Tokenisation: The Next Frontier for Private Equity?

There have never been many questions about private equity’s relevance in global markets as an asset class.

With deal structure diversities, growing business maturities and their corresponding readiness for external capital—as well as the pandemic reset on growth trajectories worldwide—private equity fund managers are raring to deploy some US$1.2 trillion in dry powder into private market investments with the aim of reaping risk-adjusted returns.

Traditionally, the majority of liquidity in managed private equity funds has come from institutional investors, with pension funds, sovereign wealth funds and other large organisations. More recently, there has been an emerging shift in attention to an estimated US$80 trillion in investable capital from a group less commonly associated with funding private equity investments: the global mass affluent.

However, given that onboarding limited partner capital is a fairly resource-intensive process, with administrative and logistical requirements alongside detailed due diligence and KYC, pursuing funds from the mass affluent segment requires more effort, resources and therefore greater expense. The obstacles to private equity participation have manifested clearly for retail investors in the form of often prohibitively large minimum tickets, lengthy lockups, and risk exposures that exceed typical retail appetites. Not to mention that “retail” investors are generally not able to access the private equity market, as Government regulations in some countries usually dictate that this market is reserved for more “sophisticated” investors.

Blockchain and digitisation

With blockchain technology, the playing field gets significantly levelled by the ability to tokenise funds, changing the profile of the retail investor from the long tail to an addressable opportunity. Tokenisation refers to the process of dividing a fund stake into digitalised fractions by way of issuing digital tokens. Through tokenisation, it can be easier and cheaper for individuals to tap into private equity funds with a whole host of potential benefits:

• Participation might be possible at more manageable retail ticket sizes with fractionalisation in place.

• Settlement for both subscribing and redeeming investors would potentially be facilitated more quickly through digitisation (versus a traditional settlement cycle).

• The lack of transferability stemming from traditional private equity/venture capital 10-year fund lives may no longer be a problem. Investors may be able to freely trade their tokens post-investment, potentially through more efficient price discovery with automated market makers and liquidity pools, assuming there are willing buyers and sellers.

The optimism around tokenisation is by no means small. Global tokenised private equity volumes are expected to reach US$700 billion by 2030, and several large private equity firms have caught on to the trend. Partners Group became the first major private equity firm to tokenise one of its funds with ADDX, a Singapore-based digital securities exchange that executed the process. Hamilton Lane, a US-based investment manager, similarly tokenised a fund in March 2022, also with ADDX, and has disclosed plans to work with digital securities platform Securitize Inc. to create tokenised feeder funds for three separate managed funds. Most recently in September 2022, KKR partnered with Securitize Inc. to tokenise part of its US$4 billion KKR Health Care Strategic Growth Fund II SCsp, referencing blockchain’s potential to open the private equity asset class “to a new audience of investors”.

That is not to say, however, that tokenisation is going to be a panacean development for the industry. Natural to its characteristic as a digital solution are the threats pertaining to digitisation. Network stability plays an obvious role in enabling commercial deployment, necessitating proper digital infrastructure for optimal uptime. Managing cyber risks (e.g. man-in-the-middle attacks) and smart contract vulnerabilities will also be paramount. Even after these are addressed, setting up a private blockchain with protocols that support scalability is key to building a proper tokenisation platform.

Where to from here?

With the nascency of blockchain technology and its applications, it is probably too early to tell whether tokenisation is headed for widespread adoption at this point. Regulatory frameworks—especially those pertaining to AML/KYC and investor protections—are still evolving, which may mean the initial sale of private equity fund tokens may be limited to sophisticated or accredited investors, resulting in only a marginal broadening of investor bases.

Tokenisation isn’t likely to radically replace traditional private equity structures (at least not anytime soon). We can probably expect at least some form of coexistence with the technology making reporting, governance and settlement much more efficient.

This article was written by Nicholas Tan, Associate Director of Private Equity.

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