Tokenisation and the regulatory landscape______

Adam Belding, Chief Architect

When we think about tokenisation, there are several things that have to be right: the technological, commercial, operational – and the regulatory. Businesses need to understand the regulatory environment to operate within it effectively, and regulators need to work closely with businesses to provide the right framework for tokenisation’s successful adoption and implementation.

In a recent webinar, I joined Wei Jie Chan, the Digital Assets Lead at PwC Singapore, and John Allan, Head of Innovation and Operations at the Investment Association (IA), to discuss the present and future regulatory landscape of tokenisation. Drawing on insights from this discussion and our own experiences, this piece explores the current regulatory environment, practical strategies for implementation, and the future outlook of tokenisation.

The importance of regulatory understanding

Asset managers and service providers see tokenised funds as the main vehicle for launching both active and passive funds within the next six to seven years. However, engaging with our numerous clients across 55 countries, we see diverse views on how to implement what we call digital investments. And while some firms cite regulatory uncertainty as a reason for caution, others are using it as a springboard to innovation. Understanding the regulatory context is essential for leveraging tokenisation’s full potential.

The UK and Singapore have been at the vanguard of regulatory initiatives for distributed ledger technology (DLT), ensuring that the various players in these regions can take advantage of the new technology and new business models afforded by tokenised investments.

Regulatory perspectives from Singapore

Singapore’s success stems from the close collaboration between the regulator, the Monetary Authority of Singapore (MAS), and industry players. Wei Jie Chan highlighted two key areas: supervision and innovation. Through continuous dialogue with the industry, the MAS has been able to address challenges and refine regulations, creating a supportive environment for digital assets. This approach has led to the implementation of sandbox initiatives and the issuance of licences to blockchain-based projects, including the first public chain business models.

On the innovation front, several pilots have started to explore the practical applications of blockchain in capital markets. MAS’s Project Guardian initiative aims to build a responsible and innovative digital asset ecosystem by supporting global efforts in testing the feasibility of tokenised assets. For example, in partnership with Schroders, we’ve been exploring the capabilities of a tokenised investment vehicle for variable capital companies. The MAS is also collaborating with international policymakers and financial institutions to design an open, digital infrastructure – Global Layer One (GL1) – to facilitate seamless cross-border transactions and enable tokenised assets to be traded across global liquidity pools while adhering to relevant regulatory requirements and guidelines.

As Chan noted, these are early days, but it shows the potential this close collaboration has in creating a pipeline from experiment to regulated entity.

The UK’s regulatory evolution

As with Singapore, the asset management industry and regulators working together has been key to unlocking regulatory barriers and a path forward in the UK.

John Allan talked about the work of the Technology Working Group of the Asset Management Taskforce, which has already produced some tangible outcomes. Working closely with the FCA, HM Treasury and asset management firms, it developed a baseline model for tokenisation at the end of last year, an entry-level model for fund tokenisation, giving firms the opportunity to start piloting the technological change now, before tackling more complex use cases. A second report in March of this year offers support for exploring specific use cases, such as including tokenised assets within a tokenised fund portfolio and collateralising money market fund tokens. It also provides a model fund prospectus to support the implementation of these strategies.

Alongside this, the Treasury recently introduced legislation to launch a Digital Securities Sandbox, allowing firms to use DLT in the issuance, trading and settlement of securities, and the government is considering how DLT can be applied to gilts. ‘All of these initiatives are pushing in the same direction,’ said Allan. ‘There’s definitely a recognition within the industry that we need to ensure that the investment fund as a vehicle for partnering individual investors on one side with the capital markets ecosystem, which is a big strength of the UK, on the other as well as possible, and ensuring that tokenised funds are able to interoperate effectively with a tokenised capital markets ecosystem.’

Practical implementation strategies

Something that often gets overlooked about DLT is that it’s not just about the technology; it’s also about the ecosystem. This requires striking a balance between thinking about it in the abstract and the particular.

With DLT, you’re trying to get the fundamental things that don’t change – buying, selling, holding, valuing – working in a more efficient, universal way, so you need to think about asset management in the abstract. What are the existing underlying processes and how can you make them operate on DLT?

However, when you come to practically implementing it, you need to think in the particular, because each asset has a different ecosystem, intermediaries and set of processes. Successful implementation requires thinking about what you want to actually achieve with the technology. What are your commercial goals? Are you seeking greater distribution, new products, or reduced operational costs? You need to get into the nitty-gritty details: how to make the new world work with the existing one, and how regulators can benefit from more transparency and immediate access to data.

For that reason, it’s important to have a tangible use case, because that’s what gives focus to what you need to do. That’s why what the IA and FCA is doing with Technology Working Group is good; it acknowledges that if you want to trial an end-to-end project, you need something like a tokenised gilt, so you can create a true tokenised end-to-end money market fund. These use cases provide immediate advantages and serve as proof points for broader application.  Importantly, they also flush out the real-world complexities of changing a decades old constellation of infrastructure and processes and help temper the compelling sounding big picture view with an element of reality.  For example, a lot of comment has been passed recently on the idea of money market funds as collateral.  We have looked into this in a lot of detail and now have a comprehensive plan for how we can make it work, but it took a lot of understanding of both the technology possibilities and what parts of the existing business processes are genuinely needed and which are not.

Moreover, given the complexity of asset management and end-to-end tokenisation, a modular approach is essential. Tokenising different elements of the fund structure allows firms to better manage complexity and ensure interoperability with traditional infrastructure. This gradual integration allows for smoother transitions and mitigates risks associated with wholesale changes. ‘Tokenisation is going to be a multi-year journey,’ said Allan. ‘The need for interconnectedness with existing infrastructure is vital –because of the size and highly regulated nature of our industry. Take Calastone’s technology as an example. Calastone has been working with DLT for a number of years. We’re already on that journey.’

As Chan noted, you also need to consider all the stakeholders in these projects, from service providers to end investors. Understanding the impacts at the organisational and departmental level, such as process changes, talent requirements, and technology needs, is essential. You also need to think about the user experience – how do you get your end users and institutional clients comfortable with such use cases? This is where a clear understanding of what business goals you’re trying to accomplish with DLT is important.

The Australian Securities Exchange (ASX) experience with DLT provides a valuable lesson. Starting in 2016, ASX set the ambitious goal of trying to replace its clearing and settlement system with a DLT-based solution, before calling it off in 2022. The problem was trying to replace a fundamental and complicated system wholesale. It underscores the importance of having a clear business use case, incremental implementation, and realistic expectations. DLT holds great promise, but its integration into existing systems needs to be managed carefully to avoid overreach.

The future outlook

The future of tokenisation looks promising, with regulatory environments gradually adapting to this new technology. Increased collaboration between regulators and industry players across different countries will lead to the development of global standards and best practices, creating a more cohesive ecosystem for digital assets and space for testing a broader range of use cases for tokenisation. As John Allan pointed out, this international collaboration is particularly key for the UK. ‘The UK is the second largest investment management hub in the world and the most global in terms of outlook. It’s important over the next 12 to 24 months that we achieve some level of harmony across European jurisdictions. But I would also call out the openness and the willingness of the FCA to participate in Singapore’s Project Guardian. This is a very important piece of international collaboration to learn lessons, share experiences, and lay out a framework for international regulation.’

The path to tokenisation is not just a technological evolution, but a collaborative effort between the government, regulatory bodies, technology businesses and the asset management industry to create an environment of shared innovation and growth. Together, we are laying the foundations for a more connected, efficient, and resilient investment landscape. With increasing regulatory aircover, global collaboration, and experimentation with tokenised assets across jurisdictions, this progress signifies the collective determination to shape a future where digital assets transform investment markets worldwide

(First published in Funds Europe June 2024:

Adam Belding, Chief Architect

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