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BlackRock's Magic Lamp

The situation

BlackRock is widely known as the world's largest asset manager by assets under management, overseeing north of $10 trillion since the beginning of 2022. Less well known, however, is that BlackRock supports the management of a further $20 trillion through its portfolio management software, Aladdin. Could this magic lamp for #portfolio managers be the next systemic risk to the financial system?

The complication

Short for "Asset, Liability, and Debt and Derivative Investment Network", Aladdin is an electronic software that helps portfolio managers around the world keep, manage, and track more than 50,000 portfolios. It provides trading functionality across a range of #asset classes and markets, delivers clear reporting, and crucially provides sophisticated analytics that enables portfolio managers to better manage risks across their positions. Aladdin benefits from powerful network effects given its size, the familiarity of investment personnel with its operation, and its existing integrations with global financial markets make it the default choice of tool for portfolio management.

It is Aladdin's drift towards becoming the default platform for portfolio management that makes it a risk for the global financial system. As more and more portfolio managers find themselves looking at the same risk metrics, the danger of correlated, systemic instabilities grows. In the case of a market downturn, common usage of Aladdin and, most importantly, common approaches to the use of its risk management capabilities could drive herding behavior, exacerbating market downturns. The presence of default settings in Aladdin's risk management tools could entrench groupthink as portfolio managers unknowingly adopt similar risk frameworks, merely through inertia in how they use the platform.

The resolution

Understanding the systemic risk posed by Aladdin should be a priority for regulators everywhere, but especially the SEC. For US regulators, the most likely resolution is a better understanding of and transparency into how portfolio managers are using Aladdin's risk management capabilities - sufficient differentiation in approach could mitigate the system risks discussed earlier. More interventionist jurisdictions, such as in #Europe, are likely to consider more direct methods such as limiting the size of asset pools Aladdin can manage. Whatever the resolution, regulators do not want to be caught in a second situation in living memory whereby an obscure acronym (remember CDOs?) wreaks havoc on the global financial system.

Go deeper

The Relentless Ambition of BlackRock's Aladdin, Institutional Investor

"BlackRock is rolling out new updates to its flagship Aladdin platform as the asset management giant tries to take over even more of the portfolio management software market."

Aladdin: BlackRock's Fintech Genie Must Shield Funds From Groupthink, The Financial Times

"There would be dangers if Aladdin became the industry standard system for US fund managers. If most big investors used the same risk metrics they might make the same mistakes, fostering systemic instabilities."

Aladdin and the Genius that Is Larry Fink, Cognitive Finance

"The story goes that in 1986 Larry Fink, the shooting star in the mortgage department at First Boston, put a trade in expecting the interest rates to rise. Instead, they did the opposite. Fink lost the firm $100 million, and in the process he lost his job, too."

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