Northern Trust Opens Doors to Cryptocurrency Hedge Funds As Part Of Pervasive Blockchain Expansion
Financial services giant Northern Trust has significantly expanded its work with blockchain and cryptocurrencies across multiple divisions.
In addition to adding a number of new blockchain features for managing its private equity workflow, the company, which has almost $10.7 trillion in assets under custody and administration, has also quietly opened its fund administration services to a select group of hedge funds betting on bitcoin and ethereum.
These potentially groundbreaking projects amount to one of the most significant pushes into cryptocurrency and other assets encrypted on a blockchain by a traditional financial institution.
In an exclusive interview with Forbes, the president of Northern Trust’s corporate and institutional services, Pete Cherecwich, provided an unprecedented look into the breadth of his company’s work with blockchain. But perhaps more importantly, he explained why the 129-year-old institution was committing so many resources to the technology.
“You can take anything today. You can take movie rights, you can take all sorts of entities, and you can create a token for those,” said Cherecwich, who has been with the company for 11 years. “We have to be able to figure out how to hold those tokens, value those tokens, do those things.”
The newest of Northern Trust’s blockchain efforts is a previously unreported project with three “mainstream hedge funds” that Cherecwich says are diversifying their portfolios with cryptocurrency investments. While he was unable to share the names of the clients due to nondisclosure agreements, he described his company’s new cryptocurrency services in detail.
Since the first quarter of this year, Northern Trust has been helping the hedge funds by comparing the numbers they report with the actual amount on record at the customer’s cryptocurrency custodian. The firm further helps value the investment as part of its fund administration services, and records the value for its clients. Many of Northern Trust’s fund administration services were developed for traditional assets, but others, including new risk and control frameworks for anti-money-laundering, asset existence validation, crypto-trade reconciliations and the ability to handle new net asset value pricing arrangements, were developed specifically for cryptocurrency.
While Northern Trust Hedge Fund Services had $370 billion in assets under management as of March 31, 2018, the financial institution is not currently taking direct custody of cryptocurrency. Nor does Cherecwich expect the company will custody cryptocurrency in the near future. Instead, he says helping the company’s customers account for their cryptocurrency investments is part of a larger effort to prepare for the day when fiat currencies are also issued on a blockchain.
“I do believe that governments will ultimately look at digitizing their currencies, and having them trade kind of like a digital token — a token of the U.S. dollar — but the U.S. dollar [would still be] in a vault somewhere, or backed by the government,” said Cherecwich, who worked at State Street for 20 years before joining Northern Trust. “How are they going to do that? I don’t know. But I do believe they are going to get there.”
Beyond the new work with cryptocurrency, Northern Trust is moving to significantly integrate blockchain into the life cycle of its $77 billion private equity business.
Launched into alpha in February 2017, the prototype for Northern Trust’s private equity platform was initially built for Switzerland-based financial services firm Unigestion, using an early version of the open-source blockchain code Hyperledger Fabric. Just a few months after the launch, Northern Trust upgraded the rudimentary private equity platform to the first enterprise-grade version of Hyperledger Fabric, and is now adding a number of new features.
The upgraded private equities blockchain moves beyond just settling a transaction, using a more automated process by which a general partner and a limited partner exchange ownership of an asset. Capital call functionality has also been built into the system, with the hope of reducing the role of middle-office middlemen and accelerating the speed at which funds are recieved.
To build the series of new blockchain services, Northern Trust established a team of 12 technology and private equity specialists working over six months, and has since supplemented the working group with product managers and operations and regulatory compliance experts who specialize in the markets targeted for implementation.
While pricing for the software solution has yet to be determined, Cherecwich said Northern Trust has demoed it to “well over 100 clients” and is working with some of them to more fully automate costly middle-office services. “We have determined that we will be able to go out and sell it,” he said.
“When I do a capital call, I will get my money faster than if I had to do it via emails and paper and everything else. So my time to market, and therefore when I’m going to get paid, is shortened,” said Cherewich. “The more automated that process becomes, it’s just less costly to run a fund.”
But cryptocurrency administration and private equity workflows are just a small piece of Northern Trust’s larger blockchain plan.
Because of its relatively low transaction rates, the $2.5 trillion annual private equity industry was seen as an ideal place to target blockchain solutions, which historically had difficulty handling high volume. Going forward, however, Cherecwich believes the transparency provided by using a shared, distributed ledger could be of interest to auditors and regulators across industries.
To prepare for that demand, Northern Trust and Big Four accounting firm, PwC earlier this year revealed a suite of auditing tools designed to give real-time access to financial reports that would otherwise be sent on a periodic basis. Already, a Guernsey financial regulator has access to a node on the blockchain designed to grant it real time access to some of the data on the distributed ledger.
“Since blockchain has an immutable record, you put a robot as a node on that immutable record, and I don’t care whether it’s private equity or anything, then that robot can audit those transactions, and make sure everything syncs automatically,” said Cherecwich.
At the core of Northern Trust’s blockchain work are two patents that could eventually help transform the legacy financial institution into a software provider. The first patent, filed in early 2017 uses biometric data of a user to confirm he or she has permission to perform various tasks. The second patent, filed late last year, is for hosting an investors meeting using Hyperledger Fabric, Ethereum or Openchain, and relies in part on the proof of identity provided by the first patent.
“What we’ve done is not only developed a patent that enables you to have the identity management that enables you to do transactions,” said Cherecwich, “but extends the transactions beyond buying and selling of the security to actual board meetings and votes.”
Some of the progress Northern Trust is making is being slowed by regulatory uncertainty, according to a position paper on the potential role of cryptocurrencies published by the firm in June. Citing measures taken by Bank of America, Citibank and Lloyds of London to prevent customers from buying cryptocurrency using credit cards, the report further noted that very few major banks have launched any crypto-related services and most are awaiting more complete regulatory oversight.
Among the most notable exceptions to this apprehension is Goldman Sachs, which is opening a bitcoin trading desk, and Bloomberg, which earlier this year helped launch the Galaxy Crypto Index with support from hedge funder, Mike Novogratz. While Northern Trust’s June report characterized the firm’s attitude toward the changing cryptocurrency landscape as “cautious,” the work being done by the financial services giant places it among the most ambitious of such efforts.
“It’s just something I’ve not seen from custodians in my 30 years” in the industry, said Cherecwich. “And I’m pretty proud.”