With the Investment Association’s (IA) “UK Fund Tokenisation: Blueprint for Implementation” (the Blueprint) receiving substantial engagement from the industry, in the words of the IA, “the era of Investment Fund 3.0 has arrived”. 

“Investment 1.0” represented the many flavours of the collective investment fund up until the 1980s, which were based on the requirements and the limitations of the analogue world. “Investment 2.0” represented the emergence of the digital era to meet more diverse investor needs from the 1980s onwards, taking advantage of product innovation such as indexation and the advance of ETFs. “Investment 3.0” aims to leverage technology more effectively and connect more efficiently with customers. 

The FCA and HM Treasury continue to act as observers and contributors to the IA’s Technology Working Group (TWG) and have confirmed no significant regulatory barriers to the baseline approach outlined in the Blueprint, enabling immediate industry adoption.

The industry’s feedback to the Blueprint has shaped the TWG’s view of the next steps to implementation¹, which this article will later discuss. 

Developments since the Blueprint

Before discussing the next steps to implementation, there were a number of other developments since the publication of the Blueprint that are important to note. These are:

• the IA's FinTech hub and accelerator, the “IA Engine” has launched the Tokenisation Hub – an area for showcasing the products and services that smaller-scale fintechs have on offer;
• the Government’s Digital Securities Sandbox (DSS) has launched which enables firms to use developing technology, such as distributed ledger technology (DLT), for the trading and settlement of traditional securities;
• authorities have provided more clarity on digital money through the Bank of England, Prudential Regulation Authority (PRA), and FCA's Cross-Authority Roadmap on Innovation in Payments. This includes work on e-money, stablecoins, and tokenised bank deposits;
• the Bank of England identified potential systemic risks from tokenisation projects utilising public blockchains, in that they may ‘increase the interconnectedness of markets for cryptoassets and traditional financial assets since they are represented on the same ledger’, it said in its Financial Stability Report;
• the Association of National Numbering Agencies (ANNA) and Digital Token Identifier Foundation (DTIF) have announced² the alignment in standards for both International Securities Identification Numbers (ISINs) and Digital Token Identifiers (DTI) which will make the identification of mainstream assets in on-chain markets easier; and
• the Law Commission (the Commission) began consulting on draft legislation to confirm that digital assets will be legally classified as personal property. The Commission is also assessing how digital assets may fit within private international law.

Further use cases

While most firms are looking at how to take advantage of the potential operational efficiencies highlighted in the Blueprint, a couple of further use cases of tokenisation have been identified:

• money market funds (MMF) as collateral: tokenising MMF units to enable the token to be pledged in bilateral uncleared trades as margin or used as collateral in the repo market would help secondary market liquidity. This could relieve redemption pressure on funds in times of market stress which often sees market actors needing to sell their MMF units to meet dynamic derivatives positions with the redemption cash generated, only for counterparties receiving that cash to purchase further MMF units with it; and 
• end-to-end on chain investment: this could take a number of different forms but could, for example, demonstrate a retail client investing through a distributor platform (the “client register” identified in the Blueprint) into a tokenised multi-asset fund (fund register) and on into tokenised underlying assets (asset register), with digital money used as the settlement mechanism. The TWG is keen to test the feasibility of such use cases, perhaps through the DSS, and assess what permanent changes to legislation are needed to allow for a more widespread adoption of developing technologies like DLT.

The next stages for fund tokenisation

Industry feedback on the Blueprint has guided the TWG’s focus towards three of the seven characteristics identified in the Blueprint:

1. on-chain settlement: this would improve the speed and control of settlement by linking the transfer of ownership of tokens directly with payment within the same technology infrastructure. The increasing regulatory clarity on stablecoins and the emergence of commercial bank solutions, grows enthusiasm that on-chain settlement may be realisable in the near term. As investor expectations on speedier access become more prevalent, and pressure increases on the fund settlement process (e.g., the move to T+1 settlement timing) the use of on-chain settlement cannot be ignored; 
2. enabling funds to hold tokenised assets in their portfolio: this would allow buy-side firms to operate fully on-chain, linking investors with the sell-side through efficient fund infrastructure; and
3. expanding the scope to include public permissioned networks: this would provide greater scalability and liquidity through open marketplaces that do not require direct interaction with each provider. This can result in more liquid secondary markets and maximum access. 

Conclusion

The Blueprint and the TWG’s latest report have clearly demonstrated the baseline model of tokenisation in the UK and identified some use cases for how that model might be applied to firm’s business models. However, there is no room for complacency and, whilst investment management is a highly competitive sector with a race to outperform each other, collaboration amongst market participants will be key. Evolving the baseline model and progressing test cases is likely to produce results more quickly than individual firms working alone and, importantly, demonstrates continuing momentum in the UK marketplace.
 

[1] ANNA and DTI Foundation align ISIN and DTI standards for Digital Tokens - ANNA issues first set of ISINs for crypto assets

[2] Further Fund Tokenisation - Achieving IF3 Through Collaboration Mar24.pdf