01 Sep 2017
Is Private Equity Blockchain’s Killer App?
How Northern Trust provided the open ledger system a powerful proof of conceptRe: Karim Lakhani; Marco Iansitiby Dan MorrellTopics:
Illustration by Jon Krause
When trying to explain how blockchain works, it helps to have a mass-culture analogue. Mike O’Grady (MBA 1992), president of Chicago-based Northern Trust, uses social media: Blockchain, he says, is a transaction ledger that is accessible to only a select group—kind of like your Facebook page.
And like Facebook, access to blockchain ledgers can vary: A new profile photo might be accessible to everyone in your social network, while you might grant only your family the ability to see a picture of your kid’s birthday party. Applied to a private equity transaction—an initiative Northern Trust has piloted—that birthday picture is a contract, and your sister is the PE firm’s general partner. The limited partners get to see only their investment; the lawyers get to see only the transactions for the parties they represent; and the regulators have access to the info they need. “It’s all about who gives the other person access to what is essentially their ‘page,’ ” says O’Grady.
These days, though, O’Grady rarely needs to shorthand blockchain. Its most famous application, bitcoin, has become an increasingly mainstream investment, and financial services firms have been testing blockchain’s potential for a few years now. But until Northern Trust’s pilot began this past spring, private equity investors didn’t have a commercial application for blockchain.
Aware of the tech’s potential impact, Northern Trust spent years ramping up its blockchain knowledge and put the question of where to apply it to a team of experts—tech gurus as well as specialists in asset management, regulation jurisdiction, and operations. The team eventually landed on private equity. O’Grady offers the example of a fund closing to illustrate its potential: “If you think about the time between agreement on the [private equity] fund, the commitment on the part of investors into the fund, and the closing—it gets measured literally in months, as opposed to days,” he says. There’s the signing and mailing paper contracts, untold emails, multiple opportunities to introduce human error, and lots of wasted energy. With blockchain, every party could validate their portions of the transaction securely, remotely, and quickly. “Right there, you say, ‘OK, there’s clearly an opportunity.’ ”
Before it could start, Northern Trust had to get the tech right and get multiple parties to go along with the plan. It worked with IBM to solidify blockchain’s functionality and security and found a willing, technologically progressive client in the Swiss private equity firm Unigestion. The final piece was bringing in similarly progressive regulators from Guernsey Financial Services Commission, an international body that handles a large number of private equity funds.
This kind of groundwork will remain necessary until blockchain sees wider adoption, says Professor Karim Lakhani, in part because it’s a departure from about 700 years of established business practice. “Since ledgers were invented, they’ve always been private,” he says. “You have to get over the cognitive block of, ‘Oh my God, this is going to be open to all the parties,’ and secondly, ‘I now have to change all my processes.’ ” The technology, Lakhani adds, is relatively simple. “It’s the human aspect and the organizational aspect that need to be addressed.” But if adoption spreads, blockchain could become what he calls a “foundational technology,” with the potential to undergird the world’s economic and social systems. In a recent article he wrote with Professor Marco Iansiti for the Harvard Business Review, Lakhani compares blockchain to TCP/IP, a network communications technology that spurred the internet’s growth. No one today, he says, thinks about how TCP/IP works. “They just use FaceTime, they just use email,” Lakhani says. Blockchain could have a similar future.
In the near term, O’Grady estimates that the blockchain application could enable Northern Trust to achieve productivity savings of “somewhere in the neighborhood of 25 to 35 percent.” The firm—which has $1 trillion in assets under management and more than $7 trillion under custody—wants to offer the technology to more clients, but O’Grady is cognizant that expansion will take time. “It’s not as though by the end of the year we’re going to have all of our private equity fund clients [on blockchain], because it’s still the early days of the application of this technology,” he says. Long-term growth will require more tech work, he adds. He brings back the Facebook comparison. “I think Facebook has more than a billion and a half members. They’ve been able to scale the capability of the technology. That’s what this doesn’t have at this point.” But Northern Trust is working on it, O’Grady says, with an aggressive goal worthy of a Silicon Valley startup: “We want to bring a scaled-up version of the blockchain application to market by the end of the year.”
From Baker Library:
Blockchain is an innovative and complex technological advance, but what exactly is it and what is it capable of doing for your business? Harvard Business Review and Deloitte provide insight on how industries and companies could use blockchain tech to their best advantage. To learn more about the forecasted growth of blockchain, take a look at the Statista database within the eBaker alumni research portal.
Class of MBA 1992, Section H