re an accountant, put a computer on your desk and said plug it in and say this is going to solve all your problems,” Truell said. “And nobody thought about how you’re going to get all the data in, how you’re going to standardize it.”
He referenced companies that have dipped into blockchain, such as Walmart, which used distributed ledgers to track products across the globe, and said the muni space could model their system after them. However, it is more difficult to do with the amount of offices and intricacies in government.
“Walmart has figured out that it works for their supply chain, but governments haven’t figured out how it’s going to help us collect property taxes or make sure that we’re billing our water and sewer services correctly,” Truell said.
Like televisions and airplanes, there is an S curve of adoption, Truell said. With blockchain, it could be a while before it takes off and becomes commonplace, but once it hits a tip point, it could quickly popularize with 60 to 90% adoption, Truell said.
There will be breakthroughs in blockchain overall in the next five years, Truell said, and government officials will find a way to use it, if it’s to their benefit.
The municipal market hasn’t seen a change in its system in decades, said Hansmeet Sethi, chief executive officer at Fetch, a brokerage for tokenized securities. Sethi thinks that if state and local governments do adopt blockchain technology, it will be a long time from now and will face many challenges. There would have to be changes on the regulatory level and professionals in the middle of the transactions would need to change with the new technology.
“Blockchains are kind of like software eating finance, and as you see in different industries that software kind of eats into the industry,” Sethi said. “It just changes the dynamics of everything. Competition changes dramatically and there’s always resistance to that.”
In the municipal space, Sethi said fees in the middle can be high and clearing a fixed-income trade can be expensive, when it doesn’t have to be.
“How you represent securities, whether they be in the form that it is today or in this new blockchain-based world — they’re the same, right? They’re still the same regulated transactions,” Sethi said. “The difference when it’s represented digitally in a blockchain is that you massively increase the efficiency of how the transactions are cleared, settled, monitored and represented.”
At his firm, Sethi said they’re building the basic frameworks to implement blockchain, and believes people are interested in seeing the possibilities of it, calling it a “curiosity market.”
“There might be cities curiously kind of looking at it and it being presented to them by brokerages and perhaps underwriters who are thinking of more innovative ways to do things using this technology,” Sethi said.
When a trade occurs, the bond is assigned a CUSIP and it takes three days for that trade to clear, said Matt Posner, founder of the Municipal Impact Coalition. With a distributed ledger, it could be a lot faster, he said.
“Now the reasons that that is a challenge is that you agree to a trade from a broker-dealer or mutual fund, what have you,” Posner said. “You agree to the trade and then you have three days to where I don’t know what my profit and loss is going to be because markets move within those three days.”
However with a distributed ledger, middleman costs can be cut, since everyone would be trading on the same ledger, eliminating the need for CUSIPs and clearing the transaction in nanoseconds, instead of days.
CUSIPs are needed currently to track securities and trades, but with everyone being on the same ledger they wouldn’t be needed, Posner said.
Truell said the muni market could do away with CUSIPs, but was concerned about the state of securities.
“What is the SEC and other regulators going to do when you start issuing securities without official statements or without all of the following the regulations that they put in place to protect investors?” Truell said.
He referenced Cook County, saying that it needed state laws to change to follow through on the technology.
“There’s a lot of nuance to what will have to be done to make that technology fit what we’re doing today and maybe the answer will be that we will have to change how we do things to fit the technology,” Truell said.
Sethi doesn’t see blockchain as an all-in approach, but said in the next five to 10 years he could see it coming about and becoming normalized, causing some municipalities to switch over.
“Today what we’re seeing is kind of the early innings of a long cycle of creating almost a parallel financial system as far as how the transactions occur,” Sethi said.