How blockchain-based technology will transform private markets
Remember the first time you drove a car with a rear-facing camera? The first time you streamed an on-demand movie at home via the Internet, or used GPS instead of a fold-out paper map to find your way on a trip? Similarly, emerging digital technologies have the potential to significantly streamline the cumbersome process of issuing and trading private securities, while automating regulatory compliance and enhancing secondary-market liquidity, transparency, and price discovery. The best part? All these benefits can be captured within existing market structures.
The growing popularity of private placements over public listings in recent years is a well-documented phenomenon, driven by tightened regulatory requirements for public issuers and a widening search for returns among investors in a low-interest-rate world.
Strong Growth in Private Markets
Source: Preqin
Acknowledging that raising capital in private markets is simpler than floating public offerings, the path to private issuance is still lengthy and complex. After capital is raised, issuers incur ongoing costs for stock transfers, escheatment, dividend payouts, and compliance. Meanwhile, participants in secondary markets must cope with complexities in making legal and transfer arrangements. Indeed, the timeline for executing trades in privates is currently calculated not in hours or days, but in weeks and months. Throughout, the process is larded with paper, paper, and more paper, stuffed into a file cabinet or residing on email servers.
Contrast that with the way new digital mechanisms can transform how private markets operate.
Smart contracts help ensure that regulated securities are “locked” from trading until expiration of post-issuance blackout periods, execute and track payment and receipt of dividends, and validate that transactions have been executed solely with accredited investors. Post-trade processes leverage blockchain’s single “source of truth” — that is, the immutability of a blockchain ledger — working with transfer agents and trust companies. Efforts are underway to use alternative trading systems (ATS) for secondary trading of regulated digital securities.
This is no pie-in-the-sky, far-in-the-future scenario. Industry standard-setting bodies like the FIX Trading Community (aka FIX), the Digital Chamber of Commerce, and ADAM (Association for Digital Asset Markets), operating within the framework of the International Standardization Organization (ISO), are at work developing ways to integrate trading of digital securities into existing market structures. For example, FIX has a globally represented working group focused on adapting its widely used messaging tools to communicate and trade digital assets.
In short, digitization of private securities can ease capital raises, streamline compliance, improve liquidity and transparency, and save issuers and investors money — all within a regulated ecosystem. In future articles, we’ll explore what the emerging digital trading landscape means specifically for issuers and investors.
Written by: Lee E. Saba, Head of Market Structure, Rialto Markets LLC