Written by Christopher Luck, Partner at CMS Cameron McKenna Nabarro Olswang LLP.

Crypto currencies may be making the headlines but there is a quiet revolution taking place in the funds sector for tokenisation and use of distributed ledger technology (DLT). In particular, tokenisation is seen as a way of increasing the opportunity for investors globally to invest in funds which in turn invest in assets of many different types, including private companies, venture capital and other assets such as real estate. Furthermore, there are a large number of digitally-aware millennials and others, who are used to or are increasingly using digital platforms, as potential investors.

The chart below looks at Europe and Asia Pacific. There are regions with growing new wealth and new types of investor. On a global scale, the opportunities are large as asset management is not a small sector. According to IPE’s 2021 asset management study, Global asset managers oversaw €90.7trn of assets at the end of 2020. New regions and customers will no doubt emerge. In addition, funds and their managers can deploy blockchain or similar technology in order to streamline and reduce the costs involved in processes such as KYC. They can also add additional benefits in relation to reporting and accounting and for subjects such as ESG.

Source: Capgemini World Wealth Report 2021

Fund managers and relevant authorities are, therefore, increasingly alive to the opportunities and there is gathering pace for tokenisation as a topic and actual projects. The eventual destination may be clear but the way there is not for a number of possible reasons:

• Interest is growing but institutional adoption is awaited;
• Benefits are perceived but more use cases are needed;
• Technology is sophisticated but standardisation and features such as custody must be built on the existing infrastructure;
• Laws and regulation are moving forward but are historic rather than digital facing;
• Regulators are willing to support, such as through sandboxes, but there is caution;
• The opportunity for finance and asset ownership is accelerating but prudential supervision and consumer protection are a necessary brake; and
• Digital technology can use data to advantage both for speed and cost efficiency but privacy and cyber security are essential.

The opportunities are however potentially restricted by levels of conformity for technology, law and regulation and concerns around topics such as data protection and cyber security. At two recent CMS webinars host speakers from CMS offices across Europe, the UK and Singapore explored legal and regulatory innovation news with industry speakers explaining projects in action. Daniel Coheur of Tokeny set the scene with the potential benefits of tokenisation including costs, liquidity and transferability of otherwise illiquid assets in a tokenised fund vehicle. He explained the use of protocols such as the ERC-3643, formerly the T-REX Protocol, for compliant and controllable securities and outlined the four steps for tokenisation:

• Pre-offering
• Issuance
• Token Lifecycle Management; and
• Transferability

Aurelien Hollard of CMS Luxembourg also set out a useful roadmap for planning a project:

Source: CMS

Other speakers gave a useful reminder that tokenisation is enabling technology but there still needs to be a good asset and business plan. In some respects, the legal and regulatory position is the main hurdle for the digitalisation of real world assets. On the legal side, Jérôme Sutour of CMS, France, explained the importance when looking at a tokenisation project of not just looking at the law and regulations "as is", but also looking down the road to what may be coming further ahead. For example, we await the Markets in Crypto-assets Regulation (MiCa) and the Financial Conduct Authority's response on it stablecoin consultation.

The direction of travel is largely very positive but different countries and regulators are progressing at different speeds or at least in different ways. For example, Switzerland, Germany, Luxembourg and Singapore have all introduced changes to their laws to allow shares to be represented as tokens. This means that the shares or even a token as a security in its own right can be issued in a digital form. In other countries, such as the UK, shares are issued to a nominee which then issues tokens representing the underlying securities. Also, new corporate vehicles are appearing which may become useful tokenisation companions. It will take some time for the legal position to become consistent or at least similar as the laws and regulatory position is localised.

The role of the authorities and regulators is a fundamental one and there are many positive examples such as in the countries mentioned above. The UK Financial Conduct Authority (FCA) and the European Commission are also generally supportive. Matt Nortcliff, from CMS Singapore, gave some specific examples of how regulators, such as the Monetary Authority of Singapore (MAS), can drive things forward. Singapore has introduced a new variable capital company (VCC) and has given clear guidance on most aspects of digital fund offerings. Needless to say, APAC has a large number of millennials and there are opportunities for private banking and wealth management on digital platforms. Digital asset exchanges are also graduating from the MAS Sandbox involving the use of native securities and tokenisation. In particular, the possibility of tokenising VCCs is a recently released project there supported by InvestaX and its partners.

A number of other exciting contributions were made by speakers on how the funds sector can evolve in this space so that there are standard platforms enabling investors to access interests in funds and to develop new opportunities such as in relation to renewable energy as an investment class. Reyer Kooy of FundAdminChain also gave a valuable insight how the FCA is enabling a radical new way for investment funds to issue shares as digital funds on a secure network and how his company is involved. No doubt there will be more on this and similar new initiatives elsewhere.

Taking this all into account it is important to watch the space and to plan ahead.

This article first appeared in Digital Bytes (6th of November), a weekly newsletter by Jonny Fry of Team Blockchain.