Unlocking Value on Balance Sheets

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Written by Ralf Kubli

Rethinking tokenisation for non-financial firms

Introduction

Tokenisation is currently heavily focused on simple financial instruments, but it could deliver far more wide-reaching consequences in a much greater range of industries. If an impact on the real economy beyond financial institutions is to be realised, tokenisation must not only expand from cash and cash equivalents to all financial assets, but also to intangible and tangible assets expand the universe of reliably collateralisable assets.

Tokenisation will allow for easy and efficient collateralisation of many more financial assets, tangible assets and intangible assets. It will also allow for the creation of more assets and significantly expand the asset base of individuals, firms and the world, which can be used in financing transactions. Tokenisation hugely increases the range of intangible and tangible assets that can be made bankable and financeable.

Financial assets are by nature digital. In order for tokenisation of financial assets to truly deliver the promises of blockchain technology, we must remember that financial contracts are the fundamental basis of all finance. These can and must be standardised in tokenised assets - starting at the lowest granular level possible, i.e. the cash flow level.

The combination of blockchain/DLT technology with the open source ACTUS financial standard will enable a dramatic expansion of financial instruments, near-automated securitisation and granularly constructed portfolios allowing for customisable risk-return based on the appetite capital providers.

The killer use case of tokenisation - from cash netting to the entire balance sheet

It is no surprise that among first financial institutions to recognise the value of digitally represented cash and deposits on shared ledgers were those serving large-non financial clients with cash and cash netting needs in multinational settings. The earliest public use cases were UBS and J.P. Morgan. The power of an immutable and secure representation of certain facts about account balances and the movement of cash and cash equivalents within seconds on a highly secure shared ledger across jurisdictions, is evident to anyone involved in banking for multinational corporations.

Today, this use case is well developed inside many banks and extends to capital markets with tokenisation of cash and cash equivalents (Treasuries and similar). The attractiveness lies in the simplicity of the underlying instrument, whether it’s cash on a bank account, money market funds, U.S. Treasuries, or deposits on a bank account. Once tokenised, collateralisation in repo contracts or netting operations can be simplified significantly, automated and shortened in time, as they are executed on distributed but shared ledgers.

When considering the needs of non-financial firms, liquidity and treasury operations are a critical part of every firm’s management function. Typically, non-financial firms, however, hold a small portion of their total balance sheet value in cash, cash equivalents or financial assets. Therefore, for tokenisation to be a relevant driver of financial innovation it must not only efficiently expand beyond cash and cash equivalents to debt, structured instruments and derivatives, i.e. all financial assets, but also tangible and intangible assets which typically constitute a larger portion of balance sheet value of non-financial firms.

Non-financial firm balance sheets, digitisation, and tokenisation

When exploring the potential of expanding the universe of assets to be used as collateral in financial instruments, a special look at the items on a typical balance sheet is required. The underlying form factor of an asset on a given balance sheet will determine the ease with which the asset can be tokenised. However, many items on non-financial firms’ balance sheets are already digital in nature today, greatly facilitating their representation with tokens.

There are many well established and highly automated processes for using financial and tangible assets from a balance sheet as financing collateral; for example, (overnight) repo transactions by large corporations or collateralised lending against fixed assets. Certain other processes, like short term working capital financing or obtaining long term credit from a local bank, can vary greatly in degrees of automation and efficiency for the parties involved. Yet, the use of certain intangible and tangible assets on the balance sheet of non-financial firms as collateral is highly complex to execute, such as borrowing against IP or inventory (from raw materials to finished goods) which are on a firm’s balance sheet.

In the context of the innovations and progress being made in DLT solutions, tokenisation will be able to reach far beyond traditional financial engineering and cost management techniques. By incorporating programmatic blockchain-based solutions, the financial industry will drive more efficient and expanded collateralisation, enabling capital access, asset utilisation and, ultimately, liquidity for an expanded universe of assets found on non-financial firms’ balance sheets.

Two foundational technologies - Blockchain/DLT and the ACTUS financial standard

Unlocking of balance sheet value of non-financial firms and the subsequent step change in capital market innovation will be driven by the unique characteristics of blockchain/DLT asserting facts in shared and immutable ledgers, as well as a key innovation in finance, the open source ACTUS financial standard. This enables transparency, automation and securitisation of financial instruments currently unachievable.

The two foundational technologies explained:

Blockchain/DLT with its capabilities to provide an assurance layer for all kinds of facts (financial and otherwise) is allowing for more efficient collateralisation in existing processes while, at the same time, enabling a significant expansion of items to be reliably used as collateral by non-financial firms for financial instruments.

The open source ACTUS financial standard provides and defines machine readable and machine executable standardised financial contracts (financial term sheets), allowing for a granular understanding of the payment obligations of all parties to financial contracts. In other words, a deterministic definition of all cash flows.

Both foundational technologies will independently have a profound impact on the way non-financial firms will be able to unlock value on their balance sheets. When combined, however, they will have a truly transformative effect on financial systems’ functionalities, with blockchain/DLT driving efficiency and expansion of reliably collateralisable balance sheet items, and ACTUS-based financial contracts providing granular understanding of the cash flow obligations of all parties and. The result is significantly expanded opportunities to unlock value on balance sheets and access liquidity for non-financial firms.

New possibilities for non-financial firms, investment banks and capital providers

Once CFOs of large non-financial firms understand the efficiency of tokenised cash and cash equivalents for netting, repo, and treasury management at scale, it will cease to be a ‘nice-to-have’: they will demand that their financial services partners utilise it. In addition, the same CFOs will soon understand the significant opportunity to increase access to capital when more items on their balance sheets can be collateralised thanks to tokenisation as described above.

Investment banks and capital providers will be equally receptive to the opportunities presented, as critical challenges in refinancing and capital markets are addressed by the combination of blockchain/DLT and the ACTUS standard.

Not only will current collateralisation processes become more efficient, but also the universe of reliably collateralisable assets (both tangible and intangible) will expand dramatically. This will result in dramatically more financial instruments issued and managed by investment banks (i.e. more through the same pipes).

The financial instruments themselves will achieve a new quality too, thanks to granular understanding and the machine verifiable state of the financial contract (i.e. higher fidelity financial assets through the same pipes). Tokenisation of financial assets with the ACTUS financial standard will result in the following step changes in finance:

• Significantly more financial assets can be issued

• Massive expansion of all kinds of asset-backed securities (ABS)

• Financial assets, previously not securitisable, can be securitised at scale and at lower cost

• Financial assets can be securitised at higher risk-adjusted yields

• Granular portfolio construction based on any risk/return profile; i.e. portfolio of one becomes reality at scale and at low cost

• Company-wide risk management and systemic risk management will be possible again

• Efficient price discovery and post-trade automation

The use case of tokenisation to unlock untapped value on balance sheets for non-financial firms is extremely compelling. As CFOs recognise these realities, they will inevitably become the drivers for innovation, enabling access to more capital and, ultimately, liquidity on a much more attractive risk-adjusted basis.

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