Continued from Part One on Tuesday January 3
The benefits of tokenised funds
The market opportunities for tokenisation could be game-changing for an industry that suffers from low margins and high competition.
Some industry experts see tokenisation as an opportunity for a better system that works for investors and fund managers with tokenised funds delivering greater transparency, improvements in data and analytics and perhaps most importantly instant atomic settlement.
It’s no surprise then that fund managers are already thinking about the possibilities. In 2022 Token City found that 73% of fund managers identified private equity assets and 65% pointed to hedge fund assets as most likely to be the first to see significant levels of tokenisation.
The impact on investors can only be positive, especially as there is fundamentally no difference between investing in a tokenised fund and a ‘traditional’ fund. The investor simply holds tokens in a digital wallet via an App on their phone.
So, what are the likely benefits driving the expectations of different industry stakeholders?
The key proposition for fund managers is:
- Instantaneous settlements with appropriate payment methods
- Immutable transaction records for quality reporting
- Reduced risk with less intermediaries involved
The benefits for investors include:
- Democratised investment through lower lot sizes or partial ownership of assets
- Increased access to private markets currently only accessible to institutions
- Improved accessibility with real-time digital access
Regulators will have the ability to:
- Track the movement of tokens in real-time to ensure the integrity of data
- Encode investor’s rights, legal responsibilities and limitations, and ownership records into funds
- Use smart contracts to automatically notify of regulation breaches
While these benefits lay the groundwork for the creation of a financial system that revolutionises how investment funds work, the challenge is to realise the benefits for all parties.
The challenges of tokenised funds
Change will always be uncomfortable, but tokenised funds fundamentally challenge the way that existing financial systems work.
That said, in a recent address, Mairead McGuinness, the European Commissioner for Financial Stability reminded her audience at the Banque de France conference that “regulation and innovation are not in conflict.”
The desire for change is clear. So, what are the challenges that fund managers need to overcome?
- Regulation prevents change: Existing regulation supports the current financial model, so international rules and regulations are needed to enable cross-border funds
- Systems constrain interoperability: There is a risk of creating siloed assets that don’t communicate with each other and limit the traceability of transactions
- Blockchain technology is immature: Modernising and updating the existing financial infrastructure will occupy budgets and resources in difficult economic times
- Complex stakeholders make consensus slow: Change depends on the collaborative efforts of investors, asset owners, banks, regulators, industry associations and global financial markets
- Limited investor knowledge: Investors need to be equipped with the knowledge to make informed choices when new products become available
- An evolution of existing roles: Tokenised funds cut out intermediaries, so traditional institutions will need to adapt to new competition in the market
It is critical to the growth of the industry that different stakeholders work together to enable new products and solutions, especially when these challenges could be an opportunity to future-proof UK investment funds.
How to manage industry scepticism
Tokenisation still raises mixed views from established fund managers.
Catherine Valega, a wealth consultant at Green Bee Advisory, says: “Retail investors will often skip the more boring financial planning tasks—emergency funds, insurance, maxing out retirement contributions—and jump right into these investments.”
Securitize CEO Carlos Domingo takes a different view: “Tokenisation has the potential to address many of the biggest challenges for individual investors seeking to participate in private market investing by enabling technological and product innovations that were not possible before.”
So, what are the tokenisation skeptics worried about and how can we address their concerns?
The most common objections to tokenisation are:
- The technology is not ready for mainstream adoption: Fund managers are often concerned that digital accounts can be manipulated or that the blockchain can be altered. Organisations can mitigate these risks by monitoring the development of the technology and establishing robust risk management strategies that include governance and security.
- Infrastructure needs to evolve to support tokenisation: As new tokenised funds emerge, legacy players will need to evolve their issuance, risk and compliance, and identity management to innovate their offerings. Funds that take advantage of partnerships with new tokenisation platforms will be able to accelerate their infrastructure maturity.
- The pace of innovation makes the future of funds hard to predict: The future landscape is hard to predict, specifically in terms of the role of traditional funds and the speed of change. Organisations will need to adapt to demands for new functionality and improved user experience as value propositions evolve with technological innovations.
It is evident that tokenisation has the potential to transform today’s financial infrastructure. The pace and depth of change depends on the ability of fund managers to confront industry skepticism and to offer solutions that resolve the challenges of tokenisation.
How to reinvent funds for tokenisation
It is evident that, to reinvent funds for tokenisation, we need to let go of traditional ideas of fund management in favour of the democratisation of investment.
However, a difficulty for fund managers is that traditional operational and regulatory structures need to be changed to support tokenised funds.
A 2021 report by Roland Berger identified a four-step approach to preparing for the shift towards tokenisation:
- Evaluate the implications of tokenisation: Fund managers should evaluate the potential impact of tokenisation on their business model and assess the relevant risks and opportunities
- Define your target position: Decide whether you want to be a frontrunner or follower and draw up scenarios for development and score them against their value, feasibility and cost
- Develop a capabilities roadmap: Map the capabilities that you need to achieve your target position in terms of technology, business model, and regulation
- Think about implementation: Start to develop your in-house skills and either build a user interface or partner with technology vendors
In addition to developing an internal strategy, fund managers need to develop broader industry relationships that help them to:
- Push for an established framework for tokenised funds to operate in the UK
- Address the need for regulation that adapts quickly to emerging developments
- Enable transparent digital information and disclosure to investors
This will help the industry to protect the UK’s position as a cutting-edge financial centre focused on supporting new developments.
There’s no mystery as to why customers want increased customisation and participation, and greater control over their portfolios. With no end to technological innovation in sight, the need for financial institutions to reduce complexity, cost and improve accessibility has never been greater.
The industry’s ability to modernise investment funds will rest on its understanding of the challenges and opportunities that underpin the global adoption of tokenisation.
Found this useful?
Take a complimentary trial of the FOW Marketing Intelligence Platform – the comprehensive source of news and analysis across the buy- and sell- side.
Gain access to:
- A single source of in-depth news, insight and analysis across Asset Management, Securities Finance, Custody, Fund Services and Derivatives
- Our interactive database, optimized to enable you to summarise data and build graphs outlining market activity
- Exclusive whitepapers, supplements and industry analysis curated and published by Futures & Options World
- Breaking news, daily and weekly alerts on the markets most relevant to you