Fund tokenisation: What are the FCA’s latest proposals?

What is the overall approach that the FCA is taking in relation to fund tokenisation?

In 2023 the FCA published a discussion paper on, ‘Updating and Improving the UK regime for Asset Management’ (DP23/2), which looked at aspects of fund tokenisation, and since then it has considered further how it can support industry tokenisation initiatives. In its letter to the Prime Minister in January this year, the FCA confirmed that it would be progressing its roadmap for digital assets within asset management, with the aim of making the UK a centre of excellence for tokenisation. The FCA has explained that this consultation looks to deliver on these commitments by setting out proposals to encourage adoption of tokenisation and tokenised funds in the UK. 

What does the proposed guidance on operating a tokenised unitholder register cover?

The FCA sets out in this paper that it proposes to take a technology positive approach to interpretating existing rules relevant to the operation of authorised fund registers, which are set out in the Collective Investment Schemes sourcebook (COLL) and the Open-ended Investment Companies (OEIC) Regulations, but that the principles and outcomes set out in those rules will apply where distributed ledger technology (DLT) is used in this context. 

In relation to this, the Blueprint was a model developed by the Technology Working Group of the previous Government’s asset management taskforce, under which it was intended that firms would be able to operate a tokenised unitholder register within existing legal and regulatory frameworks. However, the FCA explains in this paper that despite the introduction of the Blueprint, it has still received several questions from firms about aspects of the interaction between the existing rules and how tokenised systems work in practice. 

As a result, the FCA has proposed guidance on relevant the rules in COLL and the OEIC regulations, which is intended to clarify an approach firms could take in relation to these issues, for example:

• The firm responsible for maintaining the register of unitholders needs to be able to make unilateral updates to the register: The FCA explains that it understands that this may not be the default operating model for some DLT networks, but the proposed guidance clarifies that this could be potentially be delivered through smart contracts or though contractual relationships with unitholder, or the responsible firm may be able to effect updates through the use of private keys or a master-node function.
• The register of unitholders must be complete and accurate, and this includes the ability to identify aggregate positions of unitholders: the proposed guidance clarifies that, where positions of unitholders are held through different wallets, managers can still comply with the rules if the overall platform can provide reporting of units held at unitholder level.
• The register must be able to be reproduced in legible form, in the UK and to be accessible to the depositary, regulator and unitholders: The proposed guidance clarifies that firms can use systems that, for example, combine on- and off chain records to achieve this where it cannot be achieved fully on-chain.

Ultimately, it doesn’t appear that the FCA is considering amending its rules in relation to unitholder registers at this stage, but it has asked firms to consider further whether the existing rules, as supplemented by the proposed guidance, will provide sufficient flexibility and clarity.

What are the FCA’s proposals for the introduction of a direct dealing regime?

The FCA explained that it has included proposals in this paper for a new direct dealing model for processing unitholder deals in units of authorised fund, as it considers that direct dealing may help authorised funds managers (AFMs) to transition to a tokenised fund environment. This is because AFMs would no longer need to perform back-to-back transactions with investors and the fund, as it is the fund or its depositary that would act as principal in unit deals with end investors. That said, the FCA makes clear that this will be an optional, alternative operating models and that it still supports AFMs using the existing principal model. 

The FCA has further explained that it will take the approach of amending its existing rules within the current structure and will look to retain existing definitions where possible, but that it will need to make changes to certain specific rules, in particular in COLL, to enable the operation of this model. This includes removing the requirement to deal as principal in cases where direct dealing would be on equivalent terms. Some of the other more significant proposed changes to the relevant rules include:

• Issues and Cancellations account: The FCA proposes to recognise the use of an ‘Issues and Cancellations account’ (IAC) in the COLL rules, as it explains that the operation of the D2F model would require there to be a specific bank account to receive payments from and make payments to investors. The FCA also intends to allow firms to operate IAC accounts at umbrella level, subject to firms putting in place certain safeguards including introducing requirements in relation to the operation of the IAC, proposals in respect of overdrafts and fund exposures, and certain accounting controls. 
• Instruments constituting a scheme and fund prospectuses: The FCA also sets out that its existing rules, in relation to the contents of instruments which constitute a scheme and fund prospectuses, already require firms to disclose procedures for unit dealing and so it does not consider that these rules require substantial amendments. However, it is proposing to require some additional information to be disclosed to investors, such as providing a summary of the implications of using an IAC.

In addition, the FCA also highlighted that use of a direct dealing model may alter roles and responsibilities when performing anti-money laundering controls, for example that identifying the relevant person responsible for this may require specific analysis based on the instrument constituting the scheme. The FCA explains that it intends to discuss these issues further with industry and will aim to provide flexibility to ensure this model can be used, but that for now firms should take individual advice in relation to their fund structures if they intend to use a direct dealing model.

What other areas are included in the FCA’s roadmap to advance fund tokenisation further?

The FCA has highlighted two further priority use cases for fund tokenisation in this paper and explores how its considers that its existing rules can support these next steps or where they may need further development:

• Fully on chain investment markets where tokenised funds invest in tokenised assets: The FCA has made clear that it wants to support development of fully on chain models, such as where firms hold digital assets including tokenised deposits or stablecoins as part of facilitating fund operations. As a result, the FCA has asked firms to feedback on possible amendments that might need to be made in COLL to enable this, for example in relation to the general asset eligibility rules for UK UCITS or to the rules in relation to unit dealing. However, the FCA also explained that it doesn’t consider that the investment or borrowing rules in COLL impose barriers that would prevent UK authorised funds from investing in tokenised forms of eligible assets and, in fact, that it anticipates that UK authorised funds will be able to invest in digital gilt instruments issued under the Treasury’s DIGIT pilot.
• Use of tokenised money market fund (MMF) units as collateral: The FCA confirms in this paper that it agrees with the view that tokenisation could facilitate the use of MMF units as collateral, where eligible under the UK EMIR regime for non-centrally cleared derivatives, but also makes clear should it consider future work on any extension to eligible MMF categories that this would need to maintain strong prudential standards and recognise that use of tokens as collateral has the potential to create new risks. 

In relation to both use cases, the FCA is also considering how test environments could be used to enable innovation in these areas, for example using the FCA’s existing sandboxes such as the digital securities sandbox, or whether the FCA can use waivers or modifications to achieve this in the interim, in advance of any amendments to existing rules.

How does the FCA intend to support potential future tokenisation models?

The FCA highlighted certain future models that have already been put forward by industry, in particular how ‘composeability’, which looks to maximise the re-use of existing technological and operational components to build new DLT applications and services, could help firms to offer personalised investments to consumers. 

The FCA explained that it is aware that some firms are envisaging a form of tokenised portfolio management and confirmed in this paper that it considers that the existing rules largely support experimentation, as individual portfolio management services are already regulated. However, the FCA also highlighted that many of the existing rules are not as prescriptive as, for example, the COLL rules applicable to funds, because portfolio management has historically been aimed at wealth clients rather than retail, and so it also intends to conduct a review of the portfolio management rules to ensure they are fit in future for firms and consumers.

Overall, the FCA have said that they want to hear from firms as to where regulation might need to change to enable further tokenisation, and that it sees this as a potential opportunity to develop a proportionate approach to regulation in this area.

Next steps for firms

The FCA has made clear throughout this paper that it wants to enable innovation in fund tokenisation and that it wants to hear from firms in relation to the proposals it has put forward so far for guidance in relation to tokenised unitholder registers and new rules to enable direct dealing models, as well as seeking to understand what more it can do in future to enable other current and future potential use cases for tokenisation. 

Therefore, AFMs and firms operating in the wider fund and asset management sectors may want to use this opportunity to consider their own business models and approach to tokenisation, including whether the proposals made so far will allow them to develop their own tokenised offerings and also what further guidance or amendments to rules from the FCA would allow for future innovation in this space.