By: Shea Curran, director of business development for Tokensoft
The COVID-19 pandemic has impacted the world in a multitude of ways, but there is one unprecedented challenge that stands out as it directly relates to the alternative investment industry —how to embrace technology in a legacy world.
Historically, technology hasn’t always been the forefront thought of fund sponsors when launching a new product. Over time, fragmented, siloed systems dominated the industry in which paper-based manual processes became the norm. Sitting down with a client in an office to review a lengthy subscription agreement in a pre-COVID-19 time was nothing out of the ordinary, it was the standard. However, as face-to-face meetings are replaced by video conferencing, legacy systems and processes are now in a prime position for disruption.
This is not the first time we’ve seen this kind of pressure on financial institutions to incorporate technology in a changing environment. Reminiscent to the early 1970’s when NASDAQ entered the space as the first electronic stock market, NYSE had to adapt to stay competitive in an increasingly crowded space.
Even though the digital aspect of NASDAQ first started out as a “quotation system” and did not initially have the capabilities to perform electronic trades, it set off a chain of events that ultimately led to a complete transition from paper-based infrastructure to a digital one. It wasn’t overnight, however. An electronic trade process requires an ecosystem of multiple stakeholders, such as central depository institutions and clearing houses, for all parts of a trade to be automated. This transition took decades to build and implement.
It’s been almost 50 years since NASDAQ began transforming the global financial economies by embracing technology, but it seems the alternative investment industry is still stuck in a legacy world today. Operational procedures have not kept pace with those of traditional asset classes, which has continued to be labor-intensive and prone to errors due to lack of automation.
There seems to be overwhelming support to create a cohesive industry solution, so why has it not been done yet? Over the years, organizations like ADISA and IPA have existed to promote industry-specific education and innovation, so it’s not from a lack of trying. One thought is that all stakeholders have to agree on a set of standards and structure, which requires collaborative coordination to move the industry forward that hasn’t come full circle yet.
Let’s take a look at a few technologies that could move the industry forward.
Straight Through Processing
STP for short, is a method used to speed up transactions by creating a workflow that eliminates manual intervention. By “digitizing” the subscription process, the goal is to complete everything electronically, thus removing error-prone, lengthy paperwork. It enables sponsors and broker-dealers the ability to capture investor information, verify their identity, provide signatures, and transfer funds, all in a digital format.
Potential Benefits of Straight Through Processing
Reduction in administrative costs—By removing paper from the subscription process, the lack of manual intervention can help save sponsors and broker-dealers administrative costs. A digital subscription agreement can be submitted in minutes and investment time can be reduced from multiple weeks for a manual process, to a single week or less.
Lower Operational Risks—Faxing and mailing documents that contain sensitive investor information can pose a number of potential operational risks. With mail there is always a chance that information will be lost or delivered to the wrong person. Unless the recipient of a fax is at the machine, the sender has no view into who else has access to the information. Loss, destruction, or disclosure of information from subscription documents can lead to consequences for all involved, even if by accident. Since STP uses a secure digital format for processing, these operational risks can be mitigated.
Capital Raise Efficiencies—A streamlined user experience reduces NIGOs and can increase a sponsor’s ability to capture more investments.
Using Distributed Ledger Technology (Blockchain) to create Digital Securities
Although over a decade old, blockchain is still an emerging technology to the majority of large financial institutions. In a nutshell, a blockchain is a “digital ledger” of verified transactions that is decentralized, meaning not one single person or entity has control over. As the name implies, it is a chain of blocks. Each block contains digital information that is reliant on each other—think of a train consisting of multiple cars (of data).
Potential Benefits of Digital Securities
Complete Data Integrity —A blockchain is an immutable digital ledger, meaning that once the data has been recorded “on-chain” it is unchangeable. Today, even the most secure networks can be exposed by hackers. Most major financial institutions still rely on centralized servers and infrastructure, in which over time may increase the vulnerability of highly sensitive data being compromised. However, a blockchain is different from a standard centralized database, and thereby it ensures better privacy for its stakeholders.
Simplified Auditing — Being able to produce a complete, indisputable history of a digital immutable ledger allows for an easy and efficient auditing process. Proving the data has not been tampered with is a major benefit for financial institutions that need to comply with industry regulations.
Automated Compliance —One of the most promising advantages of blockchain technology is the ability to automate compliance with certain aspects of securities law. By using a “digitized” security, a sponsor could write certain transfer restrictions directly into the code of a “smart contract”, effectively embedding certain key securities law requirements like holding periods or shareholder caps directly into the security itself. Done properly, this could provide both issuers and regulators with assurance that applicable laws were being complied with, while also eliminating certain transactional frictions that make it difficult for investors to trade on secondary markets.
Although these potential solutions exist today, they are largely still considered emerging technologies in the alternative investment industry. The catalyst to move from a legacy world to a digital one is at our fingertips, but it will ultimately take an industry-wide set of standards and collaboration to make it a reality. Amidst a pandemic that will likely change global finance forever, it is critical that appropriate steps are taken to reduce the long-term negative effects. One way the industry can achieve this is by embracing technology today.
Shea Curran is the director of business development for Tokensoft, a technology provider for issuers of digital assets. A regular ADISA conference attendee, Shea enjoys networking and educating the alternative investment industry on how to embrace technology.
The views and opinions expressed in the preceding article are those of the author and do not necessarily reflect the views of The DI Wire.