By Arthur Azizov, Founder, B2BROKER Group

Today, brokerages wrap access to private markets in the same clean and sophisticated interface they use for public stocks. All the necessary data on the screen, with nothing unnecessary, and big “Buy” and “Sell” buttons in the centre, creating an impression of instant access to funds. 

Behind that interface, however, sits an entirely different age of finance. Private capital is extremely different from public markets and it still runs on documents completed by hand and NAVs for assets that may not have traded in months. The gap is significant, and while the front office operates in milliseconds, offering clients to sell assets in one tap, the back end still relies on fax machines and conducts deals slowly. 

Clients don’t see what is hidden underneath and how the processes are going, but thanks to the interfaces, they believe that everything works exactly the same as on open markets. When the front office promises the liquidity it can’t actually provide, the brokerage loses the trust of its clients.

A stress test for the market

To understand why this discrepancy may be a threat for any brokerage, start with what private assets are and how they work. Traditionally, all kinds of private assets, such as buyout stakes or private-credit loans, were managed by large financial holdings because they lacked liquidity. As the demand for such assets is rather low, investing in private capital means committing capital for years. 

Retail investors, though, were always interested in new assets, and Wall Street once again decided to help them. Institutions issued new kinds of securities, wrapping up non-liquid assets into retail-friendly funds. Such securities could circulate on the stock exchange almost freely, and over the last few years the industry has made broad public access to them through wealth platforms and brokerage apps. 

However, the main limitation stayed, and brokerages still had to actually sell what was wrapped as a fund before paying to customers. For this reason, to protect performance these products have limited redemptions, typically to once a quarter or once a month.

That mechanism worked well for some time, but at the beginning of this year, it began to fail gradually. Investors fairly believe that they have all rights to sell their assets. For example, this winter they tried to withdraw $20.8 bln at once from major institutions like Apollo and KKR. At one point, the demand was much higher than the structures were built to absorb, which led several of those investment giants, such as Blackstone and Blue Owl, to limit redemptions, since they simply didn’t have sufficient capital to settle all the deals. 

While those withdrawal restrictions were not caused by any break and were based on the fund papers’ rules, many people did not expect their money might be held in limbo for some time. They simply didn’t know there was no real connection between their “Sell” button and what was going on on the other side. 

The hidden risks of the outdated infrastructure

There are several breakpoints that enable those restrictions. Firstly, private markets do not run at the same speed as public ones. When thousands of clients tap “Sell” simultaneously, each request must be priced against a NAV that may be weeks old and then queued. Private assets, in fact, look like a patchwork. They are highly fragmented, and many exceptions require manual handling. 

Most of the data remains fragmented across different accounting management systems, the fund administrator’s books, the transfer agents’ registers, and many more. Each of them has its own copy of an asset condition, and to unify them may be incredibly difficult. Add to this exceptions which can’t be processed by a machine and should be done by hand, and the full picture of managing chaos becomes clear.

That’s where the discrepancy between what is written in a customer’s app and what is actually recorded in the administrator’s ledger or the transfer agent’s books came up from. When many clients try to withdraw their funds, brokerages need to collect data from different sources, and at the moment no one can give a client a straight answer about what is happening with their money and what to do next. 

In the end, it breaks trust and teaches the user that it may not be the best choice to keep money in those assets or even in a direct brokerage account. If that trust problem were to scale, it would be far more expensive to reverse than any back-office upgrade would have been. 

However, this mismatch between the front office and the back one should concern many other brokerages, not only those that work directly with private assets, as clients’ misunderstandings will eventually spill over into the general market. An investor who can’t withdraw money from a private fund is likely to sell whatever they can, pushing down the prices of other assets. The first in line would be the asset managers that had lost investors’ confidence. For example, due to redemption restrictions Blue Blue Owl’s stock had lost nearly half its value by April, hitting an all-time low.

Building an actual liquidity

The liquidity mismatch can be dangerous for brokerages, but, luckily, there are several ways to handle possible over-demand. The catch is that it will require investing in back-office infrastructure updates, which, however, will still be cheaper than dealing with fleeing customers.

To give people actual and precise data on their assets condition, brokerages must build a digital transfer agent that maintains one authoritative ownership record. Such programs are actually now gradually introduced alongside major exchanges.

It may be followed by a common technical standard for transfer agents, replacing on-demand and custom builds. It is always easier to prepare a common playbook for all customers than to deal with different connections and interfaces. That, in turn, will demand a programmable settlement. Coded subscriptions and redemptions with compliance and identity checks would let cash and ownership rights move much faster, reducing settlement latency from weeks to the timeframe customers expect.

The most important thing, however, is an actual secondary transferability. Customers should have access to a regulated secondary market where they can sell a position to another buyer, rather than waiting for the fund to deal with it. To make this secondary platform work well, all previous steps should be taken and be based on trusted data.

If the brokerage doesn’t want to deal with customers’ panic and withdrawals, which later spill over to other assets, it should consider building such a system for private asset management.