Justin McCormack
Head of Legal,
State Street Digital®

Thus far in 2024, there’s been significant growth in blockchain-based financial services, along with a global shift in consistency on regulating tokenized assets. What’s more, this activity is primed to continue. So does that mean global investors are finally getting some clarity on the rules governing digital assets? And could these new developments serve to accelerate growth in the digital space?

First, take a look at what regulators have been doing in the United States, the United Kingdom and Hong Kong concerning digital assets.

While the regulatory environment in the US has not been particularly favorable to cryptocurrencies, tokenization appears to be viewed differently. In February, the US Office of the Comptroller of the Currency held its Symposium on the Tokenization of Real-World Assets and Liabilities, bringing together legal experts, academics, regulators and representatives from the industry to discuss aspects of tokenization and its use cases.

In testimony before the US House Financial Services Committee on May 15, Acting Comptroller Michael J. Hsu noted, “In contrast to crypto, tokenization is driven by solving real-world settlement problems and can be developed in a safe, sound, fair and competent manner.”

Achieving legal clarity as to the property and transferability rights embodied by a token is another focus area for further adoption of tokenization. This same level of transparency (or consensus?) is on the horizon in the US, following recent updates to the Uniform Commercial Code (UCC) by the Uniform Law Commission (ULC) – the organization responsible for drafting laws such as the UCC for consideration by the states.

The ULC proposed a new Article 12, which introduces the concept of a “controllable electronic record” that is “a record stored in an electronic medium that can be subjected to control” as defined under the act. Article 12 makes controllable electronic records subject to the “take free” rule, which stipulates that a good faith purchaser who acquires control of a controllable electronic record – without knowledge of any competing claims of a property interest in that controllable electronic record – acquires it free of any such competing claims that may actually exist. This is the same treatment that applies to a negotiable instrument.

In addition to the creation of Article 12, the ULC also proposed a number of amendments to incorporate the concept of controllable electronic records into other relevant parts of the code, such as those governing security interests and securities intermediaries. As of July 2024, 24 states have adopted these amendments, with many other state legislatures reviewing them.

In the UK, the Law Commission — a statutory independent body created to keep the law of England and Wales under review and recommend reforms — published a similar consultation on digital assets that provisionally proposed the explicit recognition of a "third category" of personal property under English law (distinct from "things in possession" and "things in action”) to govern digital assets. Like the UCC, this proposal also incorporated the concept of a “take free” rule for data objects. Moving from a report to execution, the Law Commission published a consultation on a draft bill in February to amend English and Welsh property law to explicitly reference a digital component.

In January, regulations by Britain’s Treasury came into effect, establishing the framework for the UK’s Digital Securities Sandbox (DSS), to be operated by the Bank of England and the UK Financial Conduct Authority (FCA). The purpose of the DSS is to support the development of trading and settling securities by leveraging novel tokenization technology. Sandbox participants can seek to provide the following services for tokenized securities:

• Notary, settlement and maintenance activities for tokenized securities for which it would need to register as a digital securities depository (DSD) instead of as a central securities depository (CSD)
• Trading venue services of an organized trading facility or a multilateral trading facility, or both

In April, the Bank of England and the FCA published a consultation describing their proposed approach to the operation of the DSS, including the rules and fee regime, as well as guidance for applicants.

In Hong Kong, the Hong Kong Monetary Authority (HKMA) issued a number of similar regulatory guidance documents in February, including the “Sale and Distribution of Tokenized Products” and the “Provision of Custodial Services for Digital Assets.” The HKMA noted that financial institutions should conduct appropriate due diligence and implement relevant risk management protocols and controls when pursuing tokenized asset activities, and further set forth expected standards for entities safeguarding client digital assets, including tokenized assets.

So what do these developments mean?

While regulatory progress still varies by regional or national jurisdiction, this year it has begun to take shape in a reasonably consistent set of forms around tokenization.

Regulators appear to view the tokenization of traditional assets as having the potential to enhance and improve the efficiency of existing financial markets. This differs from the more skeptical and fractured regulatory approach to cryptocurrencies and other entirely new asset classes that tend to exist on decentralized networks with fewer regulatory precedents.

Many investors would agree with this modified approach as tokenized assets can be traded and custodied on secure, permissioned blockchains within the traditional investment environment, while bringing the benefits of faster, cheaper, more secure and transparent trading. There is also established demand for the tokenization of existing assets, whereas the extent of institutional appetite for cryptocurrencies is yet to be established.

What’s the bottom line for investors?

There’s good reason for institutional investors globally to expect near-term progress on consistent rules governing asset tokenization. Not only do regulators see it as a relatively easy element of digital finance to set rules for, but also as a way of establishing a foundation for other priorities like T+0.

It appears that for now, at least, regulatory focus on cryptocurrencies and the like may have to take a back seat to tokenization.