By Rashad Kurbanov, CEO & Co-Founder at iownit capital and markets
Alternative investments have been around for decades and have been a part of institutional investment portfolios for the majority of the time. Institutional investors have increasingly allocated their investment capital to these investments with an expectation that they will provide stable and consistent non-correlated returns. Over time, alternative investments, powered by the issuance of private securities in the form of equity and debt, have grown and become a larger market and have become a larger percent of diversified institutional investment portfolios. All this being said, although the private securities market has grown year over year, the technological infrastructure to support it has not kept up.
A key reason for why the private securities market did not evolve technologically was its inability to build a scalable digital infrastructure that was also able to meet the complex regulatory requirements for record-keeping and ownership of private securities. Current record-keeping requirements on private security investments would require a system that would very quickly become unmanageable and unusable due to the levels of validation required for a digital transaction.
However, there have been several key changes recently in the private securities market which could usher a structural evolution for this critical asset class:
- The SEC Requested Public Comment on Ways to Harmonize Private Securities Offering Exemptions, resulting in a broadening of accredited investor definitions and additional changes in private securities regulations
- Blockchain Technology Evolves and is Able to Provide the Digital Architecture Needed to Support a Modern Private Securities Market
- The Department of Labor Approves the Inclusion of Private Equity in Defined Contribution Plans
These three events represent a planetary alignment in the private securities market. Liquidity is a critical part of a thriving economy, and these three events can allow the necessary pieces to neatly fall into place for a more liquid private securities market. Imagine a market that is efficient, transparent, and accessible to all qualified market participants. The question is not if we arrive at this next destination, it’s how we get there.
The SEC’s purpose in harmonizing private securities offering exemptions is to enable investors to responsibly and cautiously allocate their capital to private securities that were previously unavailable to them. With proper regulation and oversight, the goal is to allow investors to invest alongside more sophisticated institutional investors for the potential diversification and returns private securities can provide. This is similar to how public markets work, as institutional investors represent the largest holders of public equity, yet individual investors can also purchase shares in those companies and assets. These updated regulations will also enable financial advisors to invest in private securities on their client’s behalf if the proper fiduciary considerations are applied.
The investment capital injected into private securities from a broader demographic has the potential to provide an additional source of liquidity and growth necessary for an efficient market. At the same time, it is important to note that without compliant transactions and records, increased liquidity will still face operational inefficiencies, leading to continued capital flow bottlenecks and information asymmetry.
The complexity of the transaction records required for private securities is a key component behind a lack of technological evolution regarding how investors transact within this asset class. However, Blockchain has changed this by enabling a scalable, compliant, and immutable record-keeping architecture that could support the breadth and depth of the private securities market.
When the Department of Labor announced that it was going to allow the inclusion of private equity in defined contribution plans (albeit in a very restricted manner to start), it likely opened the door to a source of additional liquidity for the market. The infrastructure is currently in place to support that capital and the capital is seemingly ready and willing to be put to work. So now the question is this: will asset managers accept the benefits and challenges this evolution will bring with it?
We believe that increased operational efficiency, improved transparency, and market liquidity will come to the private securities market. Investors and regulators will demand it, and the asset managers who evolve with it may benefit from the growth in their AUM.
The Department of Labor has provided a key opportunity for the private securities market, starting with the inclusion of private equity in defined contribution plans. Even some opponents of the decision recognize the value of alternative investments but demand that the proper education and infrastructure is in place to support and protect investor dollars. After all, these dollars are the retirement portfolios of hard-working people and it is the responsibility of financial service providers as market participants to ensure their investments are guided responsibly.
This evolution in private securities markets is not a winner takes all game, as the size of the global private securities market can support multiple players, but in order for us to achieve true global liquidity, these players all need to be willing to work with each other. Technology continues to evolve, and there are already solutions in place that can support the issuance, transfer of ownership, and secondary trading in private securities across debt, equity, and other investment instruments.
Retirement account dollars can be allocated to the private securities market when the market evolves to meet its requirements and support its needs. There is no chicken and egg debate here as both have arrived at the same time. It’s a question of when asset managers embrace technology to enable the flow of liquidity into private securities. This technology exists today, and it’s no longer a question of if, but rather how and when private securities evolve into the 21st century.
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