Many of these benefits will accrue to retail funds, which have wider investor bases, generally offer more frequent subscription and redemption rights, normally have greater rights of transferability, and are typically subject to more onerous reconciliation requirements. With the increasing growth of retailisation structures in private markets, efficient on-chain processes may eventually start to look attractive to alternative asset managers to lower costs, ease the administrative burden of wider investor pools, and facilitate new distribution models – although this may be some way off.
In the longer term, it is also possible that increasing tokenisation of underlying assets may facilitate faster and cheaper investment transactions by private funds, even if they only have institutional investors.
The UK regulator’s partnership with industry demonstrates a concerted effort to help the fund management industry to tokenise funds. The FCA is also actively looking to other jurisdictions, such as Singapore – which in this respect are more advanced than the UK – to identify lessons that can be learned. The UK’s more active stance compares favourably to the current EU approach which, despite the EU’s DLT Pilot Regime, lacks the same energetic push and may be hampered by over-zealous regulation.
Nonetheless, to spark a tokenisation revolution within the UK alternative asset management industry, a number of stars would need to align. Although transactions can be recorded via DLT but settled with conventional cash settlement processes, achieving efficient on-chain settlement of transactions in fund interests or in underlying assets would require a trusted form of digital money, such as stablecoins, tokenised deposits or central bank digital currencies. The UK is still finalising its regulatory regime for stablecoin issuers, and the emergence of a GBP stablecoin that commands widespread investor confidence may still take considerable time.
There will also need to be trusted and cost-effective custody arrangements for the holding of stablecoins on behalf of the relevant funds and investors, matched by efficient operational processes and certainty on the applicable regulatory framework. Similarly, managers will need to be confident that they have access to trusted DLT networks and that they have appropriate back-up systems in case of disruption or cybercrime. Economies of scale may also take time to materialise, meaning that early adopters may initially face higher costs as the required digital asset ecosystem develops – there may be a second-mover advantage. In the early days, the benefits might accrue to digital-native organisations looking to displace traditional fund administrators, registrars, depositaries and payment intermediaries. The purely financial incentives for fund sponsors and managers may be fewer.
Viewed in this light, the imminent demise of pooled investment funds in a rush to tokenised bespoke investment portfolios seems unlikely – and, to be fair, the FCA is trying to get ahead of what it thinks will be a long game. Nonetheless, as the implementation of tokenised solutions gathers pace, investor expectations may change, and traditional distribution and operating models may start to come under more pressure.
For private fund managers, especially those facing a retail investor base, it is worth starting to think about the longer-term strategic opportunities and challenges presented by the emergence of tokenisation. While they may prefer to adopt a “wait and see” approach for the time being, the industry will still want to keep abreast of future policy developments in this area to avoid one day becoming an analogue relic in a digital age.
