At first glance, this week’s move by the investment bank Societe Generale to issue a security -like bond in which it was both the issuer and the sole investor might seem like a pointless act. You see, Societe Generale’s $112 million bond issue used smart contracts built not a private, permissioned but on the public, permissionless . But, let’s remember that this French bank belongs to an industry whose member institutions repeatedly posit that permissionless blockchains are unworkable for them.
Banks have made various arguments for why they feel compelled to use private, permissioned versions of this technology: because they are beholden to know-your-customer and other compliance rules that aren’t easily enforced in a permissionless environment; or because public ’s probability-based standard for confirming trade settlement falls short of what Wall Street’s lawyers call “settlement finality.”
Yet here was the 19th-largest bank in the world experimenting with the public model.
It would be way too premature to say that Societe Generale has discounted those industry concerns about permissionless blockchains — concerns that are more likely founded on fears of the threat to existing business models than anything else.
Societe Generale appears to be placing a side bet that the future evolution of digital finance will play out much as the battle for supremacy in next-generation communications technology did in the 1990s — lest it be left on the wrong side of history.
A bet that open systems win
At the end of the nineties, it had become clear that the public, open, interoperable Internet had beaten out private, closed, walled-garden Intranets such as Prodigy, AOL and France’s Minitel to define the new architecture for worldwide information-sharing. While the deal was an entirely in-house affair, the bank did make the bond’s terms pari passu with its other covered bonds, a category of debt that securitized by specific balance sheet assets. That means that future owners, whoever they may be, would have equal ranking and risk exposure as any investors in Societe Generale’s more conventional bond issues. And with a five-year maturity, there is ample time for the bank to take the more radical step of seeking outside buyers in a secondary market once it has a blessing from regulators.
Also important was the fact that rating agency Moody’s said it considers the use of technology “credit positive” in this case, in part because of increased transparency and a reduced likelihood of errors “arising from the complexity and the number of intermediaries involved in issuing covered bonds using traditional means.”
This positive assessment points to the generalized potential of security offerings, or STOs, as a way to more efficiently issue, manage and trade traditional assets such as stocks, bonds, and commodities.
Nonetheless, STOs still promise to be extremely disruptive to capital markets, with a big impact on investment banks such as Societe Generale. Also, if it’s a permissionless system — if there are no “permissioned” incumbent financial entities functioning as gatekeepers of a private — there is nothing to stop startup service providers shifting many traditional back-end activities such as underwriting, custody and brokerage over to a decentralized network. These are services that investment banks, for the most part, currently provide.
Seeking to control the process
What’s impressive about Societe Generale’s implicit position, then, is that it seeking to understand and have some control over a technology that will inherently threaten some of its businesses.
In doing so, it may be betting that banks like it will adjust to the new paradigm much as they did in the nineties when online stock and electronic marketplaces initially threatened Wall Street’s dominance of the securities industry.
Those systems, which made market prices more transparent, drastically reduced the commissions that investment banks could charge for , but they also promoted a surge in volumes that compensated for the tighter margins. In the end, the savviest banks invested in this new and matching technology and, in taking charge of its development, managed to retain a dominant position in capital markets.
The death of banks might well be a thing to celebrate in the future. But the reality is that the market will for some time continue to value much of the expertise and market-making power that currently resides on Wall Street, even as it starts to demand that the functional back-end tasks of record-keeping, custody, trade matching and clearing and settlement be handled by smart contracts, digital currencies and distributed networks. My guess is that this is where banks will continue to be very active.
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Published at Wed, 08 May 2019 11:12:49 +0000
