Tokenisation is the next step for the asset management industry. So says not only Larry Fink, Blackrock’s CEO, but also Jeroen van Oerle, manager of Lombard Odier’s fintech strategy. He sees the potential impact mainly in private markets.
In January, BlackRock, the world’s biggest asset manager, said through its CEO that turning all assets into digital tokens on a blockchain, making them shareable, transferable and globally accessible, is the future. “It is the second step in the technological revolution in financial markets after the introduction of ETFs,” Fink said.
Among other things, tokens could close the gap between supply and demand within alternative investments such as diamonds, real estate and art, other ‘pro-token’ asset managers such as BNY Mellon, Nomura and Northern Trust have said since.
Speaking to Investment Officer, Lombard Odier’s Van Oerle sees a potential paradigm shift for private equity: “Tokenisation pushes private equity more towards the fund industry and a private equity fund becomes more like a mutual fund.”
IO: What problem does tokenisation solve?
Van Oerle: “Tokenisation enables fractional trading in illiquid assets for everyone, and it promotes customisation of portfolios. Currently, access to private assets, for example, is limited to those with an extensive network and the money to do deals. Smaller o participants cannot participate. One reason for this is that it is difficult, if not impossible, to cost-effectively manage fractional shares in private companies, let alone find a liquid market to trade these assets.”
According to Van Oerle, tokenisation should not be confused with securitisation, where assets are bundled together to then be packaged into interest-bearing securities. “There is no reliance on a third party in the case of tokenisation to bundle assets and make them tradable again.”
IO: Why would a company prefer a token to an IPO or private credit?
Van Oerle: “Going public is a massive step for a company. The costs of doing so are large and the process takes time. Some companies thought they could leapfrog by using the SPAC route, but in many cases those projects miserably failed.”
“IPO becomes ICO. But that does not mean that all those assets are of similar quality. There will be a huge difference between companies which are audited and adhere to high quality standards in their reporting, and those who simply show an excel file and a PowerPoint to their investors, unaudited and, potentially, containing wrong data. That difference needs to be reflected in a price difference, given the risk profile of lower quality stocks is much higher than that of high-quality stocks. This is, essentially, the job of portfolio managers on the private equity side.”
IO: What does this mean for private equity?
Van Oerle: “Private equity has two main functions today. Access to private companies and selection of private companies. Investors pay for both at the moment. Especially during the low-interest rate environment, the search for yield drove many investors into private assets, which meant there was a real need for access and private equity houses benefitted from those fund flows. Tokenization has the potential to delete this “access” pillar, because everyone has access to tokenized assets, not only private equity investors.”
“That implies that investors will shift their attention to paying for selection. There are many private assets out there, and the majority will fail. That is simply how the model works.”
IO: So tokenisation eats away at private equity’s profit model?
Van Oerle: “Paying a fund manager to do deep research on a company in order to select only the best deals is valuable. Simply put; tokenisation pushes private equity more towards the fund industry and a private equity fund becomes more like a mutual fund.”
“Selection and benchmarks will come to dominate the debate in private equity, just as they do in the mutual fund industry. Good managers who consistently select good companies and outperform their peers will attract investors.”
“Those who were only good at providing access to deals will indeed find it harder once tokenisation takes off. Fees are likely to behave in a similar way to the mutual fund industry.“
IO: Which countries are leading the way?
“Switzerland is far advanced, Singapore as well. In the UK the regulator is close to formulating rules and in Europe there are high hopes for MiCa which entered into force in June last year. In the US it’s more about lawsuits which will determine the path forward. There are some high-profile lawsuits, for example those which pushed the SEC to allow the Bitcoin ETF to be approved, which are good to watch to get an idea of where that market is heading.”
“From a technology perspective, there is no need to differentiate between countries. Tech-expertise can be found globally. It’s just a matter of funding and regulations which will determine progress. From that perspective, I would say Switzerland, Singapore and the US have a high chance of taking the lead.”
IO: So what is holding the industry back?
Van Oerle: “KKR tokenized a part of their healthcare fund. They recently announced a second fund, a health care growth II tokenized fund, in the US. Besides this example, it seems some large European initiatives are about to go live, with Deka in the lead. Now that we have more clarity on the regulatory framework, it is very likely we will see liftoff of tokenized assets all over the world. The technology has been tested for the last five years and regulatory frameworks were drafted, with FIinma in the lead. This all comes together in the near future to reap the benefits of tokenization across the AM industry.”
“The reason for slow adoption is pure and only regulatory. From a tech perspective there is no reason why this would slow down, although some would say we still need to come to a “standard”, but I think that the market will figure it out, just as it has done with every other technology ever created, to eventually pick a winner, or several, as I think the blockchain setup is industry dependent. Furthermore, because of this regulatory pushback, the AM industry has been in a wait and see mode for a while, as always with new things. Just think of the introduction of ETF and sustainable investing.”
“Once a few leaders start to offer it, the rest will try to fast follow. I don’t think that this is the right strategy for tokenization though. There is only a limited set of expertise in this field, and it takes a while to train, especially with more exotic assets. This implies ‘fast following’ will turn into ‘musical chairs’ and those left standing when the music stops are out. It is clear Larry Fink started the music with his latest comments around tokenisation.”