Structuring Complex Financial Products on Corda: The Sukuk Case Study
In an increasingly global capital markets landscape, Islamic finance products, such as the popular Sukuk instruments, have contributed to the growing portfolio of investment opportunities. These products are often structured to comply with Shariah law, which can make them more complex relative to conventional bond structures.
A new R3 Research market analysis, “Innovating in Sukuk Capital Markets,” cowritten with Clifford Chance and Wethaq, evaluates the Wethaq platform, a solution built on Corda intended to streamline and expand the Sukuk market.
Benefits of the Wethaq platform include greater efficiency and transparency throughout the end-to-end Sukuk lifecycle, easier Shariah compliance, interactions with cash settlement innovations, and interoperability with other CorDapps.
The Sukuk al-Ijara is a common Islamic finance instrument that allows capital raisers and capital providers access to Shariah-compliant products certified by Shariah boards.
Conventional bond structures are not considered to be Shariah compliant as they involve the payment and receipt of interest. Sukuk securities, by contrast, comply with Shariah principles through passing on the returns from an underlying asset or through a contractual arrangement with respect to that asset.
Under current industry practice, the Sukuk issuance is exclusively led by banks and fundraisers. For this, the bank relies on its own private and proprietary processes within a ‘closed’ ecosystem. The Wethaq platform intends to open and expand the ecosystem by streamlining coordination between market participants, standardize processes and automate the administration of financial services.
The Wethaq Platform
The Wethaq Platform applies distributed ledger technology to Sukuk markets with the objective of having a system that can:
- Have the ledger operate as a registry and central securities depository
- ‘Inter-operate’ with other settlement infrastructures and payment gateways
- Function within the existing regulatory framework
- Have market participants, service providers and governance stakeholders interact with each other within the platform
Smart Clauses in Wethaq Templates
Though there have been ‘data-driven’ clauses used in finance for decades, ‘smart clauses’ introduce a crucial aspect: performance of obligations is automated using strict and formal programming language which is deployed on a distributed ledger beyond the control of any single party to that ledger.
This automation creates several efficiencies:
- The execution of contractual terms recorded on a distributed ledger reduces costs by removing the requirement for several “trusted” financial institutions to manually conduct the relevant functions
- There is certainty that the code will perform the obligations delegated to it as intended by the parties and beyond anyone’s unilateral control
- Smart clauses can be programmed to ‘self-execute’ during the term of an agreement upon receipt of pre-defined data from a third-party source, known as an ‘oracle’
Public (permissionless) distributed ledgers are a unique innovation in the history of finance, given their operational decentralization, settlement times, and global liquidity access. However, within regulated wholesale capital markets, distributed ledger architectures must meet the functional and non-functional requirements of network participants. Most public distributed ledger architectures, such as Ethereum, weren’t originally built to be used for business transactions and encounter architectural complexities when the base codebases are adjusted to fit within an enterprise setting.
Corda was built from the ground-up through an intensive requirement-gathering process alongside the teams from 40+ of the largest global banks. As a result, Corda differentiates itself from other distributed ledger technologies due to its:
- Data privacy
- Well-defined identity layer
- Instant settlement finality
- Regulatory compliance
- Integration with legacy systems
By using Corda, Wethaq can interoperate with the global Corda ecosystem, and take advantage of new developments with cash (fiat) settlement functionality within a distributed ledger environment, while maintaining the unique structure of the Sukuk Al-Ijara.
Benefits and Implications
The value proposition of the Wethaq Platform is the streamlining of processes, reduction of intermediaries, and automated performance of contractual obligations through the use of smart clauses on a distributed ledger-based platform.
Interoperability with ‘CorDapps’ and other Trading and Settlement Platforms
The Wethaq Platform is not an ‘island’ but benefits from the openness and functionalities of the Corda ecosystem. Many of the world’s largest financial institutions are deploying Corda nodes; R3 has designed Corda to be the platform that bridges seamlessly from legacy infrastructure to ‘digital-first’.
Read more about interoperability between CorDapps by the SIX Swiss stock exchange.
Within the Wethaq Platform itself, third parties may use open-sourced Corda Developer Tools and, for their specific Sukuk needs, the Wethaq Developer Tools to ‘plug in’ and offer their services and products on the platform.
Interactions with Cash Settlement Innovations
The Wethaq Platform will integrate Corda Settler, an open-sourced CorDapp that allows payment obligations arising on the Corda Protocol to be settled via any traditional rail capable of providing cryptographic proof of settlement, whether ‘on-’ or ‘off-ledger’.
Read more about use cases with Corda Settler.
Cost Efficiency and Transparency
Sukuk markets have less cost efficiency and transparency than conventional debt markets due to relatively higher structural, compliance and document complexity. As an alternative to this, Wethaq would facilitate functions that would otherwise be performed by a number of banks, clearing and trustee entities all incurring separate fees and other engagement costs.
The distributed ledger facilitates cashflow record keeping in a transparent and easily reconcilable way that demonstrates the source and timing of payments. In the Sukuk context this can support transparency in the issuance and payment process and in tracking the underlying assets or cashflows generated. Additionally, the employability of ‘smart clauses’ gives Shariah boards the opportunity to ensure Shariah compliance by building and mapping real world Shariah requirements within the structure itself.
The rapid development of enterprise-distributed ledgers will inevitably disrupt Sukuk markets. Benefiting from the unique architecture of Corda and interoperability with both incumbent as well as newer market infrastructures, Wethaq is well placed to lead an evolution of the securities ‘value chain’ in these markets within existing regulatory frameworks.
Read the full R3 Research Paper