SEC Chairman Gensler is absolutely right in saying that “distributed ledger technology has been a catalyst for change that, around the globe, central banks and the private sector are looking in on how we can enhance our payment systems, and enhancing our payment systems to make them 24 hours a day, seven days a week, real time, at lower cost.”
Hence the reason pretty much everything that blockchain and smart contracts represent — other than the difficulty in design and implementation — would be good for the municipal finance industry.
As background, smart contracts are a function of a blockchain. As the Department of Commerce explains, “a blockchain is a collaborative tamper-resistant ledger that maintains transactional records.” Taking that one step further, as IBM describes “smart contracts are digital contracts stored on a blockchain that are automatically executed when predetermined terms and conditions are met.”
So in bond speak, it is like bundling in one place — actually distributed in many places — all the terms and conditions of a 300-page bond offering statement, then creating a technology that can securely and automatically send money through a repayment waterfall to bondholders based on all original, or approved and modified, terms and conditions. And a blockchain bond can close T+0.
One of the greatest complaints of municipal bond investors is that there are 50,000 issuers with 50,000 styles of disclosure, some still partaking in century-old issuance practices. However, just as technology has helped improve other financial markets, including equities, often through efficiency in execution, digital distribution and collapsing the cost structure through standardization, the same can be done for municipal bonds.
Blockchain and smart contracts are a better way to connect issuers and investors and make sure money can securely flow back and forth based upon certain conditions. And the ledger would describe each and every characteristic of the bond, the data behind it ... in real time.
The way it works is that a ledger links together past, present, and future data through a series of blocks. As Commerce explains, “a block (in a blockchain) is connected to the previous one by including a unique identifier that is based on the previous block’s data.” Today’s system of linking bonds with their data is complex and multi-tiered, whereas blockchain by its very nature, does this automatically in an open and transparent fashion.
With a true market buildout, terms and data reporting could be standardized creating even greater benefits for those seeking data, including investors, regulators, technology companies, other market participants, even taxpayers. With distributed ledger, new data that investors want or require can be associated with the previous data. Imagine real-time reporting on sales tax revenue or ESG data like carbon reduction and usage, economic consequences of systemic racism, or the budgetary impact of climate events.
This type of digital reorientation of disclosure practices around data is relatively future proof, especially as the world moves toward data-driven and outcome-based finance. Blockchain would move the market forward, making it better, and more transparent, and as public goods, municipal bonds should lead the way.
However, this is not going to be an easy transition, especially for issuers, especially for under-resourced issuers. But the value proposition is immense.
This is why the muni industry must coalesce around a solution and pledge resources for this “entire community” project, bringing together government, legal, financial, advisory, and academic participants, among others. It is not impossible.
The muni community has proven it can develop and finance super complex physical infrastructure, it must now turn its efforts collectively to create the digital infrastructure needed for a 21st century market, an agreed-upon set of terms and conditions which define the market itself and provide for safe and efficient digital transactions
And this will require leadership groups like the Municipal Securities Rulemaking Board, the Government Finance Officers Association, the National Association of State Treasurers, and others, including importantly, issuer advocacy groups that can convene specific industries to design their industry’s specific chain ledger/smart contract framework.
To accomplish this, the muni market should set a two-year timeline to develop an industry-wide ledger. The first year to organize into working groups, discuss the concept with industry leaders, and map out the higher level market organizing factors needed to re-architect the transactional aspects of the market into technology, as well as the bigger questions like programming language, who pays, who oversees, who builds, who helps issuers implement, etc. The second year to develop smaller working groups to design industry/issuer type ledgers and implement.
The municipal finance industry must look toward blockchain and standardization as a way forward, and not resist change as has been a challenge historically. Firms like Neighborly have talked about this concept, others like Alpha Ledger have started to build the building blocks, but now is the time for the municipal finance industry to come together with financial technology partners and execute.
Given the national importance of the municipal finance market, the sooner the industry begins collaborating on these new best practices, including utilizing blockchain, the smarter and more resilient the municipal finance market, and by extension, our communities will become. Embracing blockchain is the sustainable long-term solution and just good governance.
James McIntyre is the Chief Strategy Officer of Inclusive Prosperity Capital, a non-profit focusing on clean energy finance in underserved communities.
