30 August 2018
HFM recently produced a Guernsey 2018 Special Report on why Guernsey remains a beneficial, flexible jurisdiction in which to establish a broad range of structures. Here, Alex Burne of PwC details how technology is set to transform the fund sector in Guernsey.
In my role I’m responsible for the design and implementation of innovative tools across our business unit, primarily focused on our assurance practice, so I’m well aware of all the overused buzzwords and hype in the innovation space. What can’t be ignored, however, is the momentum that is building around digital transformation and the pace of change – the likes of which we’ve never experienced before. It’s exciting and something we have to embrace and adapt to.
Guernsey has a long history of innovation that extends well before our financial services industry. A history of readiness and a conviction to change to be proud of. This is partly down to the island’s characteristics, its infrastructure and skilled workforce, all collaborating and working together to remain best in class. It is our world-class stature that continues to attract a diverse range of players, from major global brands to small independent, entrepreneurial individuals. Combine that with the unique ability to get lawyers, accountants, developers, regulators and government in one place and at one time – and at short notice – and we are a formidable place for change.
At PwC, we believe blockchain technology can solve many of these problems and indeed, we are working with companies on the island to do just that. One such successful collaboration is Northern Trust’s launch of the first commercial use of this technology for the PE market. Another example is Solidium, the Guernsey-based insurance entity that for the first time, has issued digitised notes on a private blockchain, replacing the role of a traditional settlement system.
According to our recent global fintech report, 77% of businesses expect to adopt blockchain as part of an in-production system or process by 2020. It really does look like blockchain is ‘coming out of the lab’. This is consistent with the findings from our most recent Asset & Wealth Management (AWM) report: Embracing Exponential Change. Technology is set to disrupt all areas of the AWM industry from the investment advice, research and portfolio management, right through to the middle and back offices and to client engagement and distribution. The banking sector has been receptive to utilising blockchain for certain back-office operations, but PE managers are moving slower, perhaps in part due to uncertainty about its purpose, use and reach. Let’s explore this further with a particular lens on PE. But before that, let me just be clear about how I see blockchain.
I’ve listened to numerous experts talk on this subject, and some have kept my attention, and some have lost me in the depths of references to cryptography, blocks, hashing and hyper-ledgers, so allow me to curate my own description. I see blockchain as a decentralised record of transactions that no one owns yet all parties have access to via a peer-to-peer computer network. So no one owns the data. And that means that all parties can see and confirm each transaction on the decentralised records. This record system is often referred to as a ‘distributed ledger’. The blockchain is a secure, indisputable record of transactions which cannot be altered without consensus of all parties. Aside from the operational efficiencies, it is these characteristics which creates ‘one version of the truth’ that will attract PE managers to this technology.
If you think about client due diligence, portfolio company operations, deal execution, management reporting and investor relations – traditionally these areas are labour intensive and complex, yet surprisingly many managers still run these functions on spreadsheets. We’re seeing more focus from managers on their systems and processes. Some have made the painful move from a spreadsheet environment into a more structured system in recent years. However, there are some managers clinging onto the spreadsheet world where the risk of error, operational effectiveness and efficiency are all unfavourable. Take a capital call or distribution as an example. On the face of it these should be very simple transactions, but with multiple parties involved, perhaps different versions of agreements and side letters, and the use of spreadsheets riddled with human intervention – these can become complex. In a blockchain world, all the original fund records are securely executed and stored. These are made available to all parties granted permission (this concept of “one version of the truth”) and the capital transaction can be processed with all the necessary approvals, with documented delivery and movement of funds with minimum intervention – this is all done seamlessly and reliably.
PwC in Guernsey is focused on alternative asset management clients who account for more of 85% of our client base, with private equity being the dominant asset class. This is what we do!
The scenario I’ve outlined above could be applied to many of the functions a manager is involved with. Deal execution for example. In this space, intermediary costs such as due diligence and legal can run into millions and can be long and time-consuming processes. Blockchain technology has the capacity to streamline this process among all the parties involved, resulting in shorter time to market and ultimately improving returns for the investors.
Now, in a shameless display of self-interest, turning my attention back to assurance activities, I’m thinking about what this could mean for the future of my industry. Let’s look at another example in the
PE space – valuations. The manager (and the auditor) is heavily reliant on the data the underlying portfolio company provides when it comes to valuing that company. Now let’s apply blockchain use to this case. Indisputable data shared between multiple stakeholders on a real-time basis including the underlying portfolio company’s financial records and the other inputs into a valuation (such as discount, interest, fx rates, and comps) – you can start to see a picture developing of how and where valuations move from a quarterly, semi-annual, or annual basis to a real-time basis. The proposition of an integrated, real-time audit is an exciting one and one I’m sure we’ll become accustomed to in the not too distant future. But what could this mean for PE?
Look at the secondary market, principally a much-needed market to provide liquidity to what is an illiquid asset class. Purchasers will typically be looking to acquire an interest in a fund’s remaining assets and/or take on the selling investor’s commitment. Managers are also selling the ‘tail-end’ assets, those assets in a mature fund, which frees up management time and can lock-in accelerated returns. This market has grown rapidly in the past decade and is set to continue. According to Prequin, secondary transactions in private capital in 2017 totalled approximately $60bn. I can see blockchain and real-time audited data (because managers will be required to inform investors of NAV and holdings on a periodic basis) as a platform to remove a huge amount of operational friction from this process.
In 2017, Blockchain Capital raised a portion of its fund by issuing a blockchain token, so investors can sell that token to another investor in a secondary market, thereby allowing a fund to lock up the capital it needs, without locking up the investor. This is a really interesting area, especially as we see emerging compliance and regulation platforms supporting this.
Do or die… the most successful managers tend to be the ones that are innovative and lead the way on change. Should the application of new technologies lead to outperformance and cost savings, expect their peers to adapt quickly. Guernsey is ideally positioned to facilitate managers keen to seize the opportunities within the digital and transformation space. Are you ready for the change? I am!
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