What if you could launch an investment vehicle that offered significantly lower up-front and ongoing fees – as well as more flexibility and transparency – but could still give differentiated returns based on the expertise of portfolio managers? What if that fund had radically lower operating risks and costs, by cutting out many of the supporting processes mutual fund providers have managed for decades? This is the opportunity that tokenisation could offer to investors and the financial industry. While the concept is still in its early stages, Asia’s willingness to embrace tech-driven innovation and propensity to invest proactively could make it the market best placed to benefit from this new era of digitised collective investments.
Concept
The transformative power of distributed ledger technology (DLT) has perhaps best been seen through the growth of Bitcoin and other crypto-currencies and assets, transactions in which are managed securely and transparently on a blockchain, a type of distributed ledger. So far, the practical impact on the traditional investment sector has been limited, with some elements of the overall process being migrated to DLT. But there is potential for a much more fundamental, indeed game-changing, shift.
In the crypto-assets arena, tokens are often used as a simple, standardised way of representing, storing and exchanging value. But ‘off-chain’ assets – e.g. securities, property, private equity investments etc – can also be tokenised, that is, digitally represented on a distributed ledger. In the investment world, this could enable a customer to directly own and manage a range of assets represented as tokens in a virtual portfolio. The purchase, sale, and settlement of these tokenised assets would be instant, immutable and irrevocable if executed on a distributed ledger, requiring no post-trade reconciliation or manual intervention.
This could have a radically streamlining effect on the investment value chain, rendering a number of underlying processes and intermediaries obsolete, reducing cost and risk, and boosting speed, efficiency and transparency. Tokenisation also allows assets to be fractionalised, meaning individual investors could effectively purchase a small portion of either a physical asset or a highly-priced security or investment.
It’s true that buying a share or unit in a mutual fund is a form of fractionalised ownership, but the investor is very much tied to a collective structure and outcome. Buying a tokenised asset can provide a more direct and transparent form of ownership, in terms of performance and returns
Barriers
Unlike crypto-assets, the securities in a mutual fund do not derive their value from ‘on-chain’ transactions. Also, a mutual fund portfolio typically contains a range of instrument and asset types, even if specialising in one. Both facts complicate the relationship between the on-chain token and the off-chain assets.
Although tokenisation is technologically feasible, practical challenges abound, with potential for investor protection concerns over the availability of professional advice on low-fee products. Internal legacy systems at investment management firms could prove a stumbling block, as could linkages to external market infrastructures.
These linkages will be crucial to ensure accurate valuations, but may be hampered by the long-term implications of tokenisation for the business models of incumbents. For widespread industry acceptance, consensus will be needed on matters such as what a token is, how it is constructed, and how the value of assets is associated with the tokens.
We are working actively with technology firms and financial institutions as part of the InterWork Alliance, a platform-neutral, non-profit organisation established in June 2020 to develop the standards frameworks needed to make tokenisation a reality.
Solving the active challenge
Particularly among the younger generation, investors are more worried than ever about their financial security, but are finding it harder to set aside the capital needed to invest in active funds. In a recent Calastone survey, 64% of respondents based in Hong Kong said they worry about future financial security, rising to 66% of New Zealanders and 69% of Australians.
With the significant rise of passive options over the past decade, it is imperative that asset managers meet demand for products that are better tailored to Millennial investors, with smaller minimum thresholds and lower fees and charges. In the same Calastone survey, 84% of Hong Kongers said the ability to invest in smaller increments would increase the likelihood of investing in the future, compared with 80% of New Zealanders and 69% of Australians.
Investment managers also need to respond to customer demand for real-time, responsive and customised user experiences, not just through digital interfaces, but through an overhaul of underlying back-office and distribution processes and infrastructures. Tokenisation has the potential to address all these challenges, stripping out cost and risk and delivering simplicity, control and transparency to investors, whilst providing a platform for innovation.
Asia’s opportunity
In Asia as elsewhere, competition is rising from traditional and non-traditional sources, with Ant Financial’s successful entry into money market funds being the most prominent example.
For this and many other reasons, we expect discussion of tokenisation to grow louder and more frequent across the region. Many Asian countries have a long history of innovation and competition in retail investments, and a number are experiencing a wave of disruption from thrusting fintechs, some targeting the young affluent, others tackling financial exclusion. Further, the region carries less of the heavy legacy of market infrastructure that is currently weighing down momentum in Europe.
The pace of change is already accelerating. In September, GrabInvest launched its low-cost, low-increment AutoInvest service, through which consumers can invest into high-quality, liquid money market and fixed-income funds, starting from just S$1, In the institutional space, HSBC worked with the Singapore Exchange (SGX) and Temasek Holdings to issue a tokenised bond on SGX’s DLT-enabled platform, successfully reducing settlement from five days to two.
We at Calastone are already actively looking at the practical usage of tokenisation in terms of how collective investments work today, as well as what future models could become possible.
Incumbent investment management firms have grown unwieldy in recent years, weighed down by non-core tasks and responsibilities, in part driven by regulation, and squeezed by ever tighter margins. It remains very early days, but tokenisation could pave the way back to basics and back to growth.
