Asset tokenisation makes inroads in Asia

Asset tokenisation makes inroads into private assets and over-the-counter financial products

Digital technology is changing the financial world. While cryptocurrencies are capturing the most attention, tokenisation of traditional financial assets is making progress in reshaping capital markets, with blockchain and distributed ledger technology or DLT becoming an accepted part of the financial services lexicon.

Tokenisation is the process of creating a digital representation of an asset on the blockchain. US-based market research firm International Data Corporation has estimated that organisations worldwide spent US$6.6 billion on DLT solutions last year, with spending expected to reach $19 billion by 2024, representing a compound annual growth rate of 48%. 

Through DLT, a broad range of assets such as stocks, bonds, real estate, private equity and venture capital, and non-bankable assets such as fine art or ownership of an NBA team, can now be issued as tokens on the blockchain. Ownership and transaction data are consistent, up-to-date and immutable on the distributed ledger, enhancing trust among all participants.

Each token represents legal ownership of the underlying asset. Since tokens are highly divisible, each one can represent a tiny fraction of an asset. Fractional ownership reduces investment thresholds, opening up the securities market to a wider range of investors. Hence, asset tokenisation is seen as an important step towards democratisation of investment, which has long been the privilege of the affluent. 

HSBC estimated in a report in 2020 that more than 84% of the global population will need to save for more than two years to be able to afford a share in all the five largest technology stocks in the world, or FAAMG, referring to Meta (formerly Facebook), Amazon, Apple, Microsoft, and Alphabet’s Google. Fractionalisation through asset tokenisation would make it much more affordable for anyone to buy one-tenth or one-hundredth of a share in these companies.

On the blockchain, asset tokens can be bought and traded on decentralised exchanges instantly for other assets, immediately transmitting their value to the new purchaser. This is an entirely different process from buying and selling shares on a centralised exchange, which involves layers of intermediaries and takes days to transfer ownership. 

Growing institutional acceptance of digital assets, increased regulatory comfort with the blockchain technology, and continued technological advancement are accelerating use cases across the capital markets ecosystem. 

According to World Economic Forum (WEF) forecasts, up to 10% of global gross domestic product will be stored and transacted via DLT by 2027, and tokenised markets will potentially be worth as much as $24 trillion. 

“After years of experimentation, many DLT and smart contract use cases in capital markets are live across jurisdictions,” the WEF said in a May 2021 report published in collaboration with the Boston Consulting Group. “DLT is proving well-suited for addressing operational inefficiencies, and is increasingly demonstrating the possibility of better resource management across firms and markets.”

Stocks versus bonds

However, use cases of DLT solutions in capital markets have seen varying degrees of success across different asset classes. Given the scale of transformation required, most developments in centralised public equities markets to achieve the potential benefits are primarily in the early stages. 

The Australian Securities Exchange (ASX) embarked on replacing its legacy post-trade system called CHESS with a DLT-based system in late 2017. The project has experienced a series of delays and the current schedule is to go live in spring 2023, far behind the originally planned 2020/2021 start. Participants will be able to communicate with the system using ISO 20022 messages over SWIFT or a web interface, which is operationally similar to the status quo, or by hosting a DLT node, which would introduce new functionalities.

The Hong Kong stock exchange is developing a solution that will enable participants in the northbound channel of the Stock Connect programme to meet the shorter equities settlement window in China. But rather than building a new settlement infrastructure based on a distributed ledger, this platform will use smart contracts on top of the existing centralised infrastructure to synchronise workflow among parties.

It’s a different situation with bonds, which given the fragmented and over-the-counter nature of secondary market trading are more likely to benefit from DLT-based solutions, and easier to change without necessarily requiring wholesale market transformation. 

In August 2020, Singapore Exchange (SGX), Singapore state investment company Temasek Holdings and HSBC collaborated on the inaugural digital issuance of Olam International’s S$400 million ($285 million) 5 ½-year public bond offering. Based on smart contracts, the bonds were issued and settled on DLT using an on-chain payments solution. 

This solution was successfully deployed again in January 2022 when Olam International returned to the market with an additional S$250 million digital issuance. 

Building on the success, SGX and Temasek have announced the creation of a digital asset exchange focusing on the bond market, in partnership with bond issuance software provider Covalent Capital. The platform will be an end-to-end solution, employing DLT and smart contracts for relevant value chain components.

Use cases have also gone live in derivatives, securitised products and securities financing, all of which are traded over-the-counter and have high levels of inefficiencies in the manual processes. DLT solutions allow for shared sources of truth and mutualised processing across ecosystems or within institutions.

Private markets

Tokenisation is especially showing promise within private market investments, which do not benefit from the central infrastructures, standardised processes and ample liquidity of public markets. 

Singapore’s ADDX, a blockchain-based private market exchange backed by SGX, Temasek, and several investment groups from Japan and Thailand, offers accredited investors access to a variety of investment opportunities, such as private equity, venture capital, hedge funds, real estate, unicorns, and funds with cryptocurrency exposure, at a minimum investment of $10,000 instead of the $250,000 typically required in traditional non-tokenised channels. Investors can also trade past offerings with other investors on the exchange for as little as $100. 

Tokenisation and smart contract technology deliver efficiencies across different stages of the life cycle in servicing a security, including issuance, distribution, custody, compliance and post-trade services. “By bringing down the barrier to entry, ADDX is contributing to a fair and level playing field for individual investors,” Chief Executive Officer Oi-Yee Choo said in a press release for a product launch with Fullerton Fund Management in May. 

ADDX was licensed by the Monetary Authority of Singapore in February 2020, and has since listed over 30 deals on its platform, including blue chip names such as Hamilton Lane, Partners Group, Investcorp, UOB, CGS-CIMB, as well as Temasek-owned entities Mapletree, Azalea and SeaTown. 

In Japan, tokenised real estate developments use security tokens to facilitate easier ownership registration and transfer. In August 2020, Securitize Japan launched a real estate investment platform using digital securities in collaboration with real estate listing services company LIFULL to promote crowdfunding using blockchain. 

Last year, Tokai Tokyo secured a licence from Japan’s Financial Services Agency to deal in digital securities, and has partnered with ADDX on security token issuances by Japanese real estate companies and banks. Japanese investors will also be able to trade the digital securities on the ADDX secondary exchange through Tokai Tokyo.

Challenges

Despite these promising developments, it’s still early days for asset tokenisation and there are a number of challenges to overcome in order to gain industrial-scale adoption. 

For one, DLT-based solutions introduce new costs and risks given the need to run parallel operations to support multiple infrastructures. Without clear roadmaps to harmonise and bridge new and old systems operationally, many firms are less willing to adopt DLT solutions at scale in existing asset markets, preferring instead to focus on those without legacy infrastructures.

For another, it will require significant restructuring of roles, processes and operations across the industry in order to realise the anticipated benefits of DLT. There is at present limited appetite for system-wide change because there is no burning reason for an industry upheaval.

Then there is the fact that most DLT platforms currently work in silos, with no coordinated approach among market participants to enable interoperability between platforms. 

It also doesn’t help that regulations around DLT-enabled transactions and securities are still evolving, and vary across jurisdictions. Market participants are unlikely to make the substantial investments required until there is much greater certainty.

The coming years will see increasing digitisation of markets, tokenisation of assets, and more DLT use cases going live in Asia and globally. The financial industry will have to work together to address the issues and navigate the changing future of capital markets.

*This article was published in Asia Asset Management’s August 2022 magazine titled “Reshaping markets”.