Change is on the horizon for collective investments. Tokenisation could make illiquid assets widely accessible, usher in personalised portfolios and transform the distribution landscape. But stumbling blocks remain. These include inconsistent regulation, a lack of technical expertise across the industry at large and a shortage of supporting infrastructure – all of which issues were highlighted in a recent Funds Europe survey sponsored by Calastone that looked at the future of the funds industry.
I recently participated in a Funds Europe webinar that discussed these and related matters. What follows is my take on some of the key issues to emerge.
Lombard Odier’s Jeroen van Oerle started by classifying existing digital assets into three main groups: payment coins, utility coins and asset coins. The first offer little added value and most are destined to fail, he predicted. Utility coins, such as those using the Ethereum platform, offer the potential programmers and others to add value – through smart contracts for example.
But the real, long-term opportunity lies within asset coins and their use in the funds industry, where these assets can be used alongside traditional bonds and equities to add to portfolios and optimise risk/return trade-offs. The problem, he stressed, is that these distinctions are not always understood by funds industry management.
This chimed with my view that these concepts are often conflated by people who think cryptocurrencies, tokens and asset tokens representing ownership of something that is not natively on the blockchain are all the same. The challenge, as I stressed, is to use the technology, and some of the concepts of decentralised finance, to reinvigoratetraditional markets which are clunky and slow-moving. At Calastone, we are having a lot of discussions with people about creating a pathway that will allow them to take advantage of the opportunities on offer.
In time we may move to a point where central banks are directly tokenising cash. Then it would follow that equities would be digitally traded away from traditional venues. In that scenario, everything would become more fluid and easier to manage. But there is a long way to go before we get to that point. One big question is “Who’s infrastructure would this all run on?”. If it is many different DLT based systems then there is a big systems integration challenge to address.
Crypto world eating into the traditional funds market
Lex Solokin of Consensys pointed out that crypto already accounted for more than $2 trillion of assets – none of which was invested in ETFs or mutual funds. He questioned whether the funds industry would ever see that money again. Taking the Ethereum platform alone, there was over $100 billion of cash and cash equivalents in assets that looked like money market funds. Products with ‘geeky names’ that were the equivalent of manager selection platforms, asset allocations or fixed income funds were being added all the time.
Van Oerle said that as the two worlds merged there would be natural flows between them depending on returns, risk and so on. As asset coins matured, asset allocators would naturally make digital assets part of their overall asset allocation. They would simply be a new category. State Street’s Nadine Chakar agreed. It was wrong to look at crypto as something contained. It would morph and become part of the mainstream – though it would require a massive educational process with boards and regulators to achieve that.
I was asked how I saw private assets fitting into the mix. The simple answer is that tokenisation has the potential to transform access for retail investors. At present, private equity represents a huge slice of assets available only to institutions and a small group of high net worth individuals. Tokenisation could materially widen the array of instruments for retail investors to invest in by opening up what has hitherto been an untappable market.
As a parallel point, Lex Solokin pointed out that there are already funds investing in non-fungible tokens for example. The availability of open-source software on a global internet was already reshaping how people transact and invest: ‘It’s the seed of everything to come.’
Regulators playing catch-up
The question is where the regulators stand in all of this. The fund industry is highly regulated. Jerome van Oerle pointed out that there is one set of rules for the traditional institutions while there is a new industry at work that seems to be doing what it wants. The two need to be aligned but the regulators are a long way behind the curve right now. What is more, the regulation needs to be globally consistent. Otherwise regulatory arbitrage will ensue.
My view is that the technology itself can provide the solution. A lot of the historic problems encountered in markets relate to a lack of transparency. If widely adopted, DLT could fill this transparency gap, which should be seen as a boon to the regulators.
Nadine Chakar said there was a new breed of fund managers emerging that are digital natives, investing in hundreds of different coins. They struggle to find a balance between the decentralised freedom that they cherish and the reality of what happens when they are managing someone else’s money. But sooner or later the two worlds would come together. What was needed was a trusted infrastructure (State Street was building a new digital bank, starting from scratch) and clarity of regulation.
Two of the participants hoped that the latter would start to emerge within the next 12 months. Top of my own ‘wish list’ is that we see a real use case that starts to move traditional funds into the new space in a way that adds some real value and utility. It is certainly something we are working towards.