Member Update

Fund Managers Examine the Virtues of Tokenisation

Tokenisation – namely the conversion of real assets or financial instruments – into digital tokens which are traded on a Blockchain – is making waves in the funds’ industry.

This is because tokenisation can also be applied to fund shares or units. The concept of tokenisation is something which industry bodies –  including the Investment Association (IA) –  are urging UK regulators to get on top of.

But what is driving this interest exactly, and is it something the FCA (Financial Conduct Authority) ought to consider?

Proponents of tokenisation argue the practice can facilitate faster settlement, reduce counterparty risk by displacing a number of intermediaries in the investment chain, improve transparency during the transactional process, and supports fractional ownership.

In theory, fractional ownership of fund units or shares would make it much cheaper and easier for investors to gain exposure to a fund, versus buying directly into one. From an allocator perspective, this would democratise investment.

Similarly, asset managers also have a lot to gain from tokenisation – assuming it is implemented correctly.

By making the investment process less outmoded and manual, tokenisation could help managers win mandates from millennials and Generation Z investors, a retail demographic which has largely avoided putting money into traditional funds, often preferring instead to engage in day trading or speculating on unregulated products such crypto-currencies.

This could allow managers to widen their investor footprint enabling the industry to grow AUM share further and future proof their businesses.

It is hard to fault the merits of tokenisation in this particular instance.

While tokenisation could bring a number of opportunities to the traditional funds industry, there are some areas where IIMI believes it might pose challenges.

Tokenisation’s advocates have repeatedly said that fractionalisation will open up private markets and other illiquid assets to retail clients by lowering minimum investment thresholds and boosting secondary market activity. This – they argue – will unlock a lot of liquidity, which is currently trapped in the private markets.

But should private markets be open to retail investors?

IIMI is of the view that private markets ought to be the domain of institutions only.  Irrespective of whether they are fractionalised and the amounts of money involved are nominal, private markets are complicated in nature and unsuitable for retail.

Moreover,  there are mounting concerns that liquidity mismatches could emerge in tokenised versions of private markets.  If retail clients do suffer losses or are unable to redeem cash from tokenised versions of the private markets, then this could cause irreparable damage to the tokenisation cause as a whole.

IIMI is conducting a survey of its membership on digital assets, with the aim of producing a white paper later in the year. We encourage the membership to participate in this survey.