Is the Digitalisation of $100trillion of Assets a Lifeline for Traditional Stock Exchanges?

GemCap UK Non-Executive Director Jonny Fry explores the benefits of digitalisation and tokenised assets for the asset management industry.

The asset management industry is beginning to understand the benefits of digitalisation and is offering digital funds to investors. The underlying funds remain the same, but are made available in a digital wrapper. These new digital funds enable greater transparency and stronger risk management and compliance controls as well as enabling some funds to be sold to new investors. Whilst being quoted on a variety of new digital exchanges, digital funds also offer a huge market for existing stock exchanges.

The asset management industry is worth over $100 trillion and, potentially, the digital transformation of savings and pensions could prove to be the killer app for blockchain technology and lead to its mass adoption. Traditional regulated asset managers are always looking for new investors to buy their funds but remain mindful of managing their risks, otherwise they jeopardise losing their regulated status and thus their licence to operate. The cost and complexity of compliance has become a significant burden in the financial services sector, so any solution that ushers in greater transparency, stronger risk controls and, potentially, greater efficiency, is almost analogous to the holy grail for an asset management firm. Meanwhile, having surveyed 271 institutions about the tokenisation of assets such as equities, debt, funds, etc, BNY Mellon has recently issued a report, “Migration to Digital Assets Accelerates” which includes in its findings: 

  • 97% agreed that “tokenisation will revolutionise asset management” and would “be good for the industry”
  • 77% would want access to staking pools, but 47% are unable to use a digital native firm i.e., they would like one of the TradFi firms to offer such services, such as Swarm
  • 91% of respondents expressed interest in investing in tokenised products
  • Private equity and hedge funds are the assets investors would most like to see tokenised
  • The most important tokenisation benefits would be access to new or non-standard asset classes and the immutability and transparency of data
  • 70% would be willing to pay extra for increased liquidity and faster asset turnover
  • 88% of institutional investors would be comfortable with digital representation of cash using blockchain-based technology

Institutions’ views on tokenised assets

Source: BNYMellon

According to a report from investment data company Preqin, high-net-worth retail investors are going to help drive assets into Private Equity funds (PEs). They predict PE assets to exceed $18trillion by 2027. Therefore, could this help to explain why PE firm, Kohlberg Kravis Roberts (KKR), has recently announced that it will be issuing tokenised shares of its PE fund – Health Care Strategic Growth Fund II? Furthermore, this is the first time that KKR has made its funds available to individual investors. The digitally wrapped exposure to this KKR fund will be listed on the US-based digital exchange, Securitize  – its own summing-up being:

New Fund Unlocks Broader Access to Alternative Investments Through Digital Ownership on Blockchain”.

Typically, PE investors have had to ‘lock up’ their capital for five to ten years. However, by offering investors a digitally wrapped token they are hoping to be able to create a more accessible secondary market whereby enabling an exit of original PE backers who may need to raise funds, as well as offering new investors access to an existing PE fund. Given that the KKR fund will be quoted on the Securitize digital exchange, the price of the fund will be driven not by KKR but presumably by independent market makers. So, in theory, buyers and sellers of the new digital securities will get the market price.

It looks as if Prequin’s comment about PE fund managers attracting high-net worth investors is prescient. Dan Parant, MD and co-Head of US Private Wealth at KKR, has commented that:

With its ability to digitize operational inefficiencies and increase ease of use for individual investors, blockchain technology has the potential to play an important role in the future of private markets,” adding: “We’re excited to be working with Securitize to be an early adopter of this technology and look forward to opening our investments up to a new audience of investors.”

A few of the potential advantages that digital funds offer the asset management industry, regulators and investors are listed here:

  • Back-office efficiency: a digital fund can employ smart contracts to automate many of the current manual reconciliations and audit process that custodians, administrators, registrars, auditors, transfer agents and wealth managers currently have to undertake
  • Access to real-time data: this enables compliance staff, regulators, fund managers, buyers of funds and even the actual investor to have access to more data, and faster
  • Stronger compliance: potentially makes Key Investor Information Document (KIID) or Key Investor Document (KID) more up to date and robust as much of the data collection can be automated. Also, a digital fund could trade 24/7 as opposed to once a day, once a month or, for some, VC and PE funds on a match bargain-basis only. Furthermore, the price of a digital fund would be that which is quoted on a digital exchange (a market price from a third party/market maker) as opposed to the price being calculated by the asset manager
  • Attraction for the fund manager: for closed-ended funds, if some of the shares/units in the fund are made available in a digital form, then the fund manager does not have to worry about purchases and redemptions – the owners of the digital share can trade in a secondary market
  • Improved accessibility: a tokenised fund can be accessed directly via a network node which essentially replaces the online account or other non-digital access channels that exist in traditional funds. The provision of this real-time access and self-servicing produces greater efficiency through the chain
  • Speed of settlement: a digital fund makes it possible to have T+0  settlement i.e., the trade is paid for the same day as opposed to the current T+3 settlement, where the seller will not be paid for three days after the trade
  • New investors: many hedge funds, PE and VC vehicles have focused on institutional investors who are able to commit to keep money ‘locked up’ for 5 to 10 years. There are many high-net-worth investors who may find digitalised hedge funds, PE and VC vehicles more attractive as they could encash their investments in a more structured secondary market
  • Transparency: a token holder’s rights and obligations can be embedded into a security token along with a unique and immutable record of ownership. This will make transactions more transparent since all parties involved can understand the rights and obligations of each other as well as the ownership history of tokens
  • Other benefits for investors’ information: a digitised fund could allow the holder to vote on corporate matters in the underlying shares in which the digital fund invests and have more data about the ESG credentials of the fund as well as the assets it holds. The investors could have any share perks made available to them from the equities held by the fund

There are a growing number of digital exchanges such as Tokeny, Archax, Securitize, Singapore Digital Exchange, Swiss Digital Exchange, Swarm, etc, that are beginning to list, or will be listing, digital funds in the coming months. However, with traditional stock exchanges suffering from a huge decline in IPOs (a trend likely to get worse if we enter a global recession), then how long will it be before we see these exchanges begin courting digital funds and, indeed, other digitally wrapped assets?

Jonny Fry

Non-Exec Chairman, GemCap UK

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