Blockchain for Banking News

A US bank plans to tokenize commercial paper

commercial paper

Yesterday tokenization startup Prontoblock announced a deal with Mercantile Bank to enable the bank’s clients to buy or issue tokenized commercial paper – corporate unsecured short term debt. 

If you’re familiar with this sector, it might surprise you that a U.S. bank was granted permission to tokenize commercial paper, given every DLT related activity has to be approved by the Federal Reserve or OCC. It turns out that Mercantile Bank is a “U.S. bank” but based in Puerto Rico. Hence its regulator is the Puerto Rico Office of the Commissioner of Financial Institutions. 

Despite the fact that commercial paper is a security, even if U.S. investors are the target market, it turns out that commercial paper doesn’t need to be registered with the U.S. SEC if its maturity is less than nine months. It’s still exempt in the U.S. if the commercial paper is continually rolled over. There are other caveats for the exemption, including a minimum denomination of $100,000 (?**) and a total issuance amount of under $5 million. 

The U.S. commercial paper market currently has an outstanding balance of $1.1 trillion. That’s half what is was in 2007, when more than 50% of the figure was asset backed, compared to around 25% today. 

The tokenization, commercial paper combo

At a big picture level, tokenization and commercial paper are a good match. Given that commercial paper can have maturities as short as a day or a week, there’s a definite need for speed. Hence providing a shared ledger for fast issuance makes a lot of sense. Traditionally commercial paper is issued in large denominations as it’s seen as risky for consumer investors and there’s that need for speed. Potentially blockchain could support fractional issuance, but for accredited investors.

Turning to Mercantile Bank, CEO Bo Collins said, “Tokenizing commercial paper allows us to provide a diverse array of investment opportunities to our clients while facilitating their access to liquidity.”

Collins was formerly president of the New York Mercantile Exchange and set up the bank in 2019 to operate as a clearing bank for a commodities exchange based on digital assets. It has since pivoted to provide a broader range services but still providing custody and settlement of digital assets.

Puerto Rico as a tokenization hub?

We were curious about Puerto Rican “International Financial Entities” (IFEs), the designation for a bank that targets customers outside of Puerto Rico (including targeting U.S. clients). It seems a sensible structure for tokenizing U.S. commercial paper.

According to a 2017 paper by DLA Piper, IFEs can open a bank account at the New York Federal Reserve. However, that does not mean they are part of the Federal Reserve System or regulated by the Fed. A couple of Puerto Rican banks have FDIC insurance.

One of the reasons it’s called an IFE license and not a banking license is because it supports a very wide range of activities, including deposit taking, lending, asset management and securities services.

The capital requirements are pretty low – just $250,000 paid up, plus an additional $300,000 in unencumbered assets. Something that’s not great for bank customers (if we read it correctly) is there are no lending limits and no requirements to maintain reserves against deposits.

Meanwhile, there have been a variety of blockchain and commercial paper initiatives. Swiss startup Obligate supports tokenized commercial paper issuance and is backed by stock exchange SIX and stablecoin issuer Circle. In the EU, Rabobank has conducted a number of commercial paper trials, including with Euroclear and Northern Trust and DekaBank has done a live green commercial paper issuance. Over in Asia, there have been multiple tokenized commercial paper issuances including from CGS CIMB on the ADDX (formerly iStox) platform. In 2019 Orange and Citi launched ID2S, a French blockchain-based CSD (central securities depository) for commercial paper. However, it shut down two years later.

** Various references mentioned $100,000 minimum denomination for the commercial paper exemption, with some saying $10,000, but we didn’t find it in the legislation. However, the NY Fed mentioned that Bloomberg terminals have a $100,000 minimum transaction size.

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