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Treasury Management

Can Blockchain Remake the Back-Office?

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May 13, 2016

Delaware seeking to amend its corporate bylaws to allow blockchain to streamline back-office duties.

Blockchain2Financial institutions have taken the lead on initiatives to use distributed ledger technology to make their industry more efficient. Corporate issuers have been slower to embrace the technology overall but that could change in at least one area: the incorporation process. The tech may soon see the applied to incorporation, automating the issuance of securities and dramatically reducing related costs while giving them more control.

The State of Delaware is working with law firm Pillsbury Winthrop Shaw Pittman to amend its corporate law and the uniform commercial code (UCC) to ensure respectively that corporate shares can be created on and later traded via distributed ledgers. Major benefits of distributed ledgers are their immediate accessibility and immutability, since data is cryptographically recorded in a sequence that is scrutinized by participants and can’t be altered. Delaware wants to use this capability to help companies streamline their back-office functions, which in turn could save companies money.

Late last year, Nasdaq’s Linq service began using distributed ledger technology to record issuances of private shares and their subsequent trading. Traditionally, ownership in a company has been recognized and acknowledged by a physical certificate issued by the state and typically retained by the Depository Trust & Clearing Corp. (DTCC). Delaware’s initiative seeks to replace those paper certificates altogether with ownership shares represented by so-called smart contracts on a private ledger. Given that 85% of IPOs are by companies incorporated in Delaware, the state’s adoption of distributed ledger technology will impact companies considering a public offering as well as those issuing private shares. Even Fortune 500 companies, two thirds of which are incorporated in Delaware, could pursue the many operational efficiencies distributed ledgers offer.

Marco Santori, a partner at Pillsbury, noted that developing a legal structure is essential to make selling the shares to investors and subsequent trades legally enforceable transactions. He added that the amendments are anticipated to be addressed early in the Delaware legislature’s next session, starting in January 2017, and companies should be able to begin issuing shares over the distributed ledger by summer.

In an announcement after Governor Jack Markell announced its support for the distributed ledger initiative May 2, Delaware issued a statement in which it noted the key benefits for companies. They include instantaneous execution, without reliance on intermediaries, and guaranteed settlement. Proxy voting and corporate actions such as dividend payments and K1 distributions could also be automated, and communications with investors can be delivered in real time.

Using smart contracts to represent shares also provides issuers with much more control over shares, reducing compliance risk. For example, vesting schedules and restrictions on selling the shares can be programmed directly into the contracts.

“Restrictions on shares are typically just stamped in the legends with red ink, but that’s not very binding, to say the least. Compliance can be programmed into smart contracts, and that’s a huge benefit from a corporate standpoint,” said Neil DeSena, managing partner at the Senahill Partners merchant bank.

Mr. DeSena said at least half of the companies the merchant bank invests in plan to adopt Symbiont’s technology. That will require reissuing existing shares as smart contracts on a distributed ledger.

That may also be possible for very large private companies such as Uber and AirBnB, which are still relatively young and can track their share ownership. Companies that have been public for many years and have millions of shares outstanding, some perhaps in the form of paper certificates locked in individual investors’ safes, would face a much greater challenge, since they would have to find and recoup those shares to exchange them for digital ledger representations.

In both cases, however, the Securities and Exchange Commission would have to allow companies to opt out of the current system, in which certificates reside at the DTCC, which then represents the shares electrically. In the meantime there are other states supporting the adoption of distributed ledger technology, given the benefits to issuers and investors alike, and would likely prompt the SEC to follow suit.

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