An Islamic microfinance start-up has launched what is believed to be the world’s first smart sukuk issued on a block chain platform, which it hopes can channel greater liquidity to small- and medium-sized enterprises (SMEs) and social impact projects by dramatically cutting the costs associated with issuing sukuk.
Blossom Finance’s idea took shape four years ago, but the start-up had to wait for technology to catch up with its plans.
“The genesis of the company goes back to October 2014, but it was only in 2016 when we could begin working on it. The tech just wasn’t there,” Blossom Finance founder and CEO Matthew Joseph Martin told Salaam Gateway.
Blossom Finance is registered in the United States but works primarily out of Indonesia.
“In theory we could do this stuff with the original bit coin network but everyone we talked to laughed and said, ‘that’s an interesting idea, but I’ve no idea how to do that.’ We were hitting a brick wall and just had to wait for the technology.”
By tapping into Ethereum, the block chain-based distributed computing platform, last year Blossom was able to accelerate the development of its smart sukuk and opened its first issuance to investors in May this year.
Now, the vehicle allows investors to deposit fiat and crypto currency (Fiat money (or fiat currency) is currency that a government has declared to be legal tender .Crypto currency is not legal tender and not backed by a government) into its account from anywhere in the world, for which they will receive a verifiable digital contract to reflect their share of the investment, backed by the immutable nature of a block chain ledger.
By cutting out the amounts charged by banks, lawyers and currency exchanges, and charging a flat fee for each investment, Blossom claims to be able to dramatically reduce costs.
“Because it’s microfinance, the numbers are quite small,” said Martin. “We’re not talking about borrowing tens of millions; the first issuance is probably targeting maybe $1 million tops, which is a very small number.
“Block chain and the ability to move funds via crypto currency will lower costs. If someone from Dubai wants to help fund a microfinance initiative in Indonesia, and gives, say, $200, by the time it got there, it would have probably lost $80 in terms of transaction fees.”
Khalid Howladar, who advises Blossom on strategy and risk, believes it shouldn’t matter whether a sukuk certificate is issued on paper or block chain, though the latter would require an investor to have confidence in the system.
“If you’re raising such small numbers in funding, you can’t bring to bear the entire infrastructure of investment banking. All the costs of the parties involved, whether it’s the scholars, the highly paid lawyers or the bankers, when it’s advertised as a $100 million transaction, you can afford that,” Howladar, the founder of Acreditus, a UAE-based credit and sukuk advisory, told Salaam Gateway.
“But if you’re only borrowing financing for small amounts, you can’t really afford to go through that process. So this is why microfinance institutions don’t have access to the most liquid pool of funds,” Howladar adds.
The first, a sukuk al mudarabah profit-sharing structure, is collecting funds to be invested into the issuer PBMT Social Ventures, a venture capital firm that funds microfinance co-operatives that in turn extend financing to micro-businesses such as farmers and home-based convenience stores. The profits from financed activities will be returned to the fund and distributed between investors.
PMBT (PMB Technology Berhad (“PMBT”) in other companies like Blossom (Blossom is a lightweight project tracking tool for modern software development teams that love continuous delivery & simplicity.) in Indonesia using digital technology) is regulated by the Financial Services Authority (OJK) Indonesia, and has a Sharia review board overlooking the mudarabah agreement and the underlying organizations’ financing activities.
The fund is targeting a minimum subscription of $20,000 and maximum of $5 million on a 60 percent investor-40 percent issuer profit share. Blossom is projecting six percent net annualized return on the six-month sukuk.
Blossom takes a 20 percent share of the investors’ profit, or in conventional financial terms, the carried capital interest.
The sukuk falls under the United States’ Securities and Exchange Commission regulations regarding private placements. The U.S. SEC has no specific regulations for sukuk instruments.
Though it has been open since May, the first sukuk is not yet being actively marketed as Blossom tests the system for security and accuracy. According to Martin, the company is working with multiple third party auditors to perform security tests.
“Note that currently (and in the near future) Blossom will not directly receive, hold, nor store any crypto funds (or their associated private keys) so they are not exposed through any attacks directed at Blossom,” said Martin, addressing a key cyber security concern.
Martin claims to have had “quite wide international interest” in the sukuk.
“We’ve had an investor from Bangladesh, which typically people think of as a place that’s looking to raise charity, versus someone from there who has crypto currency who wants to invest it in Indonesia. I think it’s really interesting,” he said.
“We have investors from Central Europe, Southeast Asia, South Asia; not so much from the U.S. – which is surprising as we are a U.S. company-about 10 percent.”
Its second structure, an asset-based lease sukuk, or sukuk al istithmar al ijara, does not yet have any active funds available, though Martin says Blossom has the technology ready and is evaluating several potential issuers.
In this case, the sukuk would fund projects such as hospital construction: on completion, the hospital operator would lease its facilities from the sukuk’s investors at a profit.
Due to the global nature of financial technology (fintech), the regulations governing Blossom are complex.
Though it is based in Jakarta, its fund is set up in the United States and operates under American governance. Investors, in turn, must defer to the rules governing their home jurisdictions.
“Under U.S. regulations, our fund can accept either individuals or institutions provided that they meet certain minimums in terms of assets. For those who don’t fall into that category, meaning you’re not high net worth, we’re working on another fund that will be set up in Singapore,” said Martin.
As an Indonesian fintech business, Blossom must also adhere to local guidelines, many of which are currently being drawn up by banking authorities.
Block chain securities trading, which comes under the purview of Indonesia’s central bank, is still in the pipeline, though it currently falls under existing securities regulations.
Martin sees an ideal solution to regulation in the form of a “sandbox”.
In the fintech universe, sandbox refers to a mechanism for developing regulation that keeps up with the fast pace of technology innovation. Its purpose is to adapt compliance with financial regulations, in a way that doesn’t smother the fintech sector with rules, but also avoids diminishing consumer protection.
This should appeal to Indonesian authorities as they continue to evolve their approach to fintech regulation, which lags behind countries like Switzerland that recently announced a fully regulated digital platform for investors, regulators and issuers to transact in crypto currency, and Singapore, which has clear guidelines.
With a declining rupiah, authorities in Jakarta are keen to bring in outside capital to stabilize the currency, Martin believes.
“Using crypto currency is a way that could make that really easy. Hopefully they will develop some kind of sandbox, or at least pragmatically a safe harbor approach,” he said.
In July a joint venture between Dubai-based Arabian Chain Technology and tech R&D firm Curiositas announced it was developing a platform for Islamic capital markets using smart contracts and legal automation to mainly target financial institutions and investment banks for the issuance of sukuk in the $1 million to $10 million range.
“We have currently designed and developed the core platform for the lifecycle of our first sukuk product, an ijara,” Mohammed Alsehli, founder and chief executive of Arabian Chain Technology, told Salaam Gateway.
“What distinguishes us from our Islamic finance peers is our focus on capital markets, the creativity and innovation we bring to the design and development of traditional products using frontier technology and, as opposed to other recent initiatives, we are not offering retail sukuk products outside regulations, such as ‘crowd funding’ structures targeting retail customers.”