Asian asset managers show support for tokenized securities

Authored by blue-chip companies such as PwC and Linklaters under the banner of the Asia Securities Industry & Financial Markets Association (ASIFMA), the paper makes a case for the benefits of blockchain-based securities and calls on regulators to embrace the new asset class.

Blockchain-based benefits

The report defines tokenized securities as "traditional, regulated securities, but with a digital wrapper," and security tokens as assets that might include "participation in companies or earnings streams, or an entitlement to dividends or interest payments."

The authors of the report appear convinced of the merits of both types of tokens, citing their ability to reduce costs, create efficiencies, and "act as a bridge between legacy finance and the new digital world."

These benefits arise from using a blockchain to register ownership and make transfers. While it generally takes two days for a security to settle on a legacy system — known as T+2 in financial markets — tokenized securities can offer near-instant settlement.

By replacing existing technology platforms with blockchains and smart contracts, tokenized securities can also save institutions money. Onerous administrative tasks like paying out dividends and voting can be automated, allowing for greater efficiencies and smaller deal sizes that were not previously feasible.

As smart contracts are completely transparent, the technology also allows for easy interaction with regulators. Compliance can be encoded in smart contracts to specify restrictions like locking up securities for a period of time, or preventing a private company from going beyond a fixed number of investors.

And with jurisdiction-based regulations that cater to specific regions, tokens can potentially be sold to different investors around the world, at any time or day of the week.

But while the potential benefits are numerous, ASIFMA says the security token industry must be supported by proactive regulators.

Regulatory roadblocks

Unlike cryptocurrency, which has progressed without the intervention of authorities, security tokens are likely to be held back by slow regulators.

To prevent this, the report suggests that generally speaking, regulators should not feel the need to change the status of an asset just because it has been tokenized.

There are however differences in the lifecycle of tokenized securities that require clarity from regulators—these include structuring, token offerings, the selling of tokens, secondary trading, taxation, and market-making.

Custody is seen as a key barrier to security token adoption.

Investors are likely to require a third-party custodian, but are also likely to encounter "problems if the bank’s preferred custodian does not have the expertise or technical infrastructure to hold tokenized securities."

"The presence of independent institutional custodians to securely store private keys, and administer token holdings, will be crucial to attracting professional investors," says the report.

Transaction finality could also be an issue as the legal finality of legacy settlement mechanisms needs to be aligned with the operational finality of transactions on the blockchain.

As to which blockchain security tokens are best suited to, the report suggests there isn’t a ‘one size fits all’ solution. In the short-term, most platforms are expected to rely on segregated blockchains relating to their own legacy systems. This will promote quick development initially until interoperability becomes an issue and platforms must find a way to interact with each other.

"Market participants should work on integrating blockchain infrastructure interoperability across multiple platforms into legacy systems over time to prevent a fragmentation of market liquidity."

An encouraging sign, the report demonstrates that some of the biggest players in Asian finance have been won over by the promised benefits of security tokens.

And as recent developments suggest, we could expect to see authorities across Asia continue to craft regulations to promote their use.

In June 2018, Thailand made a forward-thinking move by amending the Securities and Exchange Act to allow for the issuance and trading of blockchain-based securities. And in October of this year, six major Japanese securities brokers formed a new association to support security token offerings.