Putting Risk and Compliance at the Core

By Edward Lee

Amid desultory returns elsewhere, retail and institutional investors are increasingly searching for new sources of diversification. –Alternative assets, specifically digital securities sold pursuant to Regulation A+, Regulation CF, and Rule 506(b) are now an asset class available to non-accredited investors to meet demand for diversification. However, as with any nascent asset class, investors seek the peace of mind that the alternative assets they diversify their portfolio with are traded in a marketplace that is required to follow a known, and standardized, set of risk management and compliance practices.  Automation has improved the efficiency of secondary markets, and technology has enabled market participants to solve problems with innovative solutions. Markets and market participants have also adopted advanced technologies to facilitate compliance with regulatory requirements in many areas. However, it is essential to remember that not all technology regarding risk and compliance is the same.

What does good look like for today's private alternative marketplace?  

Liquidity is undoubtedly the main risk facing investors in the fractionalized asset market. However, some allocators have yet to fully understand the differences between a fractionalized asset and traditional equity security. Accordingly, at Templum, we implement processes to help our clients overcome these various challenges. For instance, our ATS (Alternative Trading System) comes with a comprehensive and customizable surveillance engine, so you can tailor the monitoring of events and rules based on the marketplace you are running. In addition, users can configure rules for orders placed or trades executed based on various criteria, including order size (e.g., absolute or % of outstanding), trade value, price, or price differentials based on the last trade.  Rules can also be set up to alert specific parties, such as management or compliance, who can then initiate a trading halt. In addition to a comprehensive set of rules, you can customize how they apply to specific entities, assets, or investors to ensure your marketplace operates compliantly while enhancing investors' experience.  In terms of risk management and surveillance, what tools should be considered? Not all technology and solutions are the same, with some technology stacks offering nothing more than risk surveillance post-order match.

What should you look for from your technology and broker dealer partner?  

1. Pre-order match. Identifying risks once they already exist is good but the ability to identify risks before they happen is crucial, for example, the ability to prevent an insider from selling before being allowed to sell. Templum has several pre-order entry risk controls, setting it apart from other solutions. As a result, Templum's system reduces risk by not letting risk be created in the first place.

2. Post-order match. These rules are for items that the issuer does not necessarily want to prevent but be aware of as they occur.  For example, receiving an email notification when the last trade price for a security is up or down 10% from the previous trade price.

3. Customizable rules engine The flexibility to create rules based on concerns specific to your marketplaces vs the limitations of a one size fits all approach is paramount. We at Templum understand that issuers require that flexibility.  These risk and surveillance standards coupled with a registered broker-dealer ensure that investors can trade securities in a marketplace that offers automated, continuous trading in a regulated environment.

The Opportunity is Front and Center

According to Pitchbook data, global crowdfunding exploded from $8.61 billion in 2020 to $113.52 billion last year – a 1,021% increase. The US market alone doubled year on year through Regulation CF and A+, with much higher numbers being raised and over 32% oversubscribed, according to SEC (Securities & Exchange Commission) filings1. Today the growth is undeniable, and the demand from investors exists. The market is also expected to expand significantly in 2022 and 2023 as ATSs, start to list private securities; specifically, the market is projected to grow from $7 trillion in 2021 to $30 trillion in 2030, according to Forbes2. The traditional method of consummating a transaction in alternative assets was burdensome and complicated. However, the opportunities are enormous for firms that use technology to facilitate compliance with regulatory requirements at scale while bringing standardization and risk control to enhance the investor experience.  

1 https://pitchbook.com/news/reports/q2-2022-pitchbook-analyst-note-analysts-advise-on-key-trends-to-watch-as-markets-return-to-turmoil

2 https://www.forbes.com/sites/forbesfinancecouncil/2022/06/16/the-growing-popularity-of-the-private-secondary-market/?sh=6670fefd27ae‍

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