Knowledge

Introduction

The recent regulatory guidance on the tokenisation of real world assets published by the Jersey Financial Services Commission (the "JFSC") goes beyond articulating the workings of the Island's new regulatory regime – it also points the way to an interesting potential use case for Jersey structures.

Background

During the initial (and Cayman Islands-dominated) first rush of ICOs and token offerings in the 2010s, the narrative had initially settled on use cases around digital asset funds. The experience was mixed, with some high-profile failures denting market (and regulator) confidence in tokenisation generally.

But was a separate opportunity being missed?

The first generation of ICOs and token offerings was premised on an investment fund-like product, but was ultimately just a refinement of a widely-understood regulatory regime that was already working well (and which had guardrails for good reasons). And, ultimately, you just can't tiptoe a clever path around existing fund regulation.

Use case

Consider the basic selling points of tokenisation:

-      a method of transacting that is smoother with fewer points of friction;

-      a blockchain-based infrastructure that is distributed and irrevocable;

-      transactions that take place instantaneously without brokerage windows; and

-      democratised access that opens up global markets without qualifications to investor status.

All of these benefits would apply equally, and perhaps more usefully, to the securitisation of real world assets - a class that covers anything from real estate to art, from commodities to intellectual property rights.

Tokenisation also solves a problem in the context of real world assets – for investors seeking exposure to anything from fine art to classic cars or beyond, it reduces the high entry costs. Only a small number of global investors can afford a Van Gogh, but there are many more who could afford to own a small fraction of one.

More and more voices are adding to the clamour. McKinsey analysis suggests that total tokenised market capitalisation could reach around $2 trillion by 2030 (excluding cryptocurrencies and stablecoins), and Larry Fink of BlackRock said in January 2024 that "the next step going forward will be the tokenization of financial assets".

Stumbling blocks

This all paints a positive picture, but there are still some issues to be addressed:

-      If blockchain-based tokens are held in a digital wallet, where is that wallet? What laws apply to it, and in which tax jurisdiction does it exist? Does the location of a cloud-based server matter? How can you create security over a token asset? Clear and robust answers will be needed to these questions before tokenisation of real world assets can go mainstream.

-      The enthusiasm and hyperbole around blockchain-related subjects has done a great job of spreading the message and winning converts – but is the tech-bro language effective with institutional investors, who are more accustomed to a colder, clearer articulation of risk and reward?

-      Democratisation is one of the underlying selling points of tokenisation, but, as stated above, there are good reasons for some of the guardrails around investment products – can a reliable gating mechanism be created to restrict token access?

-      It took more planning and courage for Christopher Colombus to sail the Atlantic than it takes the passengers on the 30 or so daily flights from London to New York. Likewise, with the tokenisation of real world assets, the precedents, regulators' comfort level and investor risk perception will change over time, but there will be a regulatory premium for the first few years.

The Jersey guidance

The JFSC guidance issued on 28 August 2024 seeks to set out "a proportionate regulatory framework that upholds investor protection and market integrity".

It states that applications will be dealt with on a case-by-case basis but that some basic requirements will have to be met, including company incorporation in Jersey, compliance with AML/CFT/CPF standards, and published independent verification of underlying assets confirming that the tokens are 100% collateralised and ring-fenced.

It also states that the issuer must appoint and maintain a Jersey-resident director on its governing body, who must be a principal person of the trust company business appointed by the issuer.

Tellingly, the guidance explicitly makes the case for tokenisation, saying it "has the potential to significantly transform asset ownership and investment, enhancing market efficiency and inclusivity".

The road ahead

Tokenisation of real world assets is a space to watch from a global investment perspective. From a Jersey point of view, the legislature, regulator and industry are in the same position as everyone else – grappling with the challenges that accompany the opportunity. However, this latest guidance from the JFSC shows that Jersey recognises not only those challenges but also the potential for tokenisation to transform ownership and access to real world assets.