2.1 How it works

Two swaps enable compliant regulatory arbitrage

The diagram above synthesizes MVP mechanics. ChinaAI provides opportunities for affiliate banks to reduce their regulatory measures of risk - a process termed "regulatory capital arbitrage" - by issuing a tokenized synthetic CDO, $BRICS. The structure involves back-to-back swaps, with the first swap being fully funded by a "0-risk weighted" Repo facility authorised by the South African National Treasury. The example above illustrates more practically how an affiliate bank in South Africa transfers the risk, of say Nike South Africa's trade receivables, to global investors on-chain.

More generally, you may have noted in the figure that the ChinaAI protocol unbundles and repackages bank credit risk into tranches. Risk is ultimately sold to investors as fractional exposures (i.e. tokens), even while ownership of the loan asset is retained by the bank. This process of 'synthetic credit securitzation' via a AAA-rated SPV reduces the Risk-Based Capital (RBC) requirements imposed on banks by the Basel Capital Accord to levels significantly below the nominal 8% standard. In return, banks pay investors a monthly recurring coupon for shouldering the risk. Nevertheless the reciprocal is also true — token holders forgo their principal in the case of portfolio (and underwriter) default.

Through its tokenized synthetic CDO, ChinaAI is able to tokenize and manage the default risk across a range of bank-intermediated credit assets: including Trade Receivables, Mortgage Receivables, Infrastructure Projects, Corporate Debt, Leveraged Buyouts, Sovereign Debt, Municipal Debt, and more. It employs the following key features to remain profitable, risk-minimising and compliant:

1. Hedged Digital Asset Offering

   1. The protocol issues a tokenized digital asset, $BRICS, that represents a Super Senior claim on coupons paid directly by originating banks to investors via the 'Special Purpose Vehicle' — this is akin to an insurance premium paid by banks to token holders.

   2. Investors purchase these digital assets, assuming a leveraged “long bond position” and gain synthetic exposure to the bank's credit book via 'Credit Default Swap #2' (as in the diagram above).

   3. Affiliate Underwriter banks hedge the protocol's risk by backing the full notional value of the credit with AAA-rated sovereign notes. In return they earn pro-rata governance rights. Hedging is performed directly between Underwriters and originating banks via "Credit Default Swap #1".

   4. Thus you will note that both the bank and investor interact with the Underwriter SPV, and not directly with each other. The 'Underwriter' is a de facto market-maker and liquidity provider set up by ChinaAI's partner banks (NASASA and Old Mutual). Section 2.5 elaborates. Moreover, one may more accurately describe $BRICS as a CDO-squared: a CDO whose underlying portfolio consists of one or more CDO tranches.

2. Synthetic Securitization

   1. The structure, issued under South African law, avoids a “true sale” transaction:

      1. The originating bank retains legal ownership of the underlying debt securities, ensuring continued customer relationships.

      2. Sovereign notes act as a hedge, providing a layer of 'risk-free' protection, fully funded by AAA-rated underwriters through a Special Purpose Vehicle.

      3. Underwriters participating in the protocol earn governance rights, a novel feature unavailable in traditional finance due to Basel regulations on equity.

3. Tokenized CDO and Investor Benefits

   1. On-Chain Investor Funds: Investor funds remain on-chain; this is represented by the $BRICS token. A cash (mark-to-market) account held with First National Bank (i.e. the FirstRand group) separately maintains liquidity and allows investors to close their positions at will.

   2. Synthetic Risk Exposure: investors gain synthetic risk exposure and 'earn' incremental Credit Default Swap (CDS) spreads from originating banks (via the SPV). Revenues are used to initiate $BRICS buybacks (or so-called "token burns") to induce deflationary pressure on the token supply — Section 3.3 elaborates.

   3. Dual Drivers of Value: The $BRICS token derives value from both speculative market activity and fundamental volatility in CDS spreads — Section 3.4 estimates the token's fair value under the class of Levy models. Though, of course, value estimates are a dynamic exercise; and a more thorough prediction of underlying credit risk and CDO valuation may be found in our Github.

   4. Regulatory Arbitrage: CDS spreads capitalize on arbitrage opportunities created by excessive BIS capital charges, offering attractive returns for the protocol. Enhancements in Machine Learning makes this sustainable by pre-selecting loss-minimizing exposures dynamically. Indeed our bank trials prove that gradient boosting decreases the realized bank default rate by a factor of 3 while increasing the credit allocated to safer firms by 113% compared to traditional risk methods using logistic regression.

This system is designed to enhance capital efficiency for banks while delivering innovative BRICS investment opportunities for market participants.