Blockchain has the potential to revolutionize the financial services industry, in particular structured finance, and is rapidly becoming more of a when than an if. A main reason for the failure of the private-label residential mortgage-backed securities market to return to pre-crisis levels is due to a failure in trust, but this stalled market is ripe for innovations.
Today’s model for mortgage data exchange is based on an outdated notion of what is technologically feasible. The servicer’s database is still thought of as a stand alone system-of-record and the investor’s database as a downstream applications that needs to rely on, reconcile, and make sense of loan-level ‘tapes generated by the system-of-record.
This model of a single system-of-record housed with the servicer could be transformed into a blockchain, with every detail of every mortgage and all subsequent transactions captured and distributed to investors. With this new model, investor reporting as it exists today would cease to exist.
This new method would instantly update investors with borrow activity, such as refinancing, prepayment, and rejected payments. On a blockchain, these transactions are a sequence that everyone can decipher.
Using Blockchain to Garner Trust in the PLS Market
Information asymmetry is consistently a problem for many in the PLS space, with many transactions having 10 or more parties contributing to verifying and validating data, documents, or cash flows in some way. Blockchain can help to overcome this asymmetry and among other challenges, share loan-level data with investors, re-envision the due diligence process, and modernize document custody, by allowing private blockchains to share information and document access with relevant parties.
The current steps for the due-diligence process are representative of the lack of trust in the PLS market. Increased transparency, using blockchain technology, could help to restore some trust and make the process run with less resistance. Automation can streamline the due-diligence process, taking out the 100% file review that is currently required, and adding this to a secure blockchain only available to select parties. If reconciliations are deemed necessary for an individual loan file, the results could be automated and added to this blockchain.
Blockchain and Consensus
Talk about implementing blockchain into the realm of structured finance cannot ignore the issue of consensus, something at the heart of all distributed-ledger systems. Private (or ‘permissioned’) blockchains are designed for a specific business purpose, so achieving consensus requires data posted to the blockchain to be verified in an automated way by all parties relevant to the transaction.
Much of blockchain’s appeal is bound up in the promise of an environment in which deal participants can gain reasonable assurance that their counterparts are disclosing information that is both accurate and comprehensive. Visibility is an important component of this, but ultimately, achieving consensus that what is being done is what ought to be done will be necessary in order to fully eliminate redundant functions in business processes and overcome information asymmetry in the private markets. Sophisticated, well-conceived algorithms that enable private parties to arrive at this consensus in real time will be key.