Tech revolution in investment management?

The FCA’s discussion paper: Updating and improving the UK regime for asset management (for more, see here) includes within it the FCA’s thinking on how technology can support better outcomes from authorised funds as well as where amendments to certain fund rules could assist in modernising fund propositions.

The FCA recognises that technology is an essential part of the operating model of financial services firms and that regulation needs to reflect both this and the opportunities that technology can create (or otherwise risk holding firms back from making changes in the best interests of investors).  The FCA also recognises that its Handbook may lack clarity about whether and how firms are able to adopt new processes that could obstruct change.

Chapter 5 of the discussion paper focuses on identifying areas where improvements could be made to fund regulation, so that firms can take advantage of technological developments in their customers’ best interests.  Some of the key discussion points include:

• The balancing act.  Firms should plan their response to technological changes to think about how those changes could drive competition in the interests of consumers, while also balancing consumer protection. It is noted that consumer-friendly use of technology may encourage consumers, especially younger people, to seek out and engage with a wider range of products and services that meet their financial needs, but the risks must be duly considered.
• Tech in fund operations. Generally, regulation does not dictate exactly how technology might be used, but it is sometimes prescriptive about processes. Recognising the role of technology in client interactions and back-office functions (transaction settlement, fund accounting etc.), current structures could act to deter firms from finding better solutions. Long-standing processes might be made more efficient through a combination of better technology and fresh thinking about investor outcomes. One example of this is the Investment Association’s ‘Direct2Fund’ proposition making it possible for investors to transact directly with the fund when buying and selling units. The FCA has been engaging with the IA’s working group to identify different regulatory issues in introducing this new dealing model.
• Fund tokenisation. As the FCA understands it, this means the ability to issue a fund’s rights of participation (e.g. units or shares) to investors as digital tokens, usually by means of a distributed ledger.  In this context, implementation is at the investor level rather than in respect of the fund’s underlying investments. Fund tokenisation may simplify the way units are bought and sold by potentially eliminating some of the participants in the process and making remaining interactions more efficient. In principle, where a fund issues its units via a distributed ledger, the ledger is the sole and incorruptible record of the number of units held by each participant, removing the need for a separate unitholder register to be maintained. Operating funds in this way could lead to greater efficiency with resulting cost savings, and faster transactions, as well as eliminating potential administrative errors.  The FCA recognises that existing rules that govern how units are created, transferred, registered, and ultimately cancelled might not be flexible enough to allow firms to operate a ‘digital register’, and is open to exploring how to enable this (alongside considering specific risks e.g. operational resilience).  Work is currently under way and the FCA welcomes input from stakeholders.  The FCA notes that once the technology has been properly trialled in the wholesale market, it could start to become more practical and cost-efficient for at least some private retail investors to hold units directly in this way.
• Tokenised portfolio assets. The discussion paper notes that some managers might be interested in how existing assets, at the level of the fund, could be traded in a secondary market in tokenised form, with fully digitised clearing and settlement (such as through securities tokens). The government’s Digitisation Taskforce will be considering many of the relevant issues in this area. Tokenisation also raises regulatory issues which the FCA wants to consider in a cross-cutting way, such as the implications for custodians and how to manage the distinction between regulated and unregulated activities. The FCA thinks that this could be of particular interest to managers of QIS and LTAFs, for example in the context of holding tokens representing fractional interests in real estate or an infrastructure project, which could be more easily transferable than traditional forms of title and helpful for liquidity management.
• Investment in cryptoassets. It is not currently possible for authorised funds to hold unregulated cryptoassets. The Government has recently consulted on the next phase of its plans for regulating cryptoassets in the UK, including the case for bringing portfolio management of cryptoassets into the regulatory perimeter. However the FCA does not intend to consider this area further until the Government’s position is more advanced.

"Technology is an essential part of financial markets, and of the operating model of financial services firms. Firms have to make many commercial decisions about how they use technology, and those decisions collectively shape market standards. Regulation needs to reflect those standards and the opportunities that technology creates. If it doesn’t, it may hold firms back from making changes in the best interests of investors. It might also increase operational risk, or entrench poor practices that would otherwise have been corrected because of market pressure." FCA

https://www.fca.org.uk/publication/discussion/dp23-2.pdf