Once upon a time there was a king, who wanted to celebrate his birthday with 30 of his friends. He needed three birthday cakes and so he consulted the three royal chefs, telling them each to make a chocolate birthday cake. The chefs each used their own signature recipes, and, on the day, they duly presented three chocolate birthday cakes, all slightly different in their composition, but essentially the same. But how did the king choose which version to serve to which guests, and avoid some potentially feeling they had been presented with a slice that wasn’t from the best one?
As inefficient as this may sound, the same thing happens each day within the unitised funds industry. Efficiency and accuracy are paramount, yet industry players still rely on multiple Books of Record (BOR). The fund manager creates the IBOR, the custodian the CBOR, and the fund accountant the ABOR. All slightly different in composition despite being based on the same underlying transactions and securities. What if we could simplify this to a single, immutable source?
Outside of our industry, the ABOR (Accounting Book of Record) probably holds little interest for many, but proponents of the ABOR are likely to recount its importance above all other books of record. Indeed, regulators, investment managers, depositories, and fund accounting providers are all unanimous that the ABOR underpins the unitised fund world.
Aside from the functional debt that currently exists with multiple participants (perhaps with their own vested interests?), the inefficacies of the markets themselves (T+1, T+2), the absence of regulated global digital currencies, and the considerable technical debt that exists with legacy systems—why do we persist with the various books of record, and why is ABOR so critical to a well-functioning middle and back office?
Step forward the Tokenists.
The concept of tokenisation, with a single source of accounting, on an immutable blockchain that is shared and accessible by all participants simultaneously, underpins the whole argument for combining aspects of middle- and back-office reporting to achieve a singular record of accounting. By tokenising the underlying assets, you can then create a truly tokenised investment product—as opposed to tokenising an already unitised fund. This set of underlying transactions then facilitates a shared accounting record that replaces the ABOR.
Advocates of tokenisation would also argue that the immutability of the chain provides a far more robust and reliable accounting system, maintaining data integrity while offering a shared view of the same data. This shared perspective could, in theory, eliminate the need to reconcile multiple back-office books of record, reduce exceptions and investigations, and ultimately enhance operational efficiency.
With fund managers facing a multitude of change agendas—systems upgrades, controls and oversight requirements, regulatory change—there is likely to be less appetite (and budget) available for these experimental product projects. The frontier nature of tokenisation also adds an element of risk, making it a less attractive option for those managing tight budgets and timelines.
Many of the incumbents in the financial services lifecycle have a vested interest in maintaining their relevance to the traditional operating models that they are presently embedded in. Indeed, some of these entities only came into existence because of the inefficiencies and complexity of the operating model. Embracing new technologies and models at scale could easily reduce the need for them.
Historically regulators have been keen to set out guidelines for participants to adhere to, as opposed to strict regulatory specifications. With so much open to interpretation, players are reluctant to misinterpret the current guidelines for fear of getting them wrong. However, this is one area where change is happening. Noting the markets’ size and stage of progress, we see three distinct groups arise:
|
|
Markets |
Activities |
|
Exploring |
US, UK, Luxembourg |
Major markets exploring the use cases for DLT, crypto currencies, and digital assets |
|
Deployed |
Japan, Switzerland, Germany |
Major markets that have deployed regulation and are looking to steal market share from their competitors |
|
Innovating |
Cayman Islands, Singapore, Malta, UAE |
Niche players that have historically created a market presence by innovating and already have regulations in place, ready to capitalise on new entrants and existing players looking to disrupt |
Established firms have significant technical debt as front- and back-office systems were not designed to accommodate cloud environments or modern financial instruments like alternatives or real assets, let alone tokenised ones. When a large proportion of your change budget is dedicated to overhauling existing systems and infrastructure, it becomes increasingly challenging to divert resource to new and experimental architecture. The differing market views and associated risks of tokenisation further complicate its adoption, as firms must weigh these factors against the potential benefits.
And yet there are signs that things are changing. Regulatory bodies are adapting existing legislation and creating new regulations to accommodate and encourage the adoption of emergent technologies and embryonic startups.
The goal of many bodies is to balance innovation with protection, especially considering the unregulated nature of many existing blockchain currencies, and the associated risks to retail customers.
This is why so many central banks are progressing with plans to establish digital currencies of their own (CBDCs), pegged to traditional ones, to mitigate such risks. Once these digital currencies are established, the benefits from tokenisation (in particular, inter-token transfers and atomic settlement) become one step closer to reality.
Another aspect is that established players are beginning to partner with fintech disruptors and service providers that do want to explore this space as a means of cementing themselves into any new operating models that may become mainstream. These partnerships are particularly significant with illiquid assets (e.g., real estate, real assets) or where short time frames exist, as with collateral requirements that can be met with money market fund tokens. Indeed, the real disruption may be that these markets become completely transformed, whilst more traditional, UCITS-style products are on a slow burn.
There is also a demographic shift in wealth, where younger investors who are inheriting wealth are more likely to choose investments based on moral values as opposed to returns. Creating a token for use as a vehicle, investors are then able to select only those assets which align to their values. Referred to as “direct portfolios”, this tokenisation-enabled approach is being touted as the first viable means to offer mass customisation of product for retail investing.
Tokenisation shows the potential for re-addressing ABOR requirements in specific areas like MMFs, private assets, and innovative products, as demonstrated by current market initiatives. But it is unlikely to be pervasive in the near team. This potential is supported by global regulatory interest and the current market inefficiencies that have caused these areas to lag behind the traditional operating model.
However, a seismic shift from today’s marketplace to tokenisation is unlikely to happen quickly, especially without strong mandates from central banks and regulators. For now, at least, those cautious or sceptical about tokenisation continue to operate under existing frameworks while exploring these emerging technologies incrementally. In other words, they can still have their (own) cake and eat it.