Blockchain Technology Disrupting the Loan Syndications Market

Transcription

1 Blockchain Technology Disrupting the Loan Syndications Market Joshua Ashley Klayman, Of Counsel Morrison & Foerster Josias Dewey, Partner & Co-chair of Technology Industry Sector Group Holland & Knight Bridget Marsh, Executive Vice President & Deputy General Counsel LSTA Tess Virmani, Senior Vice President & Associate General Counsel LSTA Presentation to the World Bank, Washington DC May 1, 2018

2 Presentation Overview Blockchain s Impact on the Loan Market US Loan Market and LSTA Blockchain Basics: A Recap Loan Market Initiatives In Search of Operational Efficiencies Raising Capital using Blockchain Technology Initial Coin Offerings, Tokens, and Token Sales Regulator s Approach Impact of Blockchain Technology on Loan Market Documentation Adapting Contracts to Blockchain Technology: Reality and Potential Credit Agreements Secondary Trading Documents 2

3 BLOCKCHAIN S IMPACT ON THE US LOAN MARKET 3

4 LSTA is the Trade Association for the U.S. Corporate Loan Market LSTA was formed in 1995 to standardize a trade confirmation for use in loan trading. Today, loan market participants turn to the LSTA for standard forms, best practices, and general assistance with loan transactions. LSTA maintains a library of documents that can be used by market participants in the origination, servicing, and trading of loans in the loan market. Primary Market Documents and Best Practices Secondary Market Documents and Best Practices 4

5 US Corporate Lending Has Quadrupled in 20 Years $3,000 $2,500 I-Grade Leveraged Middle Market Billions (USD) $2,000 $1,500 $1,000 $500 $- Source: Thomson Reuters LPC 5

6 2017 Institutional Lending Totaled a Record $933B $350 Institutional Loan Volume 100% Refinancing New Money $300 $250 75% Billions $200 $150 $185 50% 67% $100 25% $50 $- 1Q16 1Q17 1Q18 0% 1Q16 1Q17 1Q18 Source: Thomson Reuters LPC 6

7 US Secondary Loan Market Has Grown Significantly in Last 10 Years $700 Annual Loan Trading Volume $600 Billions $500 $400 $300 $200 $100 $0 Source: LSTA Trade Data Study 7

8 BLOCKCHAIN BASICS: A RECAP 8

9 Blockchain/DLT Both Have A Decentralized Peer- To- Peer Network Blockchains/Distributed Ledger Technology share a decentralized peer-topeer network that maintains a ledger of transactions that utilizes cryptographic tools to maintain the integrity of transactions and some method of protocol-wide consensus to maintain the integrity of the ledger itself. All blockchains have certain traits in common; fundamental blockchain characteristics include: Being distributed in nature Having some mechanism for reaching consensus 9

10 Blockchain Is Considered To Be Immutable Chain in Blockchain : By aggregating the transactions into blocks, we can create links between transactions -- this is the chain in blockchain. Each block contains a unique reference to the block before it. Each block is subject to a specific mathematical algorithm that results in a unique hash. The protocol subjects the prior block to a hashing algorithm, and that algorithm, when you hash all that data, comes up with an alphanumeric string. Thus, when you hash block one and put the resultant alphanumeric string on block two, you now tie those two blocks together; this process is then repeated for every block. 10

11 Permissioned Ledgers Are More Appropriate For The Financial Services Industry Open, public networks are open to the public who can query the ledger and broadcast transactions without authorization. Closed, permissioned networks are restricted to specific individuals who have received credentials from a trusted third party. Public protocols benefit from large network effects and a largely distributed and decentralized ledger resistant to censorship or failure. Private protocols address data privacy (only those with a legitimate need have access) and KYC/AML because the platform is open only to known participants. 11

12 RAISING CAPITAL USING BLOCKCHAIN TECHNOLOGY 12

13 Business Entities Are Engaging In Digital Token Sales As A Way To Raise Funds More and more business entities are engaging in digital token sales as a way to raise funds, as well as to build a following. As this new capital raising method matures, some traditional capital markets players, including bookrunners, may identify interesting opportunities to participate in digital token sales. But even if banks and other debt providers decide that they do not wish to enter the token sale space, the emergence of token sales may have a material affect on the loan market and may interact with existing forms of credit documentation in some unexpected ways. 13

14 Traditional VC Funding vs ICO Funding Traditional Early-Stage Venture Capital (VC) Funding Subject to Negotiation Subject to Traditional Diligence Dilutes Founders Equity Cedes Some Control Traditional Closing Limited Number and Type of Investors Traditional Vehicles and Equity Securities (i.e., convertible notes, stock, etc.) ICO Funding (excluding Pre-Sales) Not Typically Subject to Negotiation? Whitepaper (although some purchasers may do more diligence, and some sellers provide more disclosure)? Does Not Require Diluting Founders Equity? Does Not Require Ceding Control to Purchasers? Closing via Smart Contracts? Potentially Many Purchasers (and multiple types of investors)? New Types of Vehicles and Token Types (which still may be securities)? 14

15 Many Other US Legal Frameworks Are Relevant Investment company Money Transmitter Laws Know Your Customer / Anti-Money Laundering Requirements Tax Broker-Dealer CFTC/Commodities General Contract Law / Requirements of Good Faith & Fair Dealing Others 15

16 BLOCKCHAIN S IMPACT ON LOAN DOCUMENTATION AND LOAN TRANSACTIONS 16

17 Smart Contracts Could Express Certain Terms of A Credit Agreement As Code Data objects representing a loan could include fields capable of tracking the borrower s financial reporting requirements and periodic financial covenant testing as required under the terms of the credit agreement. Smart contract standards could make it possible to express those financial covenants in the form of code. Thus, when a borrower periodically submits its financial reports, the relevant financial data could be extracted, and thereafter, that data could be passed to the smart contract, which then uses the agreed formulae (which are coded into the smart contract) to determine automatically whether each covenant is met. That s what the future may look like until then, many loan market participants will likely run legacy databases alongside any blockchain platform. 17

18 Blockchain Platforms Can Eliminate The Need For Reconciliation Validation rules - Like any developed database whether centralised or decentralised - a distributed ledger will evaluate data entries against certain rules which validate the data and will flag an exception if a particular rule is not met. Risk of manual transcription errors can be reduced if documentation automation tools are used. When such tools are used in this way with a distributed ledger, the credit agreement can be generated from validated data stored on the ledger. Although this can be accomplished without a blockchain, if there is no DLT there is no single source of validated data because each lender s data remains behind its own firewall. In a typical syndicated loan, that likely means many different parties, each storing information about a syndicated loan, must continually reconcile all data they receives against their own internal databases. 18

19 KYC And AML Requirements Can Be Satisfied On A DLT To comply with KYC and AML programs, a secure identity system should be employed on any framework. LSTA s KYC Guidelines could be imbedded in the smart contract implementing the framework and thus there would no longer by the need for KYC requirements to be separately processed. This could result in immense savings for the industry. 19

20 Regulators Can Monitor Transactions Taking Place On The Blockchain Blockchain protocols are generally designed to record a validated history of all transactions that have taken place on the network, including a time stamp for each transaction stored on ledger and available to network participants. These features enable financial institutions to coordinate their AML efforts in ways that are currently difficult to accomplish because of privacy laws. Current blockchain protocols allow for granular control of who can see the different types of data stored on the ledger. This allows pattern detecting surveillance to pinpoint illicit activities with anonymized data. 20

21 Several Vendors Are Working On Blockchain Technologies for the Loan Market IHS Markit is working on Stax Payments Finastra recently launched Fusion LenderComm Symbiont and Ipreo have formed a JV, Synaps LLC 21

22 Token Sales Through a Credit Agreement Lens What is a token sale? Is it a debt issuance or incurrence? Is it an equity issuance? Is it an asset sale or a sale of inventory? Is it a pre-sale of goods or services? Is it a liquidity / liquidation event, for purpose of existing warrants, convertible notes, SAFEs, etc. Is a token sale permitted under my credit agreement? Should it be? Is it a change of control? Is it a fundamental change? What if the token sale is conducted pursuant to Reg A or on an S-1? What kinds of covenants or events of default do or should apply? What is a digital token? How do you take a security interest in digital tokens held by a grantor? What rights do the token holders have? (Do they have the ability to block a sale or assignment? Do they have rights in bankruptcy?) 22

23 Token Sales Through a Credit Agreement Lens Do mandatory prepayment provisions apply? Is a token sale an equity issuance? Is a token sale a debt issuance or incurrence? Is a token sale an asset sale (and do reinvestment rights apply)? Is it excess cash flow i.e., if token sale proceeds are paid in digital tokens (bitcoin, ether, etc.)? How are financial covenants affected? If token sale proceeds are paid in digital tokens, does that increase EBITDA? Does a token sale increase total debt? Should it? Has a post-token sale obligor become riskier than loan pricing reflects? Has kyc/aml for the token sale been completed properly? Was there an illegal sale of securities, whether intentionally or accidentally? Is there a heightened risk of litigation i.e., for fraud or other reasons? Has the token seller inadvertently become an investment company? Were U.S. or non-u.s. laws violated? 23

24 Further Issues To Consider With Token Sales In engagement letters / commitment papers / fee letters: Do the exclusivity provisions explicitly include digital token sales? Does alternative transaction explicitly include digital token sales? Should flex provisions include the ability to flex a tranche to a sale of digital tokens? What amendments should be proposed to existing credit documentation, engagement letters / commitment papers / fee letters? Should specific token sale related requirements be added to credit agreements i.e., such as how credit documentation often specifies criteria required for acquisitions to be permitted acquisitions. Should lenders conduct additional diligence with respect to crypto related obligors, or require such obligors to implement compliance programs (for example, in the event of an acquisition of a tokenrelated company)? 24

25 Bios Josias Joe N. Dewey, Co-Chair of Holland & Knight s Technology Industry Sector Group, is a financial services and real estate attorney and is considered a thought leader on blockchain and distributed ledger technology. Mr. Dewey is the co-author of the book, The Blockchain: A Guide for Legal and Business Professionals, published by Thomson Reuters. Mr. Dewey regularly represents a diverse group of banks and other financial institutions, from large international banks to local community banks, life insurance companies and investment funds, in financing transactions. His finance practice encompasses a broad range of asset classes and transaction structures, including real estate financing, healthcare real estate finance and asset-based lending, such as receivable, inventory, equipment and working capital facilities. A substantial portion of Mr. Dewey s practice is dedicated to blockchain related engagements, including token generating events, virtual currency exchanges, mining operations and investment vehicles managing virtual currency and digital token assets. He has written and spoken extensively on blockchain, distributed ledger technology and smart contracts. This includes experience, as a computer programmer, with several distributed ledger protocols, including Ethereum, R3's Corda and Hyperledger Fabric. Joshua Klayman s practice focuses primarily on the Blockchain, Smart Contracts and Cryptocurrency matters. She regularly represents token sellers, cryptocurrency exchanges and relayers, venture, hedge and private equity funds and their portfolio companies, token marketers and broker-dealers, funds interested in trading digital assets, major global investment banks, financial institutions and asset managers, and others in the space. She advises clients ranging from Fortune 500 and well known publicly traded organizations to emerging companies. By background, Ms. Klayman is a finance and corporate attorney and spent well over a decade representing lenders and borrowers in leveraged finance transactions involving senior, mezzanine and subordinated debt and equity offerings and coinvestments, as well as in general lending matters. In her corporate practice, Ms. Klayman represents public and private organizations in a broad array of commercial transactions (including mergers and acquisitions, as well as royalty purchase and licensing transactions) and corporate governance matters. Ms. Klayman received her B.A., summa cum laude, from the University of Pennsylvania. She received her J.D., cum laude, from Temple University Beasley School of Law, where she was a Law Faculty Scholar and a member of the Temple Law Review. Ms. Klayman has been admitted to practice in New York and Pennsylvania, and before the U.S. District Court for the Eastern District of Pennsylvania. 25

26 Bios Bridget Marsh is Executive Vice President and Deputy General Counsel of the Loan Syndications and Trading Association (LSTA). Bridget heads the LSTA s Primary Market Committee and Trade Practices and Forms Committee and leads the legal projects for the development and standardisation of the LSTA s documentation. She is responsible for responding to and addressing secondary loan market trading disruptions and ensuring that the LSTA s primary market and trading documentation reflect current market practices. Prior to joining the LSTA, Bridget practiced as a corporate finance attorney at Milbank, New York, and as a lawyer in the corporate/m&a department of Simmons & Simmons, London, and completed a judicial clerkship for The Honorable Justice Beaumont of the Federal Court of Australia. She is a Regent of the American College of Commercial Finance Lawyers. Bridget Marsh received a B.A. magna cum laude from Georgetown University, a law degree with first class honors from Sydney Law School, University of Sydney, and a Masters in Political Science from the University of New South Wales. She is admitted as an attorney in New York, England & Wales, and New South Wales, Australia. Tess Virmani is Senior Vice President & Associate General Counsel of the Loan Syndications and Trading Association (LSTA). Ms. Virmani works with the LSTA s Primary Market Committee and Trade Practices and Forms Committee on legal projects for the development, standardization and revision of the LSTA s documentation and is also involved in resolving secondary loan market trading disruptions. Ms. Virmani participates in the LSTA s advocacy efforts, including engagement with regulators and working on industry solutions to address market developments. Prior to joining the LSTA, Ms. Virmani spent three years practicing as a finance attorney at Skadden, Arps, Slate, Meagher & Flom LLP, New York. She received a B.S. from the Walsh School of Foreign Service at Georgetown University and a J.D. from Fordham University School of Law. She is admitted as an attorney in New York. 26