Used by rival fund managers, the reach of the Aladdin platform raises possible conflicts of interest
Richard Henderson in New York and Owen Walker in London
© Bloomberg
As toxic mortgage-backed securities tore through the financial system more than a decade ago, the US government turned to Larry Fink, one of their earliest pioneers, for help. Mr Fink made a fortune packaging mortgages together and selling off slices of the combined pools in the 1980s before founding BlackRock, which today stands as the world’s largest asset manager.
As the crisis deepened, Mr Fink spoke to Hank Paulson, US Treasury secretary, more often than some chief executives of the big Wall Street banks, in brief, urgent calls. He offered the Treasury and Federal Reserve a powerful tool to gauge risk in the assets at the centre of the havoc. The arrangement would net BlackRock tens of millions of dollars in government contracts, awarded largely without a tender process, put it at the forefront of the fintech revolution and cement Mr Fink’s standing at the intersection of politics and finance.
At the heart of this exchange was Aladdin, BlackRock’s vast technology platform. The system links investors to the markets, ensures portfolios hold the right assets and measures risk in the world’s stocks, bonds and derivatives, currencies and private equity.
Aladdin’s influence has surged since the financial crisis. Today, it acts as the central nervous system for many of the largest players in the investment management industry — and, as the Financial Times has discovered, for several huge non-financial companies.
At the intersection of politics and finance: BlackRock chief executive Larry Fink, right, meets US president Donald Trump © Chip Somodevilla/Getty
Vanguard and State Street Global Advisors, the largest fund managers after BlackRock, are users, as are half the top 10 insurers by assets, as well as Japan’s $1.5tn government pension fund, the world’s largest. Apple, Microsoft and Google’s parent firm, Alphabet — the three biggest US public companies — all rely on the system to steward hundreds of billions of dollars in their corporate treasury investment portfolios.
Yet the true reach of Aladdin is unknown outside of BlackRock. The New York-based manager last revealed exactly how much of the world’s assets sit on the system in February 2017, when they reached $20tn. BlackRock told the FT that total assets do not reflect how clients use the system. One former employee says the figure is no longer disclosed because of the negative attention the enormous sums attracted. In the past three years, Aladdin has added scores of new clients, the stock market has gained a third in value and the bond market is 13 per cent larger.
Today, $21.6tn sits on the platform from just a third of its 240 clients, according to public documents verified with the companies and first-hand accounts. That figure alone is equivalent to 10 per cent of the world’s stocks and bonds.
“Aladdin has become a mainstay of the marketplace,” says Peter Kraus, chief executive of Aperture Investors and former head of AllianceBernstein, the $600bn investment group. “It has a huge historic client base.”
Aladdin has fuelled BlackRock’s all-conquering rise by tightening its links with customers and diversifying its revenues. But the platform’s success has opened up new challenges. Competitors are fast developing rival platforms that are taking some of its business. The system’s scale — unparalleled for technology offered by a fund manager — has also created possible conflicts of interest. Most of all, its importance as a fintech hub has raised the prospect of a regulatory backlash.
The world’s most powerful risk management system threatens to become a liability for its owner.
After the financial crisis, a US regulatory push sought to label certain large banks and insurers as systemically important. Asset managers were expected to be included in this list, but the larger companies lobbied hard to avoid the decision. They were ultimately successful, based on one single argument — investors who entrust fund managers with their assets technically hold them with one of a small group of specialist banks, so the assets are never on fund managers’ balance sheets.
Platforms like Aladdin were not factored into this decision, but as markets and investing become more reliant on technology the role of these systems could play a role in future decisions.
“Regulators will have to confront this issue as technology becomes more important and intertwined with the investment process,” says Monica Summerville, director of fintech research for Tabb Group, a consultancy. “They are going to have to take a stand.”
Aladdin’s sprawling influence has prompted fears that it, or BlackRock, could act as a chokepoint if either faced a shock — a cyber attack, a rogue line of code or a sudden crisis for the company — destabilising the financial system.
In January, the Financial Conduct Authority, the UK regulator, said the failure of a large portfolio and risk system, like Aladdin, “could cause serious consumer harm” or even “damage market integrity”.
“The industry is becoming reliant on a small number of players such as Aladdin,” says Jon Little, former head of BNY Mellon’s international asset management business. “Yet [regulators] seem reluctant to regulate or intervene to supervise these key service providers directly.”
Rob Goldstein, chief operating officer for BlackRock, says Aladdin’s risk tools are designed to support, rather than replace, portfolio managers © David Paul Morris/Bloomberg
Though Aladdin does not tell asset managers what to buy or sell, some argue that if a large portion of global assets respond to the warnings that Aladdin gives off, trillions of dollars will react to events — such as the outbreak of a pandemic or war in the Middle East — in the same way, causing dangerous herding behaviour. The more investment managers and asset owners rely on Aladdin to gauge risk, the less responsible they become for their portfolio decisions.
This concern was highlighted by the Los Angeles County Employees’ Retirement Association, the $58bn US pension fund, in January. It cited the potential for “groupthink” as one reason it declined Aladdin’s risk capabilities.
“Anything close to an oligopoly in risk management would be especially dangerous if there were any weakness in the system,” says Jim McCaughan, former chief executive of Principal Global Investors, the $476bn fund manager.
Aladdin’s critical role within high-profile companies also makes it a prime target for cyber crime. Ryan Dodd, a former fund manager and founder of risk consultant Cyberhedge, says BlackRock and Aladdin are enticing targets for hackers, including those backed by nation states. “They provide a master key to unlock credentials of thousands of other high-value targets, such as the users of Aladdin,” he says.
These risks are compounded by Aladdin’s complexity. Moving on and off the system can take years, because it often entails replacing a range of different systems and users have to contort the way they operate to fit Aladdin’s model. One recent client whose business transitioned to Aladdin over three years likened the process to “changing a tyre while speeding round a racetrack”.
Rob Goldstein, chief operating officer for BlackRock, says Aladdin’s risk tools are designed to support, rather than replace, portfolio managers, adding that rival platforms offer an alternative, negating the idea the financial system was overly reliant on Aladdin.
“Even though it’s a critical piece of infrastructure, there are many critical pieces of infrastructures that clients have in their inner workings,” Mr Goldstein says. “We live in an incredibly competitive environment.”
The scale of BlackRock’s dominance in both the investment industry and in providing its plumbing has led to potential conflicts of interest. As the world’s biggest asset manager, BlackRock is among the top shareholders of most listed companies globally, including many Aladdin clients.
BlackRock is the largest shareholder of Santander, for example, whose asset management unit joined the platform last year, and a major shareholder of HSBC and Credit Suisse, other recent clients. This has drawn concern from rivals that BlackRock’s influence over the companies as a major investor has helped convince them to choose Aladdin, an idea BlackRock rejects.
In some cases, the potential conflicts are multi-layered. BlackRock is the third-largest shareholder in Apple, giving it clout over the tech company’s shareholder votes, while Sue Wagner, a co-founder of the fund manager, is a board member of both companies.
Ms Wagner is also on the board of Swiss Re, another Aladdin client whose former vice-chairman, Mathis Cabiallavetta, is a BlackRock board member. Mark Wilson, former chief executive of Aviva, which uses Aladdin, accepted a seat on BlackRock’s board in 2018 while in his former role. This decision angered the UK insurer’s shareholders who worried it created a conflict of interest, as Aviva’s investment arm competes with BlackRock. He left Aviva six months later and remains on BlackRock’s board.
State Street bought Charles River, an Aladdin competitor popular with fund managers, for $2.6bn in 2018
Aladdin — which stands for asset, liability, debt and derivative investment network — began as a simple ledger for bond portfolios shortly after BlackRock was founded in 1988. As it grew, BlackRock extended its use for certain clients. The first was General Electric, which in 1994 was selling Kidder Peabody, the beleaguered brokerage, but was unsure how to price the assets on its balance sheet. A series of similar one-off arrangements eventually led BlackRock to offer Aladdin as a product in 2000.
“When we did Kidder Peabody, it was an X-ray machine,” says Mr Goldstein. “When we had the opportunity to work on the most recent [financial] crisis, it was an MRI machine.”
The system has expanded rapidly. BlackRock’s 2015 deal to acquire FutureAdvisor spawned an offshoot of the platform for financial advisers today used by Morgan Stanley and UBS.
BlackRock also offers a version of Aladdin for custody banks, including BNY Mellon, that safeguard assets managed by fund groups like BlackRock. Last year, BlackRock acquired eFront, a private equity tech platform, for $1.3bn, extending Aladdin’s reach into less liquid assets.
Powerful trends have buffeted Aladdin’s rise. Investing has become more electronic and reliant on big data. As the tools that process the information have become more complex, investors, fund managers and insurers have turned to larger platforms such as Aladdin to replace multiple specialised systems.
Aladdin’s growth is reflected on BlackRock’s balance sheet. Technology revenue, dominated by Aladdin, hit $974m last year, just 7 per cent of the company’s total, but among the firm’s fastest growing areas. Analysts at Morgan Stanley predict this revenue will more than double in the next six years.
Mr Fink has said he wants a third of BlackRock revenue to come from technology by 2022.
This includes money from Aladdin but also fees from funds that clients select on the platform.
The company offers discounts to institutions that invest in BlackRock funds and sign up to Aladdin.
Aladdin’s income, locked up in steady, multiyear contracts, diversifies BlackRock’s income away from the fees it charges on assets, which dip during a market downturn.
Apple, Microsoft and Google — the three biggest US public companies — all rely on Aladdin to steward hundreds of billions of dollars in their corporate treasury investment portfolios
“It’s the tech subscription model that investors love,” says Kyle Sanders, an analyst at Edward Jones. “It’s not sensitive to the market.”
Aladdin’s dominance has attracted heightened competition. State Street, which runs $3tn of assets, bought Charles River, a popular platform for fund managers, for $2.6bn in 2018. It has since signed up four new clients, including Lazard Asset Management.
Dimension, a platform from Copenhagen-based SimCorp, has also won a series of US clients, including the World Bank, and has a stable of European users, such as the investment units of Axa and UBS.
In January, MSCI, an analytics provider, paid $190m for a minority stake in Burgiss Group, which specialises in private asset data. The deal is a direct response to Aladdin’s push beyond stocks and bonds.
So far, BlackRock has conceded little ground to competitors, despite some offering cheaper and more flexible terms. Just one big client has publicly defected so far, the Italian fund house Pioneer when it was bought by Amundi, the €1.6tn French manager.
“We chose to have complete control of our software,” says Yves Perrier, chief executive of Amundi, Europe’s biggest investment group. “I don’t want to be dependent on a competitor.”
Fink vs Ranieri: Wall Street rivalry was genesis for risk platform
In 1986, Larry Fink led the mortgage department of First Boston, a large investment bank, and was on track to become its chief executive. Then, he lost $100m and was soon pushed out. Mr Fink had joined a decade earlier as a graduate trainee and rose rapidly. He generated hundreds of millions of dollars in part by selling mortgage-backed securities, but then made a fateful error. He misjudged a fall in interest rates, which allow mortgages to be repaid quicker, reducing their value to investors.
The tale has become an origin story for Mr Fink’s second act at BlackRock and the genesis of its risk platform, Aladdin. But he leaves out one crucial detail.
The scale of the loss was driven by his desire to beat his counterpart at Salomon Brothers, Lewis Ranieri. Mr Ranieri was later immortalised as a “big swinging dick” by Michael Lewis in Liar’s Poker, and was aggressively selling mortgage-backed securities. As the rivalry deepened, Mr Fink issued more than First Boston could sell, ending up with a large inventory on its balance sheet that would lose value when rates fell.
For Mr Fink the episode proved the need for a portfolio management tool like Aladdin to assess risk. It also reveals the competitive drive behind Mr Fink and the group of First Boston colleagues who left to found BlackRock, many who remain today.
“These are dynamite business people,” says one former First Boston colleague. “They can smell blood up the river.”
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