Tokenisation Of Collective Investment Schemes

The Malta Financial Services Authority ("MFSA") issued a press release on the Tokenisation of Collective Investment Schemes ("CIS"). This follows the release of the MFSA's Position Paper, which outlined the Authority's stance on the 'Tokenisation of Fund Units'.

In turn, the Position Paper marks an essential milestone for Malta's fund sector. As highlighted in the press release, it represents a significant step towards fostering innovation in the industry while keeping at its core the essential principles of integrity and investor protection, effectively aligning innovation with robust supervision.

Understanding tokenisation

Tokenisation refers to the issuance of a digital token representing an asset in a digital form on a shared, trusted and programmable digital ledger. These tokens are stored on a blockchain – a form of digital ledger technology ("DLT") – and can be transferred to other users on the blockchain. Tokens issued by CISs may be represented digitally, with separate tokens allocated to specific share classes.

Further, tokenisation can apply in a traditional manner ("off-chain") as well as on the blockchain itself in tokenised form ("on-chain"). In an on-chain model, the token is held on the digital ledger itself, whereas in an off-chain model, it is held by a custodian. In terms of a CIS, these tokens represent an investor's shares, which are then recorded on a shareholder register. Prior approval by the CIS itself is needed for these shares to be transferred. Traditionally, the fund administrator has sole access to this shareholder register. In the MFSA's paper, maintaining this register, whether in its traditional form or as a tokenised version, is a central focus.

The MFSA's position on tokenisation of CIS shares or units

Classification, eligible fund types and custody

Article 2(4) of the Markets in Crypto-Assets Regulation ("MiCA") confirms that tokenised shares or units fall outside the scope of MiCA when classified as financial instruments; effectively bringing them under the Markets in Financial Instruments Directive II ("MiFID II"). In essence, this ensures that said tokens are not scrutinised under two different legal regimes simultaneously, while also providing the applicability of the Conduct of Business rules in MiFID II as transposed in the Conduct of Business Rulebook.

Notably, against this backdrop, the MFSA has permitted the tokenisation of CIS shares or units for:

• Licensed Alternative Investment Funds ("AIFs")
• Licensed Professional Investor Funds ("PIFs")
• Notified Alternative Investment Funds ("NAIFs")
• Notified Professional Investor Funds ("NPIFs")
• Undertakings for Collective Investment in Transferable Securities ("UCITS")

To this end, the MFSA has also specified that tokenised CIS shares or units must have a base currency in fiat — i.e., a government-issued currency.

Roles: The fund administrator and the custodian

As identified in the position paper, the fund administrator plays a pivotal role in the management and administration of the digital shares of the fund. In essence, the fund administrator shall be responsible for the management of:

• The issuance of shares, subscriptions and redemptions – facilitated via smart contracts.
• Conducting due diligence on both investor wallets and wallet holders.

Meanwhile, the designated custodian must not only safeguard the assets but also provide a clear description of how to maintain custody of the assets. Thus, while the two roles are distinct, they are also complementary, ensuring both operational efficiency and asset protection.

Competence, disclosure and risk mitigation

Furthermore, the MFSA has also outlined three critical sections of requirements that must be adhered to by a CIS seeking to issue tokenised shares or units:

Competence requirement:

The MFSA has highlighted that the governing body of the CIS must have adequate knowledge and understanding of tokenisation, as well as the underlying technology, ensuring that this expertise supports continued adherence to regulatory standards rather than hindering them.

Disclosure requirements:

The MFSA requires that:

• Tokenised shares or units must be disclosed to the MFSA and included in the offering document for CIS shares or units to be issued.
• The offering document must, as a minimum, cover several key matters, namely:
  1. Information on AML/KYC requirements;
  2. Information on arrangements for the issuance and redemption of tokenised CIS shares or units;
  3. Limitations, if any, regarding the transferability of said tokens to third parties;
  4. Information on safekeeping arrangements which apply to tokenised shares or units; and
  5. The identification of risks associated with tokenised CIS shares or units.
• Additional disclosures must include the risks associated with tokenised shares or units and risks linked to digital wallets.

Risk mitigation:

In terms of tokenisation, the MFSA has established a broad, non-exhaustive list of key risks and recommended mitigating measures. The risks outlined include:

A key opportunity for tokenisation

The MFSA's Position Paper lays the groundwork for a structured approach to integrating tokenisation into Malta's regulated CIS framework. By focusing first on the transfer agency function – and particularly the shareholder register – the development of the position paper may prove crucial in addressing settlement inefficiencies in traditional CIS systems, opening the door to more efficient and cost-effective models that could eventually be adopted.

We look forward to similar position papers on tokenisation in other areas of traditional finance, as we are convinced that tokenisation is the future of finance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.