The rise of tokenised private funds: an Australian perspective

Tokenisation is rapidly transforming the financial landscape, allowing for the digital representation of real-world assets (RWAs) on blockchain's distributed ledger technology (DLT). In the private funds space, tokenisation enables fund units to be digitised and traded more efficiently. This innovation has significant implications for liquidity, investor access, and regulatory compliance.

However, in Australia, such tokenised structures fall within the regulatory perimeter, necessitating an Australian Financial Services Licence (AFSL). This article explores the advantages of tokenisation in private funds, the high-level regulatory framework, and the increasing trend of RWA tokenisation.

Understanding tokenisation of private fund units

Tokenisation for private funds involves creating digital tokens on a blockchain that represent ownership in a private fund. These tokens function similarly to traditional units in a managed investment scheme but offer enhanced programmability, transferability, and efficiency in settlement. Investors can hold and trade these digital representations via smart contracts, reducing the need for intermediaries and giving them access to a broader pool of investors.

Mechanics of tokenising private fund units

The process of tokenising private fund units typically involves several key steps:

• Fund structuring and legal compliance: The fund manager determines the structure of the fund, ensuring it aligns with Australian regulatory requirements, including compliance with the Corporations Act 2001 (Cth) and ASIC regulations. Most often it will be a Managed Investment Scheme or Corporate Collective Investment Vehicle, appropriately equipped with an AFSL.
• Token creation: Using blockchain technology, digital tokens representing fund units are created. These tokens are encoded with smart contracts that define ownership, transferability, and compliance rules, ensuring adherence to investor eligibility requirements. At a more advanced level, they can facilitate interactivity with the fund e.g. voting rights, or additional revenue streams e.g. on secondary market trading.
• Investor onboarding and KYC/AML compliance: Before investors can purchase tokens, they must complete a Know Your Customer (KYC) and Anti-Money Laundering (AML) process. (And, depending on the structure of the offering, wholesale investor classification / determination of whether they fall within the fund's target market determination.) This ensures compliance with Australian financial regulations and prevents fraudulent activities.
• Smart contract deployment: The smart contracts governing the tokens are deployed on a blockchain network, automating processes such as dividend distributions, transfer restrictions, and investor voting rights. These contracts can enforce compliance with fund terms and regulations in a tamper-proof manner.
• Token distribution and trading: Investors purchase tokens either directly from the fund (primary issuance) – usually through a global digital asset exchange - or from existing investors in a secondary market, subject to transfer restrictions. Smart contracts enable seamless peer-to-peer transactions while ensuring compliance with fund rules.
• Custody and security measures: Depending on the structure, tokenised fund units may be stored in secure digital wallets or custodied by regulated third-party custodians to ensure asset security and regulatory compliance.
• Ongoing fund management and reporting: Blockchain transparency allows investors to track fund performance and holdings in real time. Fund managers can automate periodic reporting and distributions through smart contracts, reducing operational inefficiencies.

Marketing and distribution of tokenised funds

Tokenisation significantly alters fund marketing and distribution by leveraging blockchain-based platforms and global digital marketplaces. These platforms often have much broader reach than traditional equity exchanges, financial adviser networks or personal networks used to distribute fund products. Unlike traditional funds that rely on intermediaries, tokenised funds can streamline investor onboarding, reducing administrative friction and broadening market access. The ability to fractionalise fund units lowers the minimum investment threshold, making funds more accessible to a wider range of investors, including those previously excluded due to high entry costs.

Additionally, tokenised fund units can be traded on secondary markets, offering enhanced liquidity and global investor participation. This opens opportunities for direct peer-to-peer transactions and alternative distribution channels that extend beyond traditional financial institutions. However, these expanded distribution methods require compliance with multiple regulatory frameworks, increasing the complexity of cross-border marketing strategies.

While tokenisation improves market reach, fund managers must still adhere to strict AFSL requirements and investor classification rules. Effective investor education, strategic partnerships with compliant digital asset exchanges, and clear regulatory positioning are critical for successfully marketing tokenised funds. Ensuring a robust governance framework and engaging with regulators will be essential in maintaining investor confidence and trust in these innovative financial products.

Advantages of tokenisation for investors

There is a level of complication in structuring compliant investment funds.  That complication is increased when performing the alchemy of changing those funds into digital tokens.  The resultant benefits are being increasingly recognised though. UK Finance recently estimated that digital assets could represent as much as 10 per cent of the global funds market by 2030, equivalent to a value of between US$4-$5 trillion.

Some of the key advantages of tokenised funds, structured correctly, are set out below:

• Enhanced liquidity: Traditionally, private funds suffer from illiquidity, with investors locked into their investments for extended periods. Tokenisation enables the fractionalisation of fund units, allowing for secondary market trading and greater liquidity, subject to fund rules and regulatory constraints.
• Broader investor access: Tokenisation can democratise access to private funds by allowing smaller ticket sizes and a wider investor base, including sophisticated and wholesale investors who may otherwise be excluded from such investments due to high minimum entry points.
• Operational efficiency and transparency: Smart contracts can automate processes such as distributions, fee calculations, and redemptions, reducing administrative burdens and lowering costs. Blockchain’s immutability also enhances transparency, as investors can verify transactions in real time.
• Regulatory and compliance benefits: When properly structured, tokenisation can enhance compliance with regulatory obligations by automating KYC and AML processes. Additionally, built-in compliance features can prevent unauthorised issuance i.e. to non-qualifying investors, unauthorised transfers and enforce transfer restrictions as per the fund’s constitution.

The rise of real-world asset tokenisation

Tokenisation is expanding beyond funds to other RWAs, driven by factors such as:

• Institutional adoption: Large financial institutions, including BlackRock and JPMorgan, are exploring tokenisation for private equity and debt instruments, recognising its efficiency.
• Property and infrastructure: Real estate tokenisation is gaining traction, enabling fractional ownership of high-value assets and increasing market participation.
• Commodities and carbon credits: Tokenisation allows for easier trading of commodities like gold and carbon credits, making these markets more accessible and transparent.
• Government initiatives: Regulatory sandboxes and pilot programs, such as those led by the Reserve Bank of Australia (RBA), are exploring the viability of tokenised securities and central bank digital currencies (CBDCs) in the financial ecosystem.

Conclusion

The tokenisation of private fund units presents a fascinating innovation that enhances liquidity, efficiency, and accessibility for investors. However, its adoption in Australia requires careful navigation of financial services regulations, including AFSL obligations and managed investment scheme compliance. As institutions and regulators continue to explore RWA tokenisation, the broader financial landscape is set for a significant transformation.

For fund managers and investors, understanding both the opportunities and regulatory obligations is critical in harnessing the benefits of this evolving technology while ensuring compliance with Australia’s financial services laws.

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