Tokenization of Real-World Assets in India: Governance Structures through the IFSCA Lens

[Fagun and Tanay are students at Gujarat National Law University.]

Tokenization and fractionalization of real estate and real-world assets (RWA) refers to fractional ownership of tangible assets. It involves converting all or some of the rights of an asset to a number of units called tokens. These real estate tokens represent fractional ownership rights as these tokenized properties are tradeable and primarily linked to the value of the tangible asset wherein rights such as equity interest, stake in debt backed property, entitlement to portion of profits, rights to distribution of rental income etc. can be exercised. Thus, essentially, tokenized securities or assets serve as digital representations of real-world assets existing off the blockchain.

The process of asset tokenization involves generating digitized versions of RWA which are converted into digital tokens which can perform actions on a fraction of or the complete RWA. These tokens are dispensed off on the blockchain and offered through Initial Coin Offering or Security Token Offering, commonly known as tokenized security offering or tokenized asset offering.

Introduction to REIT Structures and Compliances 

In the Indian context, real estate investment trusts (REIT), which are trusts that own, operate or finance income generating real estate assets and allow individuals to invest in real estate without directly owning or managing properties, present an opportunity to trade tokenized RWA’s digitally. REITs need to be registered with the Securities and Exchange Board of India (SEBI) to carry out activities prescribed under the SEBI (REITS) Regulations 2014. REITs by law are required to distribute 90% of their net distributable cash flow to unit holders in form of interest or dividend, contributing to their income-generating potential.

Investors buy REIT shares and have flexibility to trade these shares on stock exchange similar to that of a publicly traded company. SEBI also introduced self-sponsored REITs wherein investments can be made through creation of a Special Purpose Vehicle or a Holding company.

Currently, minimum investment amount for REIT is INR 10,000 to INR 15,000 for investment through initial public offerings and follow-on offers and the minimum lot size of REIT’s traded is 1 unit. 

The sponsors are required to hold minimum unit holding on a reducing scale for the entire life of REIT and this mandatory unit-holding shall be locked in and be encumbered. Currently the unit holding lock-in starts at 15% for up-to three years and then reduces overtime with the lower of 1% of unit capital or INR 500 crore after 20 years. 

Scope of Asset Tokenization through REITs in IFSCA

The IFSCA constituted an Expert Committee on Asset Tokenization (the committee) in September 2023 which was tasked with the formulation of regulations pertaining to tokenization of assets, alongside assessment of legal validity inherent in smart contracts. The committee is entrusted with formulating comprehensive regulations and policy guidelines to govern tokenization of both real and physical assets within the GIFT City framework and, to develop a robust risk management framework tailored for digital tokens to safeguard against frauds and other such avenues.

As of March 2024, IFSCA has given a conditional approval to a few entities to start a tokenization platform in consonance with the aim to unlock investment in the sector by allowing small investors to have fractional ownership in real estate & infrastructure projects using asset tokens while providing liquidity to global asset owners. One such entity is Realdom India Private Limited which is undergoing the regulatory innovation process called Sandbox to set up it’s platform to be known as Pinvest Exchange.

The committee further recently introduced a consultation paper (the paper) that presents insight into IFSCA’s forth coming integrated approach to tokenization of RWAs into digital tokens and lays a vision of legal certainty, market integrity, and innovation in the new digital asset space. Tokenization was herein defined as the process of transforming intangible and tangible assets such as financial securities, real estate, commodities, and trade finance instruments into digital tokens through the use of distributed ledger technology (DLT). The paper clearly outlines IFSCAs focus on assets of inherent economic value that can be digitally represented.  

One of the core themes highlighted in this paper is the need for clear legal recognition of digital tokens. The law should explicitly state the nature of tokens including rights that are attributed to them. Token holders can be entitled to benefits such as proportional ownership of an asset, sharing of revenue, or voting rights in asset management. One of the central debates mentioned in the paper is the nature of token ownership for whether it should be in the bearer form i.e. ownership with possession or in registered form wherein ownership is registered on a register. This would entail multi-fold implications on the security, transferability and regulation of tokens.

For market infrastructure, the paper calls for regulation of all essential functions such as issuance, custody, trading, clearing, and settlement of tokens so as to create a safe and orderly digital token market. In so far as issuance of these tokens are concerned, stringent validation procedures are recommended to be used to bar unauthorized or counterfeit token issuance. The link between asset owners and token issuers is also checked to ascertain that only genuine assets are tokenized. Custody of these tokens are also of paramount importance for which it is recommended that they shall be secured either by self-custody or by third-party custodians so that they meet the real-world upkeep and legal protection for the underlying assets.

The paper also addresses the unique challenges posed by market infrastructure to DLT. While the inherent characteristics of blockchain, transparency and immutability offer tremendous benefits, they pose challenges like scalability problems and difficulties in error correction due to the immutable nature of distributed ledgers. In majority of the cases, DLT blurs the line between trading, clearing, and settlement, thus necessitating a tailored regulatory response that takes into account settlement finality, multilateral netting, and compatibility with legal systems.

Risk management is one of the essential pillars of the suggested framework. The paper recognizes various types of risks including governance risks such as conflict of interest and absence of supervision and, technology and cyber risks such as vulnerabilities of smart contracts and potential of cyberattacks, money laundering/terrorist-financing risks fueled by cross-border transactions and partial anonymity. The framework is sought to have stringent Anti Money Laundering/ Know-Your-Customer procedures and reinforced standards of corporate governance to address these risks effectively.

The paper emphasizes the need to foster markets and innovation while safeguarding investors through industry-led best practices, self-regulation, and regulatory sandboxes to enable controlled experimentation. Some of the most important steps include detailed investor disclosures, sound compliance procedures and, transparent redress channels, all intended to foster public confidence and stimulate the take-up of tokenized finance. In effect, the paper serves as a blueprint for tokenization integration in the financial industry through the creation of a risk-based regulatory framework that promotes technological advancement and protects the interests of investors which are essential to position India as a global leader in digital asset markets. 

International Perspective

Structures for governance of Asset Tokenization are also found present in countries such as Singapore, United Arab Emirates and the United States. 

In Singapore, the Securities and Futures Act (SFA), defines ‘capital market products’ to include securities, futures contracts’, and foreign exchange arrangements, as prescribed by the Monetary Authority of Singapore which assesses digital tokens to determine if they qualify as capital market products under the SFA.

In the UAE, the Securities and Commodities Authority (SCA) regulates asset tokenization under the Crypto Assets Activities Regulation 2020 and the Crypto Assets Guidance 2021. These rules govern the offering, listing, and trading of digital assets, including tokenized real estate investments like REITs. The SCA framework includes licensing, anti-money laundering, and investor protection measures. Authorities such as the Dubai Financial Services Authority actively support the growth of the tokenized assets market, balancing innovation with regulatory safeguards.

Likewise, in the United States, Securities Exchange Commission has asked for digital assets to be analyzed to determine its characteristics to ascertain if it meets the definition of ‘security’ under federal securities law through the Howey Test.

Conclusion 

Delving into the analysis of these international frameworks presents an opportunity to widen regulatory perspective in the Indian financial sector through inclusion of REITs and involvement of appropriate regulatory bodies to govern lending of RWAs through blockchain routes. A common universal nomenclature for these terms is furthermore critical in light of increased prospects of globalization to ensure legal, tax and regulatory certainty in the digital tokens market. However, the varied characteristics of different types of digital tokens and the risks associated with each of them, makes appropriately defining digital token for RWAs a nuanced task.