Nasdaq, Goldman Sachs Creating Electronic Trading Platforms for Private Equity
The Next Frontier
But why are Nasdaq and Goldman rolling out private equity platforms at roughly the same time?
"Nasdaq is doing it because they need to find growth avenues and they think this might be the next frontier," comments Patrick O' Shaughnessay, equity analyst at Morningstar in Chicago. "Goldman is doing it because they had demand from their customers, and it's diversifying in its own right," the analyst continues. "The bottom line is both think they can make money off of it."
"The volume of 144As is increasing as companies are becoming less desirous of being on an exchange because of regulations," adds Stephen Bruel, an analyst with TowerGroup's securities and capital markets practice. "We're seeing the desire to have more liquidity across all instruments in the portfolio," he says. "The issuers get the advantage of their private placement being accepted by institutions because they'll benefit from knowing they'll have liquidity."
Industry sources say private equity firms and hedge funds are the major groups seeking to raise money in the private markets and that this demand led Goldman to design GSTrUE.
"The reason they created this system was likely to deal with a specific demand from the private equity firms and hedge funds, many of which are looking to float securities, still have a manageable shareholder base with ownership restrictions and not necessarily be subject to SOX," asserts Rosenblatt's Gawronski.
More than a year ago, Goldman came up with the idea of having a new electronic and transparent system for trading 144A offerings based on feedback from issuer clients, according to Ed Canaday, a company spokesman. "They wished there was a more accessible or transparent way or more liquid process of trading these types of securities," he says. "Under the prior system, they had to call each other and negotiate prices on their own. There was no electronic trading or settlement aspect."
Since REDIPlus is on the desk of many institutional investing clients -- and many of those clients are QIBs -- "They could easily access [GSTrUE]," notes Canaday. In addition, since not everyone uses REDIplus, Goldman built the capability to trade on GSTrUE through Bloomberg, he adds.
According to Canaday, one of the critical components of 144A is real-time tracking because issuers can't have more than 499 investors in an offering. "If you go over that number, you have to register and become public," he explains.
To help control the number of shareholders in the Oaktree private equity offering, Goldman worked with American Stock and Transfer (AST), a transfer agent that provided an accessible Web screen that institutions could use to view the offering and pricing. AST also provides a system for monitoring the number of investors.
"In the past, you didn't have an electronic system that measured the number of investors -- you had two QIBs talking to each other," says Canaday. "Now you have real-time constant monitoring so you constantly have that number." In some cases, Canaday notes, the issuers may want to limit the number of shareholders to fewer than 499.
Another key feature of GSTrUE, according to Goldman's Canaday, is that investors can see indicative bids and offers on the screen as well as last-sale information. "It's really getting to where other asset classes have been for years," he says.
In addition to the transparency provided by GSTrUE and the liquidity backed by investors who participated in the initial offering, Goldman also will commit capital to take the other side of trades, Canaday adds.
Not All Platforms Are Equal
Pointing out the differences between Nasdaq's platform and Goldman's single-dealer platform, the exchange's Jacobs says Nasdaq's Portal market is a "neutral platform. We expect all [brokerage] firms to participate." Jacobs contends that Nasdaq will have an advantage over single-dealer platforms because it's going through the SEC.
"Any individual broker-dealer that sets up a platform for 144A typically doesn't have to go through the SEC because they're not open to multifirms and their customers," explains Jacobs. "No investor wants to rely on a single firm. They want Nasdaq -- they want that kind of market." Jacobs says Nasdaq confirmed that notion in extensive interviews with firms before it built the system.
Currently, Nasdaq applies a registration process to Portal securities to determine if they are eligible. "We review them to make sure they comply with 144A so we can put them in DTCC for clearance and settlement," says Jacobs. In addition, the Nasdaq platform will include shareholder tracking functionality when it launches later this year. Jacobs also points out that Goldman's private equity offerings are not in the DTCC.
Analysts say they regard Nasdaq's Portal as a neutral system. "Definitely you want third-party oversight for compliance reasons," says Denise Valentine, senior analyst at Aite Group. "There ought to be guidelines for participation. It can't be an exclusive community or restrict viable candidates." She adds that involving DTCC helps institutions overcome the operational challenges of taking in subscriptions or redemptions.
But Morningstar's O'Shaughnessay isn't as certain that being a neutral platform is important. Rather, he suggests, liquidity will be key. "There can be something said for Nasdaq being the independent party who may create a platform and have more people access it," O'Shaughnessay says.
Other analysts agree that liquidity will go a long way in determining the success of private equity platforms. The electronic platforms, experts acknowledge, could make the private equity market more appealing to institutions if they bring more transparent pricing and build liquidity for a secondary trading market.
"Potentially a platform could attract more money to private equity," says Aite's Valentine. "It could distribute information to the industry more broadly, which could be helpful in tracking investments or in tracking performance with more benchmarking opportunities."
But while some large pension funds and hedge funds invest in private paper, some mutual funds have restrictions in their charters against investing in illiquid securities, limiting retail participation in the private equity market, according to Valentine. Further, she says, while pension plans have been active in the private placement market, these are long-term investments that have a high-risk component and fall under the alternative investment category. "You can't always price these things," says the analyst. "You usually wait years to get your return."
Still, TowerGroup's Bruel says the electronic platforms will make more people comfortable investing in 144As since it will be easier to trade in or out of positions. "At least there's a mechanism they can access to attempt to get a position or dispose of a position, whereas today there will be some trepidation over jumping into a market where you don't have more liquidity," he says.
But Nasdaq's Jacobs, who also runs new products for Nasdaq and created the QQQ (Nasdaq 100 index), says he plans to create an index on Portal that could spawn composite and subindexes on equity and debt private placements. "That could bring in retail because it's done through aggregation down the road," he says.
Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio
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