Blockchain 4 Law:

Blockchain 4 Law: All stars aligning for a major breakthrough for Private Equity and Alternative Funds

Is retailization and enhanced liquidity in the Private Equity (PE) and alternatives space a dream, or is it on the verge of becoming reality?

DLT: An Undeniable Game-Changer

Blockchain technology is revolutionary, particularly in the fund industry. Its potential to reduce operational costs, increase safety, and streamline processes is undeniable. McKinsey recently conducted a study on blockchain adoption in regulated financial services and concluded that the benefits are clear. However, for blockchain to be effectively implemented, several pieces need to fall into place: a comprehensive regulatory and legal framework, and a commitment from financial players to move beyond pilot projects and into large-scale deployment.

Luxembourg’s Role in Blockchain for Funds

Luxembourg has already led the way by implementing several pioneering laws in blockchain, but the framework had yet to fully evolve to support the decisive shift from traditional accounting ownership records to blockchain-native digital ownership records. This limitation had dampened enthusiasm for further adoption in the fund industry. Some pioneering players in Luxembourg (Moniflo by invesTRe SA) and Switzerland (Sygnum) have already started offering DLT safekeeping for funds on their digital marketplaces.

But that will now change and the missing piece in the puzzle, the Blockchain 4 Legislation, is enacted. The new law will establish a “controlling agent” authorized to act as a DLT transfer agent for funds, alongside traditional transfer agents and central securities depositories (CSDs). This controlling agent will issue and manage fund units using DLT technology, and even serve as the DLT custodian for investor units.

Industry knowledge gap

To cut short on common prejudices, using DLT technology as capital market infrastructure has nothing to do with NFTs (non fungible tokens) and cryptocurrencies. As a practioner in the regulated blockchain space, I am concerned with the lack of knowledge the EU and Luxembourg financial services industry in general still has when it comes to DLT technology and its application in regulated financial services environments.

Important to know: Any authorised and regulated investment firm will, as an account keeper under the 2001 Law, have the possibility to hold securities accounts through the use of blockchain technology. The use of blockchain technology does not affect, among others, the fungible nature of the investment fund units safekept. The rights of a client with regard to his fund units will be same as the rights of any client holding a fund unit with a Luxembourg account keeper under the 2001 Law, using traditional accounting record technologies.

A New Era for Asset Management

Now, asset managers will be able to launch funds using DLT registration, whether or not they want to take advantage of smart contract solutions to issue fund prospectuses. Investment firms acting as Controlling Agents have the flexibility to offer safekeeping services or deliver fund units directly to investors' private wallets and connect to efficent DLT trading venues fom one single platform. This will allow asset managers to interact with investors in an entirely new, digital-first manner and completely disintermediated way. The prospect of retailization and the ability to trade funds on a secondary market—such as under the European DLT Market Infrastructure Sandbox (MTF regime)—is no longer a far-fetched idea. The first fully regulated secondary market trading facilities have already been authorised in 2024 and are ready to start trading tokenised financial securities through the EU.

Sectors like PE, private debt, and infrastructure funds are pushing boundaries to extend their reach, aiming to penetrate deeper into the retail market. But can this ambition truly materialize, or is it just wishful thinking?

I recently spoke with a seasoned professional in asset management services in Luxembourg. His response was straightforward: "Retailization? I don’t see it happening." He elaborated, "How can we offer investor tickets of EUR 10,000 when it costs EUR 2,500 just to open an account?" His conclusion: "Unless we dramatically reduce operational costs across the industry, it’s not feasible."

I couldn’t agree more. The cost of investing in active-managed funds must be significantly reduced. However, I believe the industry will not meet these goals by merely optimizing existing processes with traditional technologies. The same when it comes to secondary market liquidity, a scalable, liquid and cost efficient solution will not be possible by using and optimising traditional technology and processes. The real game changer lies in Distributed Ledger Technology (DLT).

Yes, I know – skeptics have been saying for years that DLT also commonly referred to as blockchain is perpetually “on the horizon.” But here’s the thing: it is here. The real question now is whether it is fit for large scale application to crack the retailization/liquidity nut.

A Perfect Storm of Innovation and Regulation

For a significant shift in well-established markets, several trends must converge. This is exactly what’s happening with the adoption of DLT in the fund industry right now. We’re seeing investors hungry for new market opportunities, asset managers eager to tap into new investor pools as well as increase market reach by offering new opportunities to create liquidity for illiquid or semi-liquid funds, and a technology that has the potential to reinvent the investment process—making it leaner, faster, and more cost-efficient.

The Luxembourg Government has recognised the neccessity and opportunity to open the gates for further innovative solutions in the finance industry. In a record time of 4 months the blockchain 4 law has been put into force. First movers, Investment firms and banks, that

have already large scale experience with safekeeping of securities tokens are ready to tap in into the opportunity with trend making asset managers.

All these stars are now aligned. It will take vision and courage to venture into these new territories, but those who possess the technical capabilities are positioned to acquire substantial market share.

The stage is set for those ready to act. The next wave of growth is upon us - are you ready?

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