Sentinel Regulatory Services news & information

Introduction

In a bid to help the development and adoption of tokenised assets, the Financial Conduct Authority (“FCA”) has published consultation paper (CP25-28) titled “Progressing Fund Tokenisation.” The consultation applies to:

• UCITS management companies
• UK fund managers managing authorised funds
• Depositaries of authorised funds

However, it will be of interest to the wider investment community including, but not limited to:

• Fund managers of unauthorised firms
• Investment platforms
• Investment managers
• Fin Tech businesses

This article will look to highlight some benefits of tokenisation and summarise the FCA’s guidance as well as offer some practical ways in which regulatory compliance risks can be mitigated. The terms units and tokens will be used interchangeably.

The FCA’s guidance can be found in Appendix 1 of the consultation paper under COLL 6 Annex 4: Use of distributed ledger technology for the operation and maintenance of registers for authorised funds.

Key Dates

Consultation responses:

• Chapter 2-4 – by 21 November 2025
• Chapter 5 – by 12 December 2025

Useful definitions 

Private Permissioned Blockchain – defined by Lawyers Bird & Bird, private blockchains are often run and operated by an entity unlike public blockchains, where anyone can download the software, form a node, view the ledger, and interact with the blockchain.

Distributed Ledger Technology (DLT) – a digital system that records details of transactions in multiple locations at the same time, rather than on a centralised database.

Fiat money – government issued currency not convertible to money or other assets. Think cash.

Tokenisation – a way of representing an asset, or ownership of an asset, by recording it on DLT.

Nodes – tools to validate and maintain the blockchain by confirming each transaction’s validity through consensus algorithms, ensuring the system remains secure and immutable.

Smart contract – self-executing agreements stored on the blockchain, where the terms are written in code and automatically executed when predefined conditions are met.

Some benefits of tokenisation include:

• Opening new routes to distribute funds – e.g. a direct model making it possible for investors to transact directly with a fund when buying or selling units.
• Increasing fund management efficiency – e.g. through the reduction of cost in reconciling and sharing data between operators and distributors of the same fund.
• Potential for greater liquidity.
• Enhanced data disclosure.

Summary of the FCA’s proposed guidance

Fund registers & DLT

Under the Collective Investment Scheme Sourcebook in the FCA handbook (“COLL”) and the provisions in the Open Ended Investment Company Regulations (“OEIC”), the authorised fund manager or the depositary of the authorised fund is required to establish and maintain a register of unitholders and ensure it is complete and up to date.

The FCA’s guidance that, in our view, provides adequate clarity on how firms can use DLT to support the operation of fund registers including:

• The person responsible for maintaining the register (“responsible firm”) must have the power and ability to make amendments to the register. This means that, if DLT is used, the responsible firm will need to have the right to unilaterally make amendments.
• Importantly, the unilateral ability to make amendments, should not impact the usual protocols of the DLT network.
• For example, standard consensus mechanisms that validate the authority of those providing instructions to the network such as validator nodes.
• DLT could be used to allow distributors or unitholders to instruct or request amendments to the register by submitting new records. The FCA’s view is that this could still be compatible with the COLL rules and OEIC regulations provided that “the responsible firm is able to make unilateral changes to the register” and able to reverse incorrect entries.

Managing incorrect entries

The FCA makes clear that responsible firms will need to have processes and procedures in place to identify incorrect entries and then take remedial action to rectify them. In our view, these controls could include, but not be limited to:

• Automated real time monitoring and smart contract validation (see more below)
• Frequent reconciliation
• Third-party monitoring

Smart contracts & eligibility verification

With the use of DLT, there is an increased regulatory risk where unitholders (or token holders) transfer units/tokens between themselves. This increases the risk that:

• The fund register is incomplete and inaccurate.
• A unit is transferred to a person who is not an eligible unitholder under the regulatory rules, the instrument constituting the fund or the prospectus.

To control these risks, from a regulatory compliance perspective, firms could:

• Employ smart contracts that automatically notify the responsible person whenever a transfer occurs. Or, more substantially:
• Operate a ‘whitelist’ or ‘allow list’ mechanism with the support of smart contracts:
  • This would involve only enabling digital wallets that have successfully completed verification steps such as KYC, onboarding and eligibility checks to be added to the ‘allow list.’
  • When a token holder attempts to make a transfer to another wallet, the smart contract will automatically check if the receiving wallet is on the ‘allow list.’
  • If the recipient is on the ‘allow list’ the transfer happens, if not, the transfer fails.

Irrespective of the chosen method, smart contracts should be regularly audited to meet evolving industry standards.

Aggregation of units

In addition, under COLL 6.4.4 (3)b, a fund register must contain the number of units of each class held by each unitholder. This could be problematic where an authorised fund uses a DLT because, for example, a unitholder/token holder may hold units in different wallets which ultimately have different addresses.

Authorised funds will need to consider how to potentially control this risk from a regulatory compliance perspective and whether this will be done on or off the DLT.

Management of network risks and outsourcing

A functioning market allows for limited friction in buying, redeeming or transferring units or tokens. As a result, the FCA expects an authorised fund manager to have appropriate operational and business resilience plans and be able to facilitate alternative processes and to allow for unitholders to buy, redeem or transfer their units in the event of a network outage. This could require the use of fiat money or off-chain processes.

Similarly, authorised funds are able to use systems that combine both on-and off-chain records to ensure that it complies with the COLL rule of ensuring that the register is available for inspection free of charge in the United Kingdom by or on behalf of any unitholder (including the manager or authorised fund manager), during office hours.

Overseas jurisdictions, money laundering & data protection

The use of public permissioned DLT’s for issuing and the settlement of tokens could create jurisdictional and legal issues that may bring into doubt whether the fund has legal domicile and jurisdiction for service in the UK. This is because, for example, public blockchains are typically hosted by nodes across multiple jurisdictions. As such, the FCA rightly states that firms should consider the extent of the activity carried out in the UK when considering using DLT.

The FCA also makes clear that Firms must consider whether they and any service providers are required to be registered under the Money Laundering Regulations (MLRs). For example, this could include, where a fund is required to hold crypto assets to cover transaction charges. It goes without saying, firms subject to the MLR’s would need to ensure they comply with the various requirements including those around Customer Due Diligence (CDD).

The FCA also mentions in the guidance that information on the DLT may also allow trading strategies to be identified. For example, where transactions in units are recorded or instructed on DLT before execution at a future valuation point, it may be possible for third parties to anticipate large deals in underlying securities. The guidance does not offer any solution to avoid this, but in our view, one way in which this could be easily avoided is through the use of a private permissioned DLT which could restrict visibility accordingly.

What does the future look like?

Tokenisation is clearly here to stay. Larry Fink, the CEO of BlackRock, in an interview with CNBC, recently said that the financial industry is at “the beginning of the tokenisation of all assets.” Those who do not embrace tokenisation, face the risk of falling behind. However, regulatory compliance teams in the UK and across the world will be needed more than ever. Industry practitioners are encouraged to read and respond to the consultation.