A report from the UK Investment Association has found that UK fund managers are embracing and planning for fund tokenisation with 29% of fund managers expecting to tokenize their funds within the next 1-5 years and half of fund managers expecting tokenisation within the next 10 years.
A tokenised fund is:
Sometimes also known as ‘digital funds’, these funds issue tokenised shares or units to represent the investor’s interest in them and are generally traded and recorded on a distributed ledger rather than a traditional system of records.
The report highlights there are a number of moving parts to tokenising funds in the UK, which are applicable in Australia including:
Regulatory certainty for funds managers;
How AML/CTF compliance will operate in a tokenised fund world;
The availability of a central bank or commercial bank digital currency or stablecoin to facilitate settlement;
How funds can hold tokenized versions of real world assets;
How exiting custody and securities depository services need to change to accomodate tokenisation;
Digital identity and how that can integrate with tokenised funds;
The availability of banking services to businesses involved in tokenisation.
Europe has been piloting different models of tokenised funds with the German Sustainable Growth fund using a public chain and allow-list for holders, a Luxemberg money market fund using a distributed ledger for their register. The Financial Conduct Authority indicated in a letter agreement to a 'baseline' first stage with:
replacing an authorised fund’s traditional register of unitholders with tokens on a private permissioned (not publicly accessible) blockchain for which the authorised fund manager takes responsibility.
[With] the existing roles of the parties ... unchanged.
Settlement ... carried out in the usual way ‘off chain’, with no use of any form of digital money.
The fund would be comprised of traditional assets.
The fund would continue to provide a valuation point daily or on another timescale consistent with existing regulation and market practice.
This first stage and supportive approach of the regulator is sure to encourage the growth of blockchain based funds in the UK. In Australia the Assistant Governor of the Reserve Bank of Australia recently said:
It is a perennial regulatory challenge to ensure innovation can flourish in a way that is consistent with financial stability and consumer protection. Some innovations in tokenised finance have occurred in a grey zone, on the edge of the regulatory perimeter. A common theme globally is uncertainty around governance and risk management responsibilities – if a smart contract on a programmable ledger goes awry, cross-border and anti-money laundering responsibilities do not disappear, but who is accountable? Only a small number of jurisdictions have established new regulatory frameworks supporting tokenised asset markets, while others have observed that innovations in tokenised finance should operate within existing regulatory frameworks.
With potential transaction savings of $1B - $13B a year identified by the Assistant Governor, tokenisation of funds and other assets is sure to be an ongoing area of interest to the Australian government.