Information Governance Structure
The Structure phase starts with Information Governance Structure, which defines the records management framework for the asset – and also how the asset relates to transactions between entities.
This establishes the foundation for the risk and compliance processes related to conditions and actions comprising the administration of the asset.
The Structure phase also defines the Master Data Management (MDM) policy for all information, data, and records pertaining to the asset, offerings, and transactions.
Asset and Offering Structure
The next step in the Structure phase, crucial decisions need to be made regarding the terms and conditions of the asset, which must correlate to the token.
Offering structuring is an integral part of any tokenized asset offering, irrespective of the technology employed. Tokenization is not meant to be a way of avoiding compliance with applicable legal and regulatory requirements; rather, the use of technology is intended to fundamentally improve operational processes to enable innovative financial solutions.
Security tokens are issued by an entity, corporate or an individual, and provide the token holder specified rights such as ownership, repayment of a specific sum of money, or entitlement to a share in future profits. The form and structure of a tokenized security is crucial in determining the rights and obligations that the investor has in the underlying asset as well as ultimately what form of return they will receive; it will also be the starting point in analyzing how gains and losses on the tokenized security should be taxed.
Furthermore, tokenization could affect the valuation process, which may in turn affect the trading price of the security token. As tokenization is still a relatively new space, analysis of the above issues must be undertaken on a case-by-case basis. However, this may well change in the future as transaction data of tokenized securities accumulates for institutional analysis.
Securities that are structured differently benefit from tokenization in different ways. Asset owners and managers should consider the main objectives of the securities product and the rationale underlying the structure to evaluate how tokenization technology may complement the purpose and enhance utility.
For example, a bond secured by real estate has a relatively short time to maturity as compared to a real estate private equity (PE) fund. Compared to traditional issuances, a tokenized bond product would benefit more from streamlined operations and automated post-issuance corporate action management such as coupon distribution, whereas PE funds could gain significant additional advantages from increased liquidity.
The issuer of tokenized securities must also seek professional advice to make informed decisions about which jurisdictions to include in the structure of the product. The regulatory framework governing tokenized securities will vary between jurisdictions while the different tax regimes across jurisdictions could have a significant impact on the price of the tokenized securities and its cost-effectiveness.
Further, issuers should also seek advice regarding the location of target investors, as this will introduce regulatory considerations related to the marketing and offer of tokenized securities.
Fractional ownership allows the interests in an asset to be shared among a wide pool of investors, and the programmable nature of security tokens technically enables unlimited share classes and widely customizable fee structures at a low operational cost. With these new options available, issuers will benefit from clearly identifying the target investor base, including levels of investment capital commitment and anticipated demand for liquidity.