Appold Insights: The UK’s ‘Further Fund Tokenisation’ report
5 April 2024
Taken from the published LinkedIn pulse article.
Introduction
Last week, the UK’s Technology Working Group to the Asset Management Taskforce of HM Treasury released the report ‘Further Fund Tokenisation: Achieving Investment Fund 3.0 through Collaboration’. The report seeks to detail how the finance sector can adopt and expand the application of fund tokenisation within the UK’s existing regulatory framework.
The report follows a previous publication by the Working Group entitled ‘UK Fund Tokenisation: A Blueprint for Implementation’ released in November 2023, which established a compliant baseline model for fund tokenisation, compatible with UK law.
Tokenisation (the process of converting rights to assets into digital tokens recorded upon a blockchain, or distributed ledger) is viewed by many both within and outside of the digital asset ecosystem as the next significant development in blockchain use cases, with the potential to transform traditional financial services and capital markets through faster transaction settlement, higher transparency and 24/7 availability.
The new report emphasises the Government’s desire to capitalise on these transformative benefits, identifying practical use cases and exploring further developments for tokenisation facilitated by UK regulatory support infrastructure such as sandboxes (you can read Appold’s previous commentary on sandboxes, and the UK’s Digital Securities Sandbox, here).
Many believe tokenisation has the potential to transform traditional financial services and capital markets.
‘Further Fund Tokenisation’ contents
The report highlights two primary use cases that the Working Group envision as driving momentum for fund tokenisation in the UK:
The creation of fully on-chain investment markets featuring tokenised funds in securities and other asset classes.
The use of tokenised money market fund (MMF) units as eligible collateral for non-centrally cleared derivative contracts under UK law.
The Working Group encourages companies to collaborate with peers and authorities to progress these two outlined use cases, with interested participants invited to contact the Investment Association by 26th April.
The report goes on to indicate the prospective evolution of fund tokenisation in the UK, through three strategic advancements:
Implementing on-chain fund settlements using digital currencies.
Empowering funds to include tokenised mainstream assets in their portfolios.
Broadening the UK market’s technological infrastructure to embrace public blockchain networks.
Whilst acknowledging the highly competitive nature of financial markets and the desire to achieve commercial advantage, the report emphasises that tangible progress towards advancing fund tokenisation beyond the baseline model and testing of use cases will require collaboration between firms and authorities.
The report then outlines new actions arising from the report to be taken, the timescales and the bodies responsible for them:
The government through HM Treasury will continue to examine and engage with firms on the possible applications and benefits of applying distributed ledger technology to a sovereign debt instrument (6-12 months).
The government will review the eligibility of fund tokens for ISA and other tax-wrapped products (6-12 months).
Firms, either collectively or individually, should implement fund tokenisation projects or test the emerging use cases (1-12 months).
In its conclusion, the Working Group again encourages companies to implement their tokenisation strategies or collaborate with peers and authorities to progress the two use cases and to contact the Investment Association by 26th April.
Appold View
There is always a fine line between real working groups making real progress and “talking shops”. While the ‘Further Fund Tokenisation’ report lacks substantive detail and could in many ways be seen as ‘academic’ in nature, it is encouraging that firms are now encouraged to implement their tokenisation projects and given a model for tokenisation with which to follow, hopefully kickstarting real progress in advancing this space. An emphasis on a collaborative approach between the Government, regulators, and the industry is also welcome, as this will be necessary to meaningfully integrate tokenisation within the financial sector and fully reap the benefits of utilising distributed ledger technology.
Economic Secretary to the Treasury, Bim Afolami MP, to whom the Working Group reports.
In providing an assessment of the Government’s progress on integrating tokenisation into financial markets, it is important to note that the role of the Government and by extension its Working Group is to advocate for an approach towards new financial technologies that balances innovation with ensuring financial stability. This balance continues to require a measured and cautious approach to innovation, and one that can sometimes be frustrating for the industry in the speed (or lack thereof) of progress.
With that being said, digital asset tokenisation has been a reality for many years without significant traction being made towards widespread implementation in the UK. This report, while encouraging the practical implementation of tokenisation, still very much believes that we are at an early ‘testing’ stage of its evolution, which leaves considerable risk of the UK being left behind.
There has been legitimate criticism from industry participants of government latency when it comes to achieving its much-vaunted vision of turning the UK into a global hub for digital assets. Sandboxes, for instance, an important pillar of the Government’s approach to integrating new financial technologies, are multi-year projects (with applications for the Digital Securities Sandbox not expected to open until Summer 2024). Sadly, there also remain significant barriers to digital asset industry participation, such as ‘de-banking’, adversely and mostly unfairly affecting innovators.
Such issues must be meaningfully addressed and require proactive action that goes beyond the positive rhetoric included in such reports as ‘Further Fund Tokenisation’. We won’t be holding our breath but hope to be proved wrong on what appears to be a long, slow road to positive innovation in the sector.
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