ACCESS A BROADER MARKET PERSPECTIVE TOKENS OF APPRE

CIATIONBY KATY BURNE S S FIVE REASONS TO TOKENIZE

• SIMPLER, FASTER AND CHEAPER CAPITAL RAISING

• ACCESS TO BROADER SWATH OF POTENTIAL INVESTORS

• MORE TRANSPARENCY FOR ALL PARTIES TO A TRANSACTION

• INSTANT SETTLEMENT WITH FINALITY AND IMPROVED LIQUIDITY

• POTENTIAL ELIMINATION OF UNNECESSARY MIDDLEMEN

COVER ILLUSTRATION: MARK MCCORMICK MARKET PARTICIPANTS HOPE TO SPEED UP SETTLEMENT AND COLLATERAL TRANSFERS WITH DIGITAL TOKENS RECORDED ON THE BLOCKCHAIN

BY KATY BURNE

magine an integrated ecosystem right to property or delivery of an asset. registered broker dealer for tokenized in financial markets, where every Ownership changes are recorded on an securities. “We are using technolog- real-world asset is also repre- unalterable, shared digital ledger called ical innovation to provide enhanced I sented by a digital unit or token. a “blockchain,” similar to the infra- capabilities and advanced features to That token could be utilized and trans- structure underlying cryptocurrencies products that issuers/investors already ferred more efficiently than the phys- like bitcoin and ethereum. know and understand.” ical asset, introducing additional trans- The potential benefits of tokeniza- parency, 24/7 liquidity and instanta- tion are significant — both pre-trade, HYPE VS REALITY neous settlement to the investment for issuers who could save money by Tokenized assets can come in almost lifecycle. removing layers of friction in their any form, including as security tokens The concept of digitalizing own- normal workflows; and post-trade, referencing traditional units like stocks ership rights, in a process known as where the technology could be used and bonds, or non-traditional ones like “tokenization,” is the latest hot topic for efficiencies in things like collateral artwork or music. Central bank curren- sweeping the boardrooms of broker- transfers and trade reconciliation. cies can also be tokenized. In fact, pro- ages, fund-management companies Distributed ledger technology (DLT) ponents in Canada and Singapore have and banks. Some see it as having the has digital signatures in it that govern already tried it. potential to reduce operational costs the transfer of token ownership and “It doesn’t change the nature of and minimize the number of market allow peer firms to exchange value the asset; it just changes its texture venues and intermediaries needed in directly. These trades are recorded as and enables it to be more liquid,” says capital raising. distinct events on the blockchain. Then Subhankar Sinha, head of blockchain at Tokenization could also reshape the issuers, as well as other eligible partic- BNY Mellon. investing landscape by connecting up ipants in the transaction, can use it to One of the primary use cases is in issuers to a more diverse set of buyers see who owns what — and any move- real estate. For instance, there was the and sellers, who may consider frac- ment in the chain — simultaneously, in tokenization of an $18 million stake tions of assets more attractive and near real time. in the St. Regis hotel resort in Aspen, affordable. “We’re not reinventing the capital Colo., a few years ago, although other Here’s how tokenization works: the markets wheel,” says Timothy Furey, recent deals — including a student digital token references someone’s CEO of ConsenSys Digital Securities, a housing deal from Convexity Properties FUTURE PERFECT? How equities, commercial real estate and currency could be tokenized and traded between a broad set of participants.

FOR SALE TOKENIZATION DIGITALIZED ASSET TRADING

SOURCE: BNY MELLON

and a venture between Fluidity and So far, the hype has not been recorded about the deal and guaran- Propellr — have reportedly faltered. matched with broad investor participa- teed its security. Another asset class being explored tion, in part because of the time it will “One cannot dismiss the presump- by tokenization experts is commodi- take for platforms and other infrastruc- tion that there will be a benefit of ties. A Russian billionaire reportedly ture to be built and adopted. Tokenized increased liquidity to investors, but wants to tokenize palladium, while the deals to date have faced a range of I don’t think at this point that can Perth Mint in Australia is looking to challenges in how they were offered, be said with any certainty,” says Nic tokenize gold. structured and distributed, says Ian Niedermowwe, CEO of crypto-ded- Structurally, there are many options Taylor, head of advisory services at icated fund management company for how these offerings can come to Galaxy Digital, a digital-assets-focused Prime Factor Capital. market. There are tokenized securities merchant bank. “While I am confident tied to equity or debt, for example; these markets will develop, issuers DISRUPTIVE FORCES “utility” tokens representing services are, quite wisely, being cautious until Tokenizing traditional financial assets or infrastructure; tokenized money we see demonstrated engagement from isn’t a far-fetched concept. Indeed, dig- linked to fiat or crypto currency; and investors,” he notes. italized securities have been around for “stablecoins,” a kind of cryptocurrency Andrew Keys, co-founder of hedge decades. American Depositary Receipts whose values are pegged to fiat curren- fund Digital Asset Risk Management are already an analog representation of cies like the U.S. dollar. Advisors (DARMA Capital), says it is too shares in non-U.S. companies, issued Security tokens are attractive early for him to put money to work in elsewhere in the world but listed in because they may enable private-equity security tokens, but he is bullish about U.S. markets. shareholders to exit their investments their potential. He was among a group Most stock certificates are also faster than the typical seven- to 10-year that helped the Monetary Authority stored electronically, thanks to a pro- time horizon, notes Juan Hernandez, of Singapore issue a token tied to cess called “dematerialization,” which co-CEO of Openfinance Network, a sec- Singapore dollars in an initiative called was extended after Hurricane Sandy in ondary trading venue. One of its recent Project Ubin. 2012 flooded a lower vault listings was a tokenized venture capital Parties to a digital ledger may be and forced settlement giant Depository fund for Blockchain Capital. Those more likely to trust the origins of the Trust & Clearing Corp. to send tons of tokens sold in 2017 for $1 apiece and as assets underlying tokenized offerings the certificates away to be freeze dried. of Feb. 17 were valued at $3.69. if an agent has verified the information Today, tokenization is about “It doesn’t change the nature of the asset; it just changes its texture and enables it to be more liquid.”

—SUBHANKAR SINHA, BNY MELLON

marrying up traditional financial prod- banks governing any one of five cur- targeted for digital disruption: from ucts with new blockchain technology. rencies (CAD, EUR, GBP, JPY, USD) and bonds issued by Daimler, Société Most large banks are investing in some then exchange digital settlement assets Générale and the World Bank, to cross- proof-of-concepts so as to be ready referencing those deposits instanta- border payments, trade finance and for what they anticipate could be a neously, without middlemen. The mutual funds. rapid evolution in age-old settlement project is set to be extended beyond BNY Mellon is partnering with procedures. the initial 15 stakeholders in due a blockchain trade-finance initia- For its part, BNY Mellon is eager to course, according to Rhomaios Ram, tive called the Marco Polo Network, digitize its existing capabilities and CEO of Fnality. founded by TradeIX and R3. And leverage blockchain technology to “This is the evolution of money,” says Franklin Templeton Investments in improve its interactions with clients. Lucien Foster, head of digital partner- September filed a preliminary pro- As one of the world’s largest custo- ships at BNY Mellon. “We’re going from spectus to register a new kind of block- dian overseeing $37.1 trillion as of Dec. the old days of stock certificates being chain-enabled money market fund, 31, 2019, the bank has a series of toke- run across Wall Street to digital tokens where the fund’s shares can be sold and nization development projects under that can be moved and settled with a redeemed on an app. way to learn about different use cases, keystroke.” any risks to its adoption and what mar- The growth in blockchain technology CHANGING THE GAME ketplace frictions it can remove for cli- has also inspired a slew of related digiti- Among the most exciting projects sur- ents. For example, the bank is working zation projects at BNY Mellon. In 2016, rounding tokenization are platforms to issue bonds and syndicated loans on the bank created a blockchain-based, that would allow for participants to a digital ledger. parallel record of all its broker-dealer exchange collateral instantly in toke- Another such project is the bank’s clearance and collateral management nized form. participation as one of 15 shareholders transactions. The so-called “BDS 360” In October, New York fintech startup in the Fnality Global Payments initia- project is key because the bank pro- Paxos received temporary regulatory tive, formerly called Utility Settlement cesses more than $10 trillion in Fed- relief to launch a settlement service Coin, a digital payments system eligible securities each day. for the simultaneous exchange of cash designed to leverage the tokenization Blockchain technology has already versus U.S. equities on its private block- of cash. The idea is for banks in the net- been deployed in multiple areas chain. The platform launched Feb. 20. work to deposit cash with the central of financial markets that are being Other infrastructure providers such BRAVE NEW WORLD Tokenization should reduce settlement times and o ers big bene ts for highly illiquid assets

RESIENTIAL REAL ESTATE INRA STRUCTURE

UNS

INE ART

OL RECIOUS METALS TOKENIZED CURRENCY

RIVATE EUITY

INTELLECTUAL EUITIES COMMERCIAL ROERTY REAL ESTATE

OTENTIAL OR TOKENIATION MUSIC

I LO

SOURCE: BNY MELLON

“The power of tokenization comes from allowing workflows to be standardized and automated in safer, faster, cheaper ways.”

—JUSTIN SCHMIDT, GOLDMAN SACHS as HQLAx are working to allow instant ownership transfers in baskets of securities like government and corporate bonds residing at multiple custodians, using tokens. The arrangements are expected to REGULATORY mobilize and expand access to global pools of col- lateral, paving the way for near-real-time settlement OVERHANG? in the repo and securities finance markets. With collateral able to move as quickly as the tokens, it could become possible to synchronize Markets are rife with innovators looking to use more transaction workflows and reduce settlement blockchain-based solutions to upend traditional failures, some say. Tokenization could help because finance models. One complication giving investors it involves instantaneous settlement and wouldn’t pause: regulators are not moving nearly as quickly. need both sides of a trade to perform in a given This is partly because regulators had previously timeframe. conflated tokenization with cryptocurrencies like Such solutions would be useful, considering that bitcoin. Another reason is regulators were criticized European regulators have issued rules for harmo- for being late to scrutinize Initial Coin Offerings nizing operating procedures between settlement (ICOs), sales of digital tokens that bypassed tradi- providers under the Central Securities Depository tional fundraising sources. Regulation (CSDR). Those rules, which came into For now, Security Token Offerings (STOs) force on Sept. 17, 2014, will force CSDs to mitigate are sold mostly as private placements, meeting settlement fails. the Securities and Exchange Commission’s A key issue in the development of tokenization, Regulation D or Regulation S or even Regulation A+ however, is a perceived lack of clarity around regu- exemptions. lating it. While a tokenized security is still a security, But some tokenized deals do not come in the there are new technologies and risks to be consid- form of securities that are deemed “investment con- ered before adoption. tracts” under the SEC’s Howey test. Where they are The merger of the traditional finance world with not securities, they could be overseen by another new blockchain models also has significant implica- regulator. tions for record-keeping and what it will mean for all In April last year, the SEC issued a statement on parties to a deal to share a single record that can be its framework for digital assets. In the framework both customized and updated in an instant. the regulator said even on some deals where regis- Participants and regulators are increasingly able tration was not required, activities involving “digital to distinguish between what are cryptocurrencies assets” could still be subject to SEC oversight. The and what are traditional financial instruments on the UK’s Financial Conduct Authority issued its own blockchain, says Justin Schmidt, head of digital asset policy statement last July, saying security tokens are markets at Goldman Sachs. But regardless of the set- within its so-called regulatory perimeter. ting, the deal terms need to stand on their own. While regulators are refining their approach to “If a project is tokenizing just for the sake of overseeing digital assets, investors will need to be fractionalization, that’s not innovation,” he notes. careful to ensure the proper protections are there. “Almost all major financial markets already support As far as commodities futures, “We don’t have fractionalization, and the power of tokenization a good regulatory framework for digital assets comes from allowing workflows to be standardized generally,” notes Timothy Massad, former head of and automated in safer, faster, cheaper ways.” the Commodity Futures Trading Commission and a senior fellow at Harvard’s Kennedy School for public policy. “There are gaps under existing laws, Katy Burne is Editor-in-Chief of Aerial View Magazine such as for cryptocurrencies, and where the laws in New York. Questions or Comments? do apply, we don’t have clarity on exactly how tra- Write to [email protected] in ditional standards apply to this new world.” the Digital Team, [email protected] in Clearance & Collateral Management, or reach out to your usual BNY Mellon relationship manager. BNYMELLON.COM

BNY Mellon is the corporate brand of The Bank of 34363596). DNB holds office at Westeinde 1, 1017 ZN (“DFSA”) and located at DIFC, The Exchange Build- New York Mellon Corporation and may be used Amsterdam, the Netherlands. ing 5 North, Level 6, Room 601, P.O. Box 506723, as a generic term to reference the corporation Dubai, UAE, on behalf of The Bank of New York as a whole and/or its various group entities. This The Bank of New York Mellon SA/NV operates in Mellon, which is a wholly-owned subsidiary of The material and any products and services may be Luxembourg through its Luxembourg branch at Bank of New York Mellon Corporation. issued or provided under various brand names of 2-4 rue Eugene Ruppert, Vertigo Building – Polaris, BNY Mellon in various countries by duly authorized L- 2453, Luxembourg. The Bank of New York Past performance is not a guide to future perfor- and regulated subsidiaries, affiliates, and joint Mellon SA/NV, Luxembourg Branch is subject to mance of any instrument, transaction or financial ventures of BNY Mellon, which may include any of limited additional regulation by the Commission structure and a loss of original capital may occur. those listed below: de Surveillance du Secteur Financier at 283, route Calls and communications with BNY Mellon may be d’Arlon, L-1150 Luxembourg for conduct of business recorded, for regulatory and other reasons. The Bank of New York Mellon, a banking corpo- rules, and in its role as UCITS/AIF depositary and ration organized pursuant to the laws of the State central administration agent. Disclosures in relation to certain other BNY Mellon of New York, whose registered office is at 240 group entities can be accessed at the following web- Greenwich St, NY, NY 10286, USA. The Bank of New The Bank of New York Mellon SA/NV operates in site: http://disclaimer.bnymellon.com/eu.htm. York Mellon is supervised and regulated by the France through its Paris branch at 7 Rue Scribe, New York State Department of Financial Services Paris, Paris 75009, France. The Bank of New York This material is intended for wholesale/profession- and the US Federal Reserve and is authorized by Mellon SA/NV, Paris Branch is subject to limitted al clients (or the equivalent only), is not intended the Prudential Regulation Authority (“PRA”) (Firm additional regulation by Secrétariat Général de for use by retail clients and no other person should Reference Number: 122467). l’Autorité de Contrôle Prudentiel at Première act upon it. Persons who do not have professional Direction du Contrôle de Banques (DCB 1), Service experience in matters relating to investments The Bank of New York Mellon operates in the UK 2, 61, Rue Taitbout, 75436 Paris Cedex 09, France should not rely on this material. BNY Mellon will through its branch (UK companies house (registration number (SIREN) Nr. 538 228 420 RCS only provide the relevant investment services to numbers FC005522 and BR000818) at One Canada Paris - CIB 13733). investment professionals. Square, London E14 5AL and is subject to regula- tion by the Financial Conduct Authority (“FCA”) The Bank of New York Mellon SA/NV operates in Not all products and services are offered in all at 12 Endeavour Square, London, E20 1JN, UK and Italy through its Milan branch at Via Mike Bongior- countries. limited regulation by the PRA at Bank of England, no no. 13, Diamantino building, 5th floor, Milan, Threadneedle St, London, EC2R 8AH, UK. Details 20124, Italy. The Bank of New York Mellon SA/NV, If distributed in the UK, this material is a financial about the extent of our regulation by the PRA are Milan Branch is subject to limiteed additional regu- promotion. If distributed in the EU, this material is available from us on request. lation by Banca d’Italia - Sede di Milano at Divisione a marketing communication. Supervisione Banche, Via Cordusio no. 5, 20123 The Bank of New York Mellon SA/NV, a Belgian Milano, Italy (registration number 03351). This material, which may be considered advertis- limited liability company, registered in the RPM ing, is for general information purposes only and Brussels with company number 0806.743.159, The Bank of New York Mellon SA/NV operates in is not intended to provide legal, tax, accounting, whose registered office is at 46 Rue Montoyer- England through its London branch at 160 Queen investment, financial or other professional advice straat, B-1000 Brussels, Belgium, authorized and Victoria Street, London EC4V 4LA, UK, registered on any matter. This material does not constitute a regulated as a significant credit institution by the in England and Wales with numbers FC029379 and recommendation or advice by BNY Mellon of any European Central Bank (“ECB”) at Sonnemann- BR014361. The Bank of New York Mellon SA/NV, kind. Use of our products and services is subject to strasse 20, 60314 Frankfurt am Main, Germany, London branch is authorized by the ECB (address various regulations and regulatory oversight. You and the National Bank of Belgium (“NBB”) at Bou- above) and subject to limited regulation by the FCA should discuss this material with appropriate ad- levard de Berlaimont/de Berlaimontlaan 14, 1000 (address above) and the PRA (address above). visors in the context of your circumstances before Brussels, Belgium, under the Single Supervisory acting in any manner on this material or agreeing Mechanism and by the Belgian Financial Services Regulatory information in relation to the above to use any of the referenced products or services and Markets Authority (FSMA) at Rue du Congrès/ BNY Mellon entities operating out of Europe can and make your own independent assessment Congresstraat 12-14, 1000 Brussels, Belgium for be accessed at the following website: https://www. (based on such advice) as to whether the referenced conduct of business rules, and is a subsidiary of bnymellon.com/RID. products or services are appropriate or suitable The Bank of New York Mellon. for you. This material may not be comprehensive The Bank of New York Mellon, Singapore Branch, or up to date and there is no undertaking as to the The Bank of New York Mellon SA/NV operates in is subject to regulation by the Monetary Authority accuracy, timeliness, completeness or fitness for Ireland through its Dublin branch at Riverside of Singapore. The Bank of New York Mellon, Hong a particular purpose of information given. BNY II, Sir John Rogerson's Quay Grand Canal Dock, Kong Branch (a branch of a banking corporation Mellon will not be responsible for updating any Dublin 2, D02KV60, Ireland and is registered with organized and existing under the laws of the State information contained within this material and the Companies Registration Office in Ireland No. of New York with limited liability), is subject to reg- opinions and information contained herein are sub- 907126 & with VAT No. IE 9578054E. The Bank of ulation by the Monetary Authority and ject to change without notice. BNY Mellon assumes New York Mellon SA/NV, Dublin Branch is subject the Securities & Futures Commission of Hong Kong. no direct or consequential liability for any errors in to limited additional regulation by the Central Bank or reliance upon this material. of Ireland at New Wapping Street, North Wall Quay, The Bank of New York Mellon is exempt from Dublin 1, D01 F7X3, Ireland for conduct of business the requirement to hold, and does not hold, an This material may not be distributed or used for rules and registered with the Companies Registra- Australian financial services license as issued the purpose of providing any referenced products tion Office in Ireland No. 907126 & with VAT No. IE by the Australian Securities and Investments or services or making any offers or solicitations in 9578054E. Commission under the Corporations Act 2001 any jurisdiction or in any circumstances in which (Cth) in respect of the financial services pro- such products, services, offers or solicitations are The Bank of New York Mellon SA/NV is trading vided by it to persons in Australia. The Bank of unlawful or not authorized, or where there would in Germany as The Bank of New York Mellon SA/ New York Mellon is regulated by the New York be, by virtue of such distribution, new or additional NV, Asset Servicing, Niederlassung Frankfurt am State Department of Financial Services and registration requirements. Main, and has its registered office at MesseTurm, the US Federal Reserve under Chapter 2 of the Friedrich-Ebert-Anlage 49, 60327 Frankfurt am Consolidated Laws, The Banking Law enacted Any references to dollars are to US dollars unless Main, Germany. It is subject to limited additional April 16, 1914 in the State of New York, which specified otherwise. regulation by the Federal Financial Supervisory differs from Australian laws. Authority (Bundesanstalt für Finanzdienstleistung- This material may not be reproduced or dissem- saufsicht, Marie-Curie-Str. 24-28, 60439 Frankfurt, The Bank of New York Mellon has various other inated in any form without the prior written Germany) under registration number 122721. branches in the Asia-Pacific Region which are permission of BNY Mellon. Trademarks, logos and subject to regulation by the relevant local regulator other intellectual property marks belong to their The Bank of New York Mellon SA/NV operates in in that jurisdiction. respective owners. the Netherlands through its Amsterdam branch at Strawinskylaan 337, WTC Building, Amsterdam, The Bank of New York Mellon Securities Company The Bank of New York Mellon, member of the Feder- 1077 XX, the Netherlands. The Bank of New York Japan Ltd, as intermediary for The Bank of New al Deposit Insurance Corporation (FDIC). Mellon SA/NV, Amsterdam Branch is subject to York Mellon. limited additional supervision by the Dutch Central Bank (“De Nederlandsche Bank” or “DNB”) The Bank of New York Mellon, DIFC Branch, reg- © 2020 The Bank of New York Mellon Corporation. on integrity issues only (registration number ulated by the Dubai Financial Services Authority All rights reserved.