Much thanks for submitting this application. From my vantage point, and as I have previously stated (re: Decentraland/MANA), it seems to me that some projects have left information out of their applications that the DAO needs to understand before we onboard collateral. In particular, I’ve noticed a lack of legal and regulatory info and analysis.
Here, for instance, why are no materials provided and a question goes unanswered when asked about the legal or regulatory positioning of ConsolFreight DROP (look at question nos. 10 and 11). Anyway, I realize that this is the first time for all of us to go through this MIP, so I’ll give you the benefit of the doubt and classify it as an oversight. Happens to everybody.
That said, in the interest of time, I had some thoughts on matters relevant to Consulfreight and other similar “off-chain” asset projects that MKR holders should consider. Can @aleG or @spin please lend a hand when you have the chance?
Several application excerpts caught my eye. I tried to highlight the specific parts that were the most noteworthy:
“The asset type we are proposing for inclusion in MCD is slightly different to the majority of collateral applications: the Asset Originators will be using MCD directly as a line of credit to originate new loans against freight invoices (invoice factoring and reverse factoring).”
“In April of 2020,
ConsolFreight conducted a pilot with MakerDAO and Centrifuge to transform logistics access to liquidity through a Defi Solution.”
“Along with the necessary technical infrastructure to bring these assets into DeFi, the Asset Originator sets up a legal structure that provides the necessary support to ensure that
anyone that owns a DROP token has a legal claim to the underlying assets. This is done with a legal structure very commonly used in the traditional financial system:
The collateral for the individual loans are assigned to a legal entity, the “special purpose vehicle” and lenders get an ownership interest in the entire portfolio of this entity (with this entity the assets are in an a
bankruptcy remote structure that is not influenced by the Asset Originators).”
7. How is the applying collateral type currently used?
Centrifuge Tinlake has been in development since early 2018. We did a first technical POC where a pre launch version of MCD on Kovan was used to deposit an ERC20 token that was backed by an NFT in April 2018. Only a few months later we deployed the first version of Tinlake to Ethereum mainnet and worked with five different Asset Originators to facilitate loans in DeFi.
In a joint effort with MakerDAO to develop a tool to bring real-world assets into MCD we financed four of those Asset Originators with funds provided by the Maker Foundation totaling a volume of 250,000 SAI. The Asset Originators included a residential bridge loan as well as a mortgage originator, a financing solution provider for music royalties and a logistics platform providing invoice factoring. This allowed us to gain first experience with the setup and iterate on the smart contract and risk architecture. The current version of Tinlake has been audited and tested with two running deployments.
8. Does one organization bear legal responsibility for the collateral? What jurisdiction does that organization reside in?
ConsolFreight has incorporated ConsolFreight Pilot LLC, a Delaware (USA) limited liability company (the special purpose vehicle, “SPV”). This SPV has been formed to finance ConsolFreight’s assets.
This SPV structure
creates a bankruptcy-remote entity whereby owners, debt holders or interested parties of this newly created SPV are left unaffected by the parent’s financial, operational and/or legal health.
We are collaborating with
OpenLaw to open-source these contracts in order to make it accessible to other Asset Originators and use their infrastructure to allow public review of the signed contracts by anyone.
13. (Optional) List any parties interested in taking part in liquidations for the proposed Collateral type.
The way this collateral type is used varies from how standard vaults are opened: DROP tokens have a stable USD price and any small fluctuations in the loan portfolio performance should be covered by the insurance provided by the TIN tranche. This means that under normal operation, the Asset Originator would not see their Vault get liquidated.
A liquidation would only occur if a large amount of defaults occur across the portfolio that the risk model did not calculate.
In case the Vault gets liquidated,
the Tinlake contracts enforce a rebalancing of the pool to bring it back to its required collateralization ratio and will not allow issuing any new loans. Instead the Tinlake contracts are from this point
on taking all of the cash flows generated by the borrowers and disbursing these to DROP token holders. Trade finance assets are usually short term assets and the instance of ConsolFreight the entire pool can be liquidated in <55 days (45 day term invoices + a grace period for late payments).
Overall this means
keeper liquidations will be a much less common occurrence that only happen when the risk model worked out for a given collateral type did not perform. In the debt finance world there are
companies that specialize in buying distressed loan portfolios that can be onboarded as keepers for MCD that would be ideal candidates for buying any DROP that MCD wants to liquidate before the underlying portfolio is liquidated.
First of all, the above description of the DROP mechanics describes what most people around the world would understand as a debt security, or rather a transferable instrument representing a legal claim against the future disbursements of an entity’s proceeds in satisfaction of a debt. The security status of DROP is further raised by the uncertain cash flows into the SPV, following Vault liquidation, from the originator and Tinlake “rebalancing”. @AleG’s comment above acknowledges that this process is a “securitization.” This presents a whole host of issues for MKR holders – not least of which are the implications of forced transfers pursuant to government action. Have ConsolFreight or Centrifuge undertaken any securities law analysis of DROP and/or obtained legal counsel regarding its status, including a legal memo reflecting such analysis that can be shared with MKR holders?
@AleG’s comment above references a “legal process” in relation to “securitization” but there is no detail provided in the application or the comment. What is that legal process composed of? Has ConsolFreight or Centrifuge retained legal counsel to advise on, conduct, design this legal process? Did OpenLaw provide you with this legal advice?
Next, while not fully explained or stated, it appears that potential DROP buyers (addressed below) purchase DROP exclusively through the MCD liquidation/auction process. I have only a lay understanding of this, but most jurisdictions generally require a regulated intermediary to conduct sales of securities. Certainly, in the US, one has to generally sell securities through an SEC-registered broker-dealer. MakerDAO is not such a regulated entity and, as far as I can tell, there is no provision for a broker-dealer in your plan to administer auctions. Has ConsolFreight or Centrifuge analyzed this issue? If so, what do the applicants propose as a solution to this? Is there some reason this is immaterial? What is it?
Were the pilots you all conducted with the Maker Foundation, MakerDAO or both? Please note that the Foundation and the DAO are separate concerns. Also, it’s stated that Centrifuge and MakerDAO “develop a tool to bring real-world assets into MCD” – aside from Centrifuge’s public blog posts and the answer to the above question, what did the Maker Foundation or MakerDAO do to develop Tinlake, if anything?
If the pilots were directly funded by the Foundation (and not a Vault) and that was seemingly the Foundation’s only role in the Pilot, were you still able to test DROP deposits, auctions and DROP holder redemptions (on Kovan at least)?
Who owns the SPV? Is it a Consolfreight or Centrifuge controlled parent? Please name the directors, members, shareholders and management of the SPV’s parent.
Will you disclose the names of each ultimate beneficial owner of the SPV’s parent?
Should we expect anyone who holds in an interest in the SPV to provide their identity in case of redemption? In other words, should a liquidation occur, and I win several DROP auctions with my keeper, will I be expected to identify myself in order to redeem my DROP for the underlying off-chain collateral (cash if you all are successful in selling the actual invoices)?
If the SPV cannot liquidate its assets to pay DROP holders, what’s next?
What happens if the SPV fails to hold the underlying collateral and is unable to redeem DROPs for the collateral or cash? What then? Who can keepers (or MKR holders, for that matter) pursue?
What is the relationship with OpenLaw? Are they providing legal counsel (as noted above, OpenLaw is not generally in the business of providing legal advice)? Or are they simply a technology provider?
How does the structure ensure that the SPV is bankruptcy remote? And remote to whose bankruptcy – the originator’s? Tinlake’s? Its own?
Do the SPVs have guarantors? Typically, with SPVs, although they are bankruptcy remote (if structured correctly), companies will establish a guarantor to ensure payment to creditors. Has Consolfreight and/or Centrifuge considered such a structure?
Will Consolfreight (or Centrifuge) guarantee redemptions or is it publicly going to disavow liability?
Will Consolfreight (or Centrifuge) provide legal insurance surrounding the SPV for its guarantees?
Do Consolfreight and Centrifuge envision other potential keepers for the Tinlake program aside from typical purchasers of distressed debt, i.e. hedge funds? Regardless, what happens if other entities do act as keepers? This suggests there may be some whitelisting/blacklisting for DROP keepers; is that so?
Are there ideal characteristics of a DROP keeper? What are they and why? Is that because it is implicitly understood that DROP would be a security and thus necessitate certain types of purchasers to avoid violation of the securities’ laws?
Please indicate whether ConsolFreight or Centrifuge have interacted with any regulatory agency regarding TinLake and/or DROP? If so, please state (a) the regulatory agency; (b) when those interactions occurred; and © the conclusion of those discussions.
The Tinlake organizational graphic and application response to question 9 suggest that both an operating memorandum and loan agreement will be executed by the Lender, presumably MakerDAO. Please correct me if I am wrong.
- Where does exchange for the asset occur?
SPV enters into a subscription agreement with lenders who are receiving DROP from the SPV in turn for providing DAI. The DROP token can be redeemed against the cash flows of the underlying collateral directly from the SPV by any DROP holder. This is ensured by the Tinlake smart contracts and the primary way for interacting with these tokens.
The graphic from question 9 is a bit confusing, so can we run through a few things: the lender is MakerDAO; the SPV is the entity Consolfreight (or somebody) creates; the Asset Originator is Consolfreight; and the final borrower is the company that creates the invoices, right?
Where does the SPV’s parent sit? With this graph it looks like Centrifuge is the parent. That can’t be right, can it?
How are you going to have a loan agreement and an operating memorandum with MakerDAO – who can sign on behalf of “MakerDAO”? How can it be enforced by or against MakerDAO? Have you guys thought about these questions – they seem basic. And if there is no contract between the Lender – MakerDAO – and the other entities, how does your proposed arrangement work?
How dependent is the structure on off-chain legal agreements?
Back to the SPV, how will the system you describe ensure the preservation of SPV assets, and thereby value to DROP holders, i.e., by contract, bylaws, etc.?
Why have none of these issues been addressed in your application? I get the technological focus but Consolfreight and Centrifuge are trying to move MakerDAO into the regulated waters. If you want us to do that, we need details. Otherwise, we’re sailing blind into a potential squall (the lack of color on the SPV-Parent relationship is confusing enough without exploring the potential unregistered and non-brokered securities auctions and the concomitant issues).
There is likely more to unpack here and certainly responses to the above will generate more questions.
I hope these questions start to bring out data points and information that MKR holders require in order to thoroughly and thoughtfully assess ConsolFreight DROP’s inclusion as collateral in MakerDAO.
As I noticed some push back to my tone in the Decentraland/MANA application, so I would like to clarify that these questions are not meant to attack or temper the excitement of incorporating off-chain assets. Rather, I hope to elicit fulsome responses so we, the DAO, can better conduct the due diligence to ensure the Protocol’s success and perseverance into the future.