Secretive, behind-the-scenes deals. An elite set of investors. That’s what private markets – or investments that are not traded on a public exchange – look like today.
The bilateral nature of private market deals can cause a complex process of settlement. It’s de rigeur to rely on an entire network of intermediaries such as brokers, custodian banks and lawyers to maintain trust between parties. Asset classes such as private equity, private credit, infrastructure, real estate, infrastructure and others rely on such participants.
Now consider blockchain. Think of it as a giant Excel spreadsheet that is shared across many computers. Each time the spreadsheet is updated, all the users see the change.
What happens when blockchain, also known as distributed ledger technology (DLT), meets private markets? It’s a collision of opposing forces – a technology that promises transparency and accessibility to everyone on the network, versus an industry that thrives on being relatively inaccessible.
If blockchain prevails, it could redefine the entire operation of private markets.
It’s no exaggeration to say that blockchain offers a potentially existential threat to the operation of private markets today.
Currently, powerful private market operators such as fund managers, lawyers and large institutional investors hoard hard-to-get information on promising investments. Blockchain promises to break open such closed information networks, making them transparent to a larger number of participants.
The technology should make shareholder reporting and governance faster and easier too: limited partners typically receive monthly or quarterly updates on the prices of their holdings.
“Historically, investors have not been able to track all the steps in the transaction lifecycle; they can only get the end reporting. There is more transparency [with DLT], which offers real-time transaction tracking,” noted Justin Chapman, global head of market advocacy and innovation research at Northern Trust.
Northern Trust ranks among the pioneers experimenting with blockchain for private markets. It collaborated with US-based financial services firm IBM to administrate a private equity fund of Swiss manager Unigestion via blockchain in February 2017.
It upgraded the system in March 2018 to enable audit firms to access relevant fund data for real-time auditing. Chapman, who is based in London, told AsianInvestor confidence among investors will build as more assets come into the digital ecosystem.
THE TOKEN IS COMING
The advent of blockchain could have myriad implications. For one, it could allow private equity fund houses to automate the administration of their private funds.
Traditionally this is a labour-powered and time-intensive process, which can include everything from sharing data between different parties and signing contracts to managing transactions and closing deals. In truth, shifting to blockchain would have limited benefits. “Back and middle-office work at private equity houses are typically low-volume, low-margin activities, in our view limiting any cost and efficiency savings for a PE fund,” said UK legal firm Latham and Watkins, in a note on financial technology trends published in August.
A blockchain-backed technology could have far more impact on today’s private fund industry: tokenisation.
This is a process under which real-world assets are turned into digital tokens on the blockchain. Blockchain’s distributed ledger can be used to tie real-world assets such as property, infrastructure – and even exotic investments such as fine wines and vintage cars – to digital tokens.
By their nature, these tokens are divisible, which can remove restrictions on investment size and create a more liquid market.
“Illiquid assets could be transformed into a more fungible asset class,” noted Markus Mueller, global head of the chief investment officer of Deutsche Wealth Management told AsianInvestor. “By breaking up a larger asset into smaller portions this way, tokenisation has the potential to create liquidity in previously illiquid markets.”
It’s already starting to happen. In October, tokenisation was partly used to put a $30 million Manhattan condominium development on the market. Previously, in August, the World Bank raised $81 million by launching bond-i. It was the first bond to be created, allocated, transferred and managed through its lifecycle using distributed ledger technology.
Blockchain-powered platforms to invest in fine wines, vintage cars, art via digital tokens have also sprouted around the world.
This story was adapted from a feature in AsianInvestor December 2018/January 2019 edition.