Today at the World Economic Forum (WEF) in Davos, David McKay the CEO of the Royal Bank of Canada (RBC) revealed that the bank is experimenting with blockchain for tokenization, perhaps even private equity. He was talking during the “Automated Markets” panel.
Adena Friedman, the CEO of Nasdaq had commented that retail stock investors have never had it so good. They benefit from low costs, low spreads and near instant execution at competitive prices. There was one area where she sees room for improvement, and that’s private equity. “If you’re an average person you’re not getting access to some great private companies,” said Friedman. “And that’s one disadvantage that I’d like to see change over time.”
“That’s where blockchain comes in,” interjected RBC’s McKay. “We’re experimenting with taking an asset and breaking it into smaller pieces and registering that in a decentralized register called blockchain. You can take an asset or even a company and create a unit on a decentralized blockchain and then sell that into the marketplace.”
McKay continued: “Blockchain is an opportunity in the future to take assets that are less liquid and make them more liquid. I think that’s exciting.” Friedman chimed in that it applies to real estate as well.
Passive investing
The context of the private equity comments came from discussing the shift to passive investing in public markets. In turn this is driving active investors to move into private equity.
Bill Ford CEO at General Atlantic and board member of BlackRock commented that ten years ago about 9% of public markets were passive and now the share is roughly 44%. Nasdaq’s Friedman clarified the 44% includes fixed income and that approximately 20-25% of US equities are passively invested. “Investors basically are moving away from active public management to those two poles, private markets and passive,” said Ford.
RBC’s McKay echoed concerns about the impact of passive investment on corporate governance and oversight, as well as the concentration of ownership in three large organizations. The big index investment managers Vanguard, Blackrock and State Street, own 15% or more of most S&P 500 listed companies. When other passive investor figures are included the statistics are often 30-40%. Bill Ford added his concerns about governance: “They’re not going to react to a business plan put forward by an activist because it’s not their job.”
Fragmentation
The second big theme was the fragmentation of execution and the risks that come with that.
“The biggest concern I have when you touch on risk is this fragmentation of liquidity. It used to be that liquidity was centered in the Nasdaq and some other exchanges around the world, and now when we talk at Blackrock we use 70 liquidity centers, 70 market makers on a daily basis to execute our volumes,” explained Bill Ford.
“The thing that’s so different is what happens in a period of stress? These firms have no obligations to make markets”. He continued: “During [end of day] closing periods, during periods of stress, they’re absent. It was different when [it was] the major banks and the exchanges who have a more affirmative responsibility to keep markets moving. These folks will withdraw immediately, and I think it’s a big deal.”
RBC’s McKay expressed similar concerns that a potential lack of market liquidity could result in distortions.
Canada’s biggest bank was one of the first banks to sign up to JP Morgan’s Interbank Information Network. The blockchain payment network aims to deal with payment exceptions more efficiently compared to SWIFT. RBC is also known to have explored using blockchain for credit scoring.
Blockchain and private equity
Northern Trust announced that it’s working on a private equity blockchain system. However, its focus is on digitizing the administration rather than tokenizing investment for trading.
There are numerous initiatives focused on tokenized securities and digital asset exchanges including ICE’s Bakkt and Switzerland’s SIX, not to mention the Australian Securities Exchange‘s plans to use blockchain. In Finland Nordea and OP Financial recently ran a PoC with Tieto exploring tokenizing unlisted company shares.
