Prelude to the future of finance? Large bank raises loan from DeFi protocol to refinance tokenized bonds
Societe Generale GLE,
(SocGen), one of the largest investment banks in the world, raises a loan through a subsidiary of the decentralized platform MakerDAO, to refinance certain token bonds it holds.
If this materializes, it will be the first time that a major bank has borrowed from decentralized finance, or DeFi protocols, which refer to programs powered by cryptocurrencies and blockchains without resorting to intermediaries.
While DeFi protocols replace human intermediaries with self-executing computer programs, they claim to be more efficient, faster, and cheaper. Supporters also point to DeFi’s potential to benefit unbanked communities, as no government ID or social security number is required to use the platforms.
However, DeFi has also raised concerns from regulators and some investors, as they fear that a loophole in the code could lead investors to lose assets, when no one would take responsibility for it.
DeFi platforms are often seen as competitors of banks. However, the most recent experience of SocGen may herald some integration between the two worlds. Advocates envision a future where DeFi plays a major role in the European covered bond market of 2,900 billion euros and even the nearly $ 11 trillion US corporate bond market.
“I really consider the banks and the financial sector as a whole as probably the best and the biggest customers, potentially, of these decentralized protocols”, Jean-Marc Stenger, general manager of the subsidiary SociÃ©tÃ© GÃ©nÃ©rale – Forge (SG Forge), MarketWatch said in an interview.
The Maker Protocol is a decentralized application that allows users to create DAI, an algorithm-based stablecoin indexed 1: 1 to the US dollar, by depositing collateral assets. As one of the first DeFi protocols to be mass adopted, Maker has $ 15 billion worth locked on from Monday, October 18.
Unlike most centrally managed companies, Maker is governed by a Decentralized Autonomous Organization, or DAO, where a group of MKR governance token holders make decisions.
The future of bond refinancing?
SG Forge is raising up to 20 million DAI, which is equivalent to $ 20 million, with a duration of six to nine months of MakerDAO, according to a proposal the firm posted on the MakerDAO forum on September 30. The loan proceeds will be used to refinance certain OFHs bond tokens due 2025 held by SociÃ©tÃ© GÃ©nÃ©rale, depending on the position.
In 2020, SociÃ©tÃ© GÃ©nÃ©rale SFH, a subsidiary of SocGen, security tokens issued called OFH tokens on the Ethereum blockchain, representing 40 million euros of zero coupon covered bonds due 2025 backed by home loans. The bond has received top AAA ratings from Moody’s and Fitch.
Security tokens are when securities such as stocks, debt or derivatives are issued on blockchains.
Compared to traditional securities, issuing security tokens would allow access to larger pools of liquidity, according to Stenger. âWhen you issue such securities on a public blockchain, it’s a global infrastructure,â Stenger said. âYou can access it from anywhere in the world. It’s like the Internet.
âThis first experimentation with a security token refinancing structure via a DeFi protocol will allow us to shape the future of the bond refinancing business,â SG Forge wrote in an article on the MakerDAO forum.
SG Forge plans to offer such refinancing solutions for security tokens to its clients starting next year, according to Stenger. The company has structured debt instruments including covered bonds, secured and unsecured notes and structured security token products, the first of which was launched in 2019.
In the test case with MakerDAO, SocGen used OFH tokens to facilitate the process, as the bonds were issued by a SocGen entity and all held by SocGen since then. In addition, they bear zero coupon interest, so the deal could “avoid the complexity of asset management.”
In traditional loan financing, debtors typically post collateral that far exceeds the loan principal to mitigate risk to creditors, but if the collateral depreciates, it could take up to a week to adjust its amount. Stenger noted.
However, an automated lending platform like MakerDAO could cut collateral adjustment time to less than an hour.
âThe amount of over-collateral you have to post before these trades is drastically reduced. Stenger said. “So that translates into much better financial conditions for the asset manager who owns the security.”
To raise the DAI loan, SG Forge would pledge all OFH bond tokens of 40 million euros held by SocGen as collateral.
To complete the transaction, SG forge will grant a loan in US dollars to SocGen, which will then transfer the OFH tokens it holds to SG Forge. SG-Forge will borrow the DAI from the Maker protocol, then exchange the DAI for US dollars with a stockbroker.
As MakerDAO is not a legal person, the community will have to nominate a natural person or a legal person to represent it, noted SG Forge in its proposal.
Interact with a DAO
Even for SG Forge’s Stenger, who has over 15 years of experience in traditional finance, interacting with a DAO is still a relatively new experience.
“We have been in contact with some members of this community to make sure we have the right understanding of how things should work and all the financial and legal engineering we needed to organize this transaction in a compliant manner.” , said Stenger.
As SG Forge suggested a new form of guarantee, it was requested to submit a proposal for discussion and comment. The MakerDAO community will vote on the proposal later, and if it passes, the risk, oracle, smart contracts and possibly protocol legal teams will assess the project.
According to SG Forge’s proposal, most of the people who took part in the conversation seemed positive about this. (Forum participants are not necessarily MKR holders.)
âMaker and SocGen-Forge are on the brink of financial history. What a long time to be alive, “wrote user” PaperImperium “.
âThis MIP6 (type of proposal) is a new benchmark in DeFi and shows how DeFi and TradFi (traditional finance) merge to create Finance 2.0,â wrote user âSebVenturesâ. âThis guarantee should be seen as step 1 of what will follow. Integrate all publicly traded bonds (which will be on Ethereum as we all know) and provide pensions. A fairly huge market.
Some have expressed concerns about the return of MakerDAO. “No information on the stability fee or on an existing rate had been announced?” Commented user “AXA”.
Stability fees are those that users have to pay to “face the risk inherent in generating Dai (DAI) against collateral in Maker Vaults”. It resembles the concept of an interest rate in traditional loan financing.
An SG Forge representative wrote in a follow-up article on Oct. 7 that the stability fee should be close to the refinancing rate for a covered bond, plus a liquidity premium. Other mortgage backed covered bonds issued by SocGen SFH bear interest rates ranging from 0.01% to 4%.
Some participants envisioned a future where all back-to-back mortgages European covered bonds are issued on the blockchain, where information is stored in the general ledger and can be viewed publicly.
âWhile this is a very positive first step, let’s not forget that we need to stay focused on a future where we tokenize all 350,000 mortgages in the pool for full chain transparency,â wrote user “Jason”.
âJasonâ painted a picture where the issuer, credit rating agencies, rating firms, auditors, Maker rep and âall junior tranche investorsâ work together to measure risk and set price of the loan.
âSuch a structure will help resolve some of the audit deficiencies that surfaced in 2008,â âJasonâ wrote.
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