The cryptocurrency world was once likened to the Wild West, marked by volatility and regulatory uncertainty. Over time, however, governments worldwide have introduced regulations to reduce risks and foster trust in the sector. Many companies have embraced these legal frameworks, recognizing the importance of compliance in protecting investors and creating stability in an otherwise unpredictable landscape.

In this exclusive interview, The Byteline delves into the critical legal considerations that companies must be aware of when setting up a tokenized fund. We spoke with a Dubai-based legal expert who played a key role in establishing one of the UAE’s first tokenized funds within the Abu Dhabi Global Market.

We sat down with Philip Dowsett, Partner and Head of Investment Management and Funds at Addleshaw Goddard's Dubai office. Philip’s expertise in structuring, regulatory compliance, and entity setup offers invaluable insights into why legalizing tokenized funds is crucial. He also discusses what companies should consider when choosing the right jurisdiction and why navigating the legal landscape of different countries is such a pivotal part of the process.

What are the most important legal aspects companies should be aware of or focus on when setting up a tokenized fund in the UAE or similar jurisdictions?

It's important to set the stage by noting that this is a hugely nascent area of law, technology, and investment. There are only a handful of tokenized funds globally, likely not even reaching double figures. These funds are located in various jurisdictions, including Jersey, Bermuda, Switzerland, and the UAE, which now has one in ADGM. There are many aspects to consider, and one key consideration is the distinction between the legal side and the regulatory side.

In several of these jurisdictions, there isn’t a regulatory framework in place. In such cases, the fund or the manager isn’t regulated and operates outside of regulatory oversight. On the other hand, some funds operate within regulated jurisdictions, where laws govern the company register and other related aspects, and a regulator oversees the fund and its manager. This was applicable in our case with the Realized T-Bills Fund. It was a much bigger undertaking to take such a new concept and implement it in a traditional fund jurisdiction with a regulator. Navigating the laws, regulations, and other considerations for the first time was challenging. We worked closely with the ADGM authority and the FSRA, the regulator in ADGM, to bring everything together and ensure that all parties were on the same page regarding how the fund works and complies with fund rules, company laws, and all other relevant regulations.

For anyone looking to establish a tokenized fund or platform, clearly defining your goals is crucial. The easiest approach is to go to a jurisdiction without regulations and launch the platform there. However, the global investment and fund world generally rely on the regulation of fund managers, vehicles, and platforms to ensure investor protection, the credibility of managers, and the security of the products being offered. A strong legal system and a reliable regulatory framework back these safeguards.

What were the main legal challenges you faced when setting up this tokenized fund in the Abu Dhabi Global Market (ADGM)?

The biggest legal challenge in doing something this new is understanding the entire landscape. As mentioned, several different bodies oversee the fund and its vehicles, and several laws and rules apply.

Our fund, the Realized T-Bills Fund, is a corporate fund, meaning its structure is that of a company. By default, this means all company laws apply to this company, and we had to comply with all such laws. On top of that, it is also a registered fund in ADGM, which is registered with the FSRA. As part of this, all the fund laws, collective investment laws, and fund rules applicable to a vehicle operating as a fund also come into play, and compliance with these was necessary.

Given the space we are in—digitalization and digital assets—what we were essentially doing was an initial security offering (ISO). This introduced yet another body of rules within ADGM that needed to be addressed. These rules detailed what compliance and awareness were required and the process for conducting an ISO.

Altogether, there were three bodies of laws that needed to be addressed. This was the first time a tokenized fund had been successfully launched in ADGM, even though there had been one previous attempt that did not get off the ground. It was necessary to bring together these different laws, ensure they did not conflict or contradict each other, and create a framework for operating as a fund while also being tokenized and digitalized.

Why are these laws important, and why should companies adhere to them?

The risk of not complying with the rules, especially in a regulated jurisdiction, can be significant. Regulated platforms are typically much more investor-friendly, gain more traction, and provide greater comfort to investors due to the oversight from regulators.

Failure to comply with the rules—whether they are company laws, fund rules, or other regulatory requirements—can result in sanctions from one or more regulators. These sanctions can range from minor infractions, which might be easily remedied, to more severe breaches that could lead to the fund being shut down. In the most serious cases, there could be criminal implications stemming from non-compliance with the laws.

The regulatory aspect is particularly important for regulated fund managers and registered funds. This status comes with a stamp of approval from the regulator, which serves to protect investors. Acting outside the scope of what you are licensed to do, failing to deliver on your promises, or not adhering to policies and procedures around anti-money laundering (AML), know-your-customer (KYC), and similar requirements can lead to civil penalties, fines, and potentially criminal charges. This has been observed in various jurisdictions worldwide.

The implications of non-compliance can be severe, which is why it’s risky to take a chance on the structure or rules of your fund, hoping for the best without thorough planning. One of the biggest undertakings of this exercise was to review all relevant laws and rules, conduct a global comparative analysis, and determine how to implement our plans within the ADGM framework. This process involved preparing a comprehensive white paper and proposed structure, presenting it to the authorities, and ensuring alignment with their expectations and regulatory standards. This approach ensured that what we aimed to achieve was both realistic and compliant with the regulators' requirements.

How did you ensure the fund follows all the rules and regulations required by the ADGM?

The process began with a global comparative analysis to understand how tokenization was being implemented in other countries. This included examining jurisdictions without specific regulations or regulated structures, as well as those that are highly advanced and have tokenization laws and rules in place. We assessed how these frameworks worked in ADGM and adopted the best practices from these jurisdictions while ensuring full compliance with all relevant laws and regulations in ADGM.

The primary focus was on tokenizing the vehicle as a company—something that had not been widely done before. This included determining how to tokenize a company that operates as a fund and is also registered and regulated as such. The challenge was to bring together these different aspects in a way that provided comfort to all stakeholders, including regulators, investors, and fund managers.

How should tokenization companies approach setting up in multiple countries, and what steps can they take to navigate and comply with different legal regulations worldwide?

The primary focus for compliance depends on the jurisdiction where your platform is based. In our case, that was ADGM, so our primary level of compliance was with ADGM's rules and laws. Since ADGM is located in the UAE, certain UAE-wide laws also apply to ADGM companies and their operations, which we had to ensure compliance with at all times.

Beyond this, the fund operates on a broader scale. The Realized Fund is a tokenized, open-ended strategy fund that invests in U.S. Treasury bills. Theoretically, investors from around the world could benefit from and invest in the platform. This raises the question of how to ensure compliance with various securities laws while limiting access to the platform, its documents, and the fund itself to the appropriate individuals. This includes ensuring access is restricted to those who are entitled to it and that others must take specific steps to gain access to the fund or its assets.

Extensive discussions were held on how to maintain the sanctity of the fund. This involved adhering to the fund rules to ensure that only certain investors, referred to as professional clients, could access the fund. These clients could only invest specific amounts when tokens were created. Additionally, we considered the process for transferring tokens, which sparked significant discussions about creating liquidity for the tokens and the extent to which liquidity could be allowed.

We explored questions such as: Should tokens be tested for compliance only at the entry and exit points (when created or redeemed), or should compliance checks be conducted at each stage of ownership transfer? Currently, for full liquidity and legal ownership of tokens, the fund manager maintains a register of unit holders. This register undergoes the checks required by ADGM and FSRA to ensure compliance.

As this space evolves, the next step is to work with regulators to explore ways to achieve full liquidity within these structures while providing everyone involved—regulators, investors, and fund managers—with confidence and comfort.

Additionally, it is important to distinguish between the two main types of tokenization: direct and indirect. Indirect tokenization is the easier method and involves a traditional fund issuing shares. An entity then holds these shares in a non-regulated jurisdiction or a country that facilitates tokenization. That entity tokenizes the shares, creating several layers: token holders, a depository or entity holding the actual assets, and the fund itself at the bottom. This method is commonly used by tokenized funds globally.

In contrast, direct tokenization eliminates the middleman and allows the fund to issue the tokens directly. This approach streamlines the process but is more complex and challenging. In our case, we sought to directly tokenize the fund, even though there are no explicit tokenization laws in ADGM. The token represents a contractual interest in the underlying assets held by the fund.

To achieve this, the structure establishes a contractual nexus between the token holder and the fund. The fund manager holds shares to satisfy company law requirements, ensuring the corporate existence and structure of the fund. The tokens, in turn, act as a digitalized representation of the value within the fund. For instance, if a thousand tokens are issued and the fund holds $100 million in Treasury bills, each token represents a $100,000 value. At any point, a token holder can contact the fund manager to redeem their token, at which point the token is burned, and the equivalent value is cashed out.

This distinction between direct and indirect tokenization demonstrates the effort involved in streamlining the process and creating an efficient, compliant structure for tokenized funds.

Both direct and indirect tokenization are valid approaches, each suited to specific purposes. However, the focus in this case was on streamlining the process and proving that direct tokenization is possible within ADGM. This approach has been groundbreaking, showcasing how tokenization can evolve and set new benchmarks in the UAE.

Direct tokenization eliminates intermediaries, creating a direct connection (privity) between the token holder and the fund. This differs from the indirect method, where a trustee in another jurisdiction holds shares or interests, tokenizing them on behalf of the fund. In the indirect model, token holders only interact with the intermediary, adding complexity and separation from the underlying asset.

By adopting direct tokenization, the fund simplified the structure, offering investors a transparent and efficient framework. This method redefines how tokenization can operate within ADGM, highlighting its potential to innovate and lead in the global financial landscape.

What do you see as the future of tokenization across the GCC region, and how significant is the role of hubs like ADGM in shaping this growth?

Regulators are increasingly paying attention to tokenization, but it requires a sophisticated regulator with the appetite to navigate its complexities. The Realized T-Bills Fund, for instance, is an open-ended fund investing in U.S. Treasury bills, demonstrating how tokenization can work for stable assets. However, the potential extends far beyond this.

Discussions are underway to apply tokenization to venture capital, single-asset private equity deals, real estate, debt instruments, feeder funds, and parallel funds. Each asset class requires tailoring to ensure investor confidence, regulatory compliance, and clarity in ownership structures. For example, tokenizing real estate would involve not just ADGM and FSRA but also regulators like the Dubai or Abu Dhabi Land Department.

While the Realized T-Bills Fund model offers a strong foundation, tokenization isn’t a one-size-fits-all approach. Every asset class presents unique challenges and considerations. As the sector evolves, the focus remains on adapting the direct tokenization model to suit each asset while ensuring regulatory approval and investor trust. The possibilities are vast, but each step requires careful planning and collaboration with regulators.

What recommendations or advice would you give ADGM if they were drafting an actual tokenization law to benefit everyone in the long run?

There were many lessons learned from this transaction, which highlighted the strength of the tokenization model. When considering pure tokenization laws, the key question is how to fully tokenize a company or fund without relying on traditional structures like management shares issued to managers. Some jurisdictions already allow for purely digital representations of shares via tokens, but most are not yet at this stage.

The next step is to assess the value and risks of entirely tokenizable platforms and companies. Our current model combines a tested corporate structure with tokenized representation for investors, ensuring both certainty and security. Removing traditional shares entirely in favor of tokenization raises questions about maintaining protections and certainty. This debate will need to focus on whether such a shift adds value or introduces unnecessary risks.

While some may prefer retaining traditional share issuance alongside tokenization for investors, the potential of fully tokenized structures is immense. Teams like the Realized Fund group are already exploring innovative ways to expand tokenization globally, showing what’s possible when management shares themselves are tokenized. However, any advancements must carefully balance innovation with security and investor confidence.

What advice would you give to businesses or individuals who want to start tokenized funds?

There were many lessons learned from this transaction, which highlighted the strength of the tokenization model. When considering pure tokenization laws, the key question is how to fully tokenize a company or fund without relying on traditional structures like management shares issued to managers. Some jurisdictions already allow for purely digital representations of shares via tokens, but most are not yet at this stage.

The next step is to assess the value and risks of entirely tokenizable platforms and companies. Our current model combines a tested corporate structure with tokenized representation for investors, ensuring both certainty and security. Removing traditional shares entirely in favor of tokenization raises questions about maintaining protections and certainty. This debate will need to focus on whether such a shift adds value or introduces unnecessary risks.

While some may prefer retaining traditional share issuance alongside tokenization for investors, the potential of fully tokenized structures is immense. Teams like the Realized Fund group are already exploring innovative ways to expand tokenization globally, showing what’s possible when management shares themselves are tokenized. However, any advancements must carefully balance innovation with security and investor confidence.

The first and most important factor in selecting advisors is finding someone with proven experience. Tokenization is not a "copy-paste" process; it requires advisors who have explored different approaches, understand what works, and have overcome challenges. 

On the technology side, it is crucial to have a developed and proven platform capable of handling tokenization and decentralization. Many people are trying to enter this space, but only a few have demonstrated the ability to deliver successfully.

Ultimately, proven expertise is what sets successful advisors apart from those merely exploring the field. It’s about finding individuals or teams who have already navigated the challenges of tokenization and can provide practical, tested solutions.