Fund Tokenisation - 10 challenges you should be aware of...

As the topic of Fund Tokenisation in Asset Management continues to gather rapid pace and take-on here in the UK and other regions, whilst offering numerous potential benefits, it also poses several challenges - We have highlighted 10 key areas that you should be aware of:

1. Regulatory Uncertainty

• Evolving Landscape - The regulatory landscape surrounding tokenised securities is still developing and varies across jurisdictions. This will no doubt create uncertainty for fund managers and investors.
• Legal Classification - The legal classification of tokens can be unclear, leading to complexities in complying with existing securities regulations.
• Cross-border Issues - Differences in regulations across countries can complicate the cross-border distribution and trading of tokenised fund shares.

2. Technological Challenges

• Infrastructure - Implementing tokenisation requires robust technological infrastructure, including blockchain platforms, smart contracts, and secure custody solutions.
• Interoperability - Ensuring interoperability between different blockchain platforms and traditional financial platforms is crucial for seamless trading and settlement.
• Cybersecurity - Tokenised assets are susceptible to cyberattacks, requiring strong security measures to protect against theft and fraud.

3. Operational and Administrative Complexities

• New Processes - Fund managers will need to adapt their operational processes to manage tokenised securities, including issuance, transfer, and record-keeping.
• Compliance - Integrating KYC/AML compliance into tokenised fund offerings can be complex and require specialised solutions.
• Valuation - Valuing tokenised assets, especially illiquid ones, may be challenging and require new methodologies.

4. Market Adoption and Liquidity

• Investor Education - Investors will need to be educated about the benefits and risks of tokenised funds, which may take time.
• Market Acceptance - The widespread adoption of tokenised funds depends on market acceptance and the continued development of a robust ecosystem.
• Liquidity - Ensuring sufficient liquidity for tokenised fund shares can be a challenge, especially in the early stages of market development.

5. Cost Considerations

• Technology Investment - Implementing tokenisation requires significant upfront investment in technology infrastructure and expertise.
• Ongoing Costs - Ongoing costs include platform maintenance, compliance, and administrative expenses.

6. Governance and Control

• Smart Contract Risks - Smart contracts governing tokenised funds need to be carefully designed and audited to avoid vulnerabilities and unintended consequences.
• Decentralisation vs. Control - Balancing the benefits of decentralisation with the need for control and oversight will require consideration.

7. Accounting and Reporting

• New Standards - Existing accounting standards may need to be adapted to accommodate tokenised securities.
• Reporting Requirements - New reporting requirements may be necessary to ensure transparency and investor protection.

8. Tax Implications

• Tax Treatment - The tax treatment of tokenised funds and their distributions may be unclear and vary across jurisdictions.
• Tax Compliance - Ensuring tax compliance for tokenised fund offerings could be complex.

9. Investor Protection

• Custody and Security - Ensuring the safe custody and security of tokenised assets is crucial for investor protection.
• Fraud and Manipulation - Tokenised markets may be vulnerable to fraud and manipulation, requiring appropriate safeguards.

10. Legal and Contractual Issues

• Smart Contract Enforceability - The legal enforceability of smart contracts will require clarification across different jurisdictions.
• Liability - Determining liability in case of errors or disputes related to tokenised fund transactions could be complex.

Addressing these challenges will be crucial for the successful tokenisation of funds. Collaboration among regulators, industry participants, and technology providers will be essential in developing standards, best practices, and a clear regulatory framework.

Contact us at [email protected] to see how we can help you with preparing and becoming ready for implementation.