Asset Management in Focus - Tokenisation digital assets

The potential of tokenisation for asset managers - Edition 2

29 May 2023

7 min read

Asset Management in Focus - Edition 2

Welcome to Asset Management in Focus, a series which has been designed to give you an in-depth look into topics within the Asset Management sector. In this edition we will explore the potential of tokenisation for asset managers and the role of KPMG in supporting clients as they navigate new opportunities.

As the asset management industry continues to evolve, it has become increasingly clear that blockchain technology and digital assets will play a major role in the future. One of the key developments in this area is tokenisation, which has the potential to transform how shares in investment funds are traded and managed.

Conor Moroney, a Director in KPMG’s Asset Management practice, sets out below some of the considerations around tokenisation for asset managers, and how KPMG can help in supporting clients to navigate this emerging technology.

What is Tokenisation?

Tokenisation is the process of representing an asset as a digital token on a blockchain. This allows the asset to be traded and managed using blockchain technology, which offers several advantages over traditional methods. For example, blockchain transactions are secure, transparent, and can be executed quickly and efficiently. Additionally, blockchain transactions allow for democratisation of markets making them more accessible, inclusive, and open to a wider group of potential investors.

An example of an asset that can be tokenised and traded using blockchain technology in the asset management industry is a share in a private equity fund. Private equity funds are typically illiquid, long-term investments that can be difficult to trade. However, by tokenising a private equity fund on a blockchain, it can be divided into smaller units, which can be traded on secondary markets.

Tokenisation of a private equity fund can provide greater transparency to investors by creating a digital ledger of ownership and transaction history.

Tokenisation can also be applied to other assets classes, including shares in traditional investment funds, such as mutual funds and hedge funds. By tokenising these shares on a blockchain, asset managers can unlock benefits such as increased liquidity, enhanced access to a broader pool of investors, and improved information flow. Tokenisation enables the fractional ownership and trading of shares, allowing investors to buy and sell smaller units, thereby increasing liquidity in traditionally illiquid investment funds.

Additionally, blockchain technology can be used to automate certain aspects of fund management, such as dividend payments and investor communications helping to reduce costs and increase transparency - both important factors for any investor.

However, there are several challenges that must be addressed for tokenisation to become a conventional feature of the asset management industry, which include:

Regulation: The regulatory landscape around tokenisation and digital assets is still evolving, and there are many legal and regulatory hurdles that need to be addressed, including AML and KYC regulations. Asset managers must navigate a complex regulatory environment to ensure compliance with laws and regulations, which can vary by jurisdiction. Other considerations include legally managing and monitoring cross jurisdiction transfers of digital assets.

Technology: Tokenisation requires robust and secure technology infrastructure to manage and trade digital assets. This infrastructure must be able to handle large volumes of transactions and provide sufficient security to protect against cyber threats.

Liquidity: While tokenisation has the potential to increase liquidity in the asset management industry, the market for tokenised assets is still in its early stages, and liquidity can be a challenge. There needs to be sufficient market demand for tokenised assets, and secondary markets must be established to provide liquidity for these assets.

Standardisation: The lack of standardisation in the asset management industry can make it difficult to tokenise assets, as each asset may have unique characteristics that require customised tokenisation solutions. Developing standardised tokenisation practices will be critical for widespread adoption of tokenisation in the industry.

Education: Investors need to be educated on the benefits and risks of tokenisation and digital assets. There continues to be a lack of understanding around tokenisation, and more education is needed to build trust and encourage adoption.

How can KPMG support asset managers on their tokenisation journey?

Given these challenges, asset managers need support to navigate the tokenisation journey. KPMG's deep expertise in blockchain technology, financial services, and regulatory compliance makes us well positioned to support asset managers. By working with KPMG, asset managers can accelerate their tokenisation initiatives and gain a competitive advantage in the market.

Audit & Assurance: KPMG offers audit and assurance services to asset managers utilising tokenisation and digital assets in their investment strategy. Our support includes conducting audits of funds trading in tokenised assets, evaluating blockchain technology and processes, assisting with compliance and regulatory requirements, evaluating internal controls, providing guidance on financial reporting and accounting, and ensuring data and system reliability. By leveraging KPMG's expertise, asset managers can enhance transparency, strengthen controls, meet regulatory requirements, and build trust with investors and stakeholders.

Tax: KPMG helps asset managers understand and comply with tax regulations specific to tokenised assets, such as tax treatment of gains or losses, valuation methodologies, and jurisdictional tax considerations. We can also assist in identifying tax-efficient strategies, optimising tax positions, and managing tax risks associated with tokenisation initiatives. By leveraging KPMG's tax expertise, asset managers can ensure tax compliance, optimise their tax positions, and effectively manage tax implications throughout their tokenisation journey.

Strategy and Design: KPMG can work with asset managers to develop a clear tokenisation strategy that aligns with their business objectives and risk appetite. KPMG can help with the design of the tokenisation solution, including the choice of blockchain platform and token standards, as well as the implementation of smart contracts to automate processes and reduce operational costs.

Regulatory Compliance: KPMG can help asset managers navigate the complex regulatory landscape surrounding tokenisation. This includes advising on the legal and regulatory implications of tokenisation, as well as helping asset managers comply with existing regulations such as securities laws, anti-money laundering (AML) and know-your-customer (KYC) regulations, as well as tax laws.

Cybersecurity: Tokenisation presents new cybersecurity risks that asset managers need to manage. KPMG can provide cybersecurity assessments and help develop and implement security controls to protect the tokenisation infrastructure and the assets being tokenised.

Valuation and Accounting: Tokenisation introduces new challenges for asset valuation and accounting. KPMG can provide guidance on how to value tokenised assets, including the development of appropriate valuation models. KPMG can also help asset managers ensure that their accounting policies and practices are compliant with applicable accounting standards.

KPMG Law: KPMG Law offers legal advice to asset managers navigating the legal complexities associated with tokenisation and digital assets in their investment strategy. Our support includes advising on the legal implications of tokenisation transactions, regulatory compliance, and contractual matters. With KPMG Law’s expertise, asset managers can navigate the legal challenges of tokenisation, mitigate risks, and make informed decisions to protect their interests and ensure compliance with relevant legal requirements.

Talent Development: Tokenisation is a new and rapidly evolving area, and there is a shortage of skilled professionals with expertise in blockchain and tokenisation. KPMG can help asset managers build their internal talent pool by providing training and development programs for their staff.

What should asset managers do next?

In conclusion, tokenisation presents a significant opportunity for asset managers to transform how assets and investment funds are traded and managed. However, there are also several challenges that must be addressed, across a spectrum of areas. By working with KPMG, asset managers can navigate these challenges and successfully implement tokenisation initiatives, moving them ahead of competitors in the marketplace.