Fund tokenisation – Part IV: Regulation, the next step for adoption

24th January 2023 | Blogs, Member News

First published on Quant's website on 16 January 2023 >

Market regulation in Europe will clarify the rules for secondary trading giving fund managers new reassurances to consider tokenisation.

Over the next few years, trust will be a huge factor that determines the adoption rate of tokenisation within asset management.

Although blockchain provides transparency on the movement of tokens, at the outset investors need certainty that fund managers can link the security token to the real economic rights of the underlying asset.

The private investment bank, Brown Brothers Harriman, believes this is best done “through financial institutions that have a high degree of familiarity and trust with consumers and other institutions, who can guarantee the ‘connection’ between the token and the real asset.”

Regulation will improve the ‘trust’ aspect of investing in tokenised funds by providing managers and investors greater clarity on the legal aspects involved. This will be a vital step forward towards institutional adoption.

DLA Piper, the global law firm, has been recognised for its innovation efforts on the back of TOKO, a digital asset creation engine that empowers asset owners and investors to remove the legal complexities associated with digital asset creation.

It is a prescient move ahead of upcoming European regulation. Regulation to sell tokens on the primary market is already quite clear. But what is still opaque is the regulation around buying and selling tokens on the secondary market.

In June 2022, the European Parliament and European Council finalised new legislationfor the EU’s DLT pilot regime for tokenised securities. The new regime will come into force in Q1 2023.

This DLT pilot regime, a regulatory sandbox, is being introduced to help facilitate the development of secondary market infrastructure and allow eligible firms to operate a DLT-based trading facility and settlement system for financial instruments. It will help provide the regulatory guardrails for financial instruments to be tokenised and traded; and should reassure investors by building further trust in digital fund assets over the coming years.

In the UK, the HM treasury plans to introduce a “Financial Market Infrastructure Sandbox” this year. No draft legislation is currently in place, but the UK government is engaging with industry practitioners and regulators to work on the details of this initiative.

All in all, it becomes a chicken and egg question–is the regulation following the industry adoption, or vice versa? Right now, tokenisation projects and new oversight regimes are occurring in parallel. This is a positive sign- the visionaries are innovating and taking new products and services to market. Whilst the regulators are looking at systemic issues and risks to consumers and broader financial stability. Both sides are operating symbiotically with increasing speed, scope and application.

This is the last in a series of articles on fund tokenisation.

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