Capital markets have existed for centuries and have fueled the modern capitalist economic structure that is constantly in search of new markets and opportunities to satisfy an insatiable desire for growth. These capital markets continue to play a pivotal role in economic growth by matching investors to investment opportunities. Although we have seen substantial innovation in the Public Markets (e.g Stock Exchanges), the Private Markets have lagged behind in adoption.
How Do Private Markets Differ From Public Markets?
Regulatory Differences – Entities issuing securities or assets in the private markets can leverage prospectus exemptions to raise capital; however, they are governed by a separate set of rules which restricts who can hold those securities. In most cases, investing in the private capital markets is restricted to high net worth individuals, accredited investors and institutions.
Limited Liquidity – Securities offered in the private markets typically have longer hold periods (3-7 years) and thus are more difficult to sell. This can be partly attributed to the nature of private securities, as many are used to fund longer term projects in real estate, renewable energy, mining, etc.
Fragmented Reporting – Unlike publicly listed companies, private issuers are not required to disclose much financial information to the public. This makes it much more difficult for investors to cash out at any given time and can materially increase the perceived risk associated with such assets and securities.
How Can Technology Address The Unique Nature of Private Markets?
Recent advancements in digital technology have the potential to transform private capital markets by addressing the inefficiencies and offering expansion opportunities through accessibility to average investors.
Know Your Customer (KYC) and Anti Money Laundering (AML) checks can now be conducted automatically which drastically reduces the cost, in both time and capital, for issuers.
For investors this process becomes quick and easy. They simply upload pictures of their identification documents and biometrically verify their identities while an AI driven back-end system conducts the checks to confirm authenticity and provides risk scores associated with the individuals or entities.
Assuming the risk scores are acceptable, tickets are then automatically created and sent to the appropriate company personnel. This form of automation can reduce compliance costs by up to 60%.
Due to the longer term nature of securities in the private markets, investors sacrifice flexibility in cashing out in exchange for higher yields. Historically, there have been few Alternative Trading Systems (ATS) available for large institutions to trade amongst themselves and even fewer for smaller individual investors, making it difficult for many people to enjoy such a luxury. This is now changing.
By creating digital securities on the Blockchain, issuers can offer all investors, regardless of size, the opportunity to redeem their investments at any time. This is made possible by the decentralized Peer-to-Peer exchange which does not require human intervention for settlement and clearing.
Compliance requirements can be embedded within the digital security itself, allowing issuers to programatically enforce rules and ensure that only those that are eligible to hold the security partake.
Any entity that offers an investment must be transparent and held accountable by its investors. Thus, any and all information that is related to the opportunity must be disclosed as it becomes available. In a paper driven system, this process is cumbersome and requires hours of work to consolidate, error-check and ultimately distribute.
In a digital environment, reporting becomes transparent and automated. By recording all financial transactions on a Blockchain ledger, all permissioned participants have real-time access to the information to ensure correctness. Moreover, financial reporting can be generated instantaneously because the information has already been recorded. These features are highly valuable in tracking the flow of funds and the asset operations.
Through the use of Internet of Things (IoT) sensors, issuers and investors can directly procure data from a variety of assets, be it a commercial real estate property in the heart of the city or a wind turbine located in the wilderness. These assets can be effectively monitored and the data can be securely shared with stakeholders to provide greater transparency and alleviate many of the previous constraints inherent to the private markets.
What Does The Future Hold?
There is only one thing that is guaranteed of the future – it will look much different than it does today. Businesses will need to adapt or risk being left behind.
With technological advancements and demographic shifts churning beneath the surface, capital market leaders must consider their strategy and outlook five to ten years in the future. Blockchain, IoT and Artificial Intelligence offer uncapped value to the capital market ecosystem by significantly driving down costs, enhancing transparency and maximizing accessibility.
At Metavest, we are focused on helping issuers and broker dealers, issuers, transfer agents & other capital market stakeholders transition to the new digital securities ecosystem so they can bridge the gap between traditional and digital finance and position themselves for success in the years ahead.