Tokenized Funds Practice Note: Accounting, Reconciliation and Embedded Compliance
The Investment Association, working with Elliptic, has released the first in a series of practice notes on tokenized funds, and it carries real implications for fund accountants, auditors, and CFOs. The paper sets out what tokenized funds are, why they exist, and how the underlying distributed ledger technology (DLT) changes the operational model, including the parts that touch financial reporting, reconciliation, and compliance. This is not a distant concept: the paper describes hybrid structures that are already being contemplated, where one share class operates traditionally while a second runs on-chain.
What a Tokenized Fund Actually Is
A tokenized fund, sometimes called a digital fund or a blockchain-traded fund, represents shares or units in a fund (or a feeder fund) as digital tokens recorded on a distributed ledger. The token replaces the share or unit certificate. Ownership and transfer are recorded on the DLT network rather than on a central shareholder register maintained by a transfer agent.
Security tokens and what they represent
Where the token represents a traditional financial instrument, such as a share or a unit in a collective investment scheme, it is issued through a security token offering. The legal rights attached to the underlying instrument follow the token. The paper is careful to distinguish this from uncertificated securities recorded by the fund itself: the DLT ledger, not the fund, holds the record. That distinction matters when you are scoping an audit or designing a controls framework.
Tokenization is not limited to fund units. The same logic applies to real estate, loan revenue streams, and intellectual property. The paper highlights fractional ownership as a specific use case: DLT makes it possible to manage fractional interests in relatively illiquid assets securely and efficiently, even if fractional ownership as a concept predates blockchain.
NAV Calculation and What Changes for Fund Accountants
One of the clearest takeaways for accounting teams is that tokenization does not change how a fund is valued. Net asset value (NAV) remains the basis of valuation. What changes is the denominator: instead of NAV per share, the calculation becomes NAV per token, dividing the fund's NAV by the number of outstanding tokens.
Implications for crypto financial statements
For firms preparing crypto financial statements under IFRS or US GAAP, this reframing has practical consequences. Under current IFRS, there is no single standard specifically addressing digital assets held by investment funds, and preparers have typically looked to IAS 32, IAS 39 (or IFRS 9), and IFRS 13 depending on the nature of the instrument. The IASB's ongoing work on digital assets is relevant context here, even though the practice note does not reference specific accounting standards directly.
On the US GAAP side, ASC 350-60, which FASB introduced for certain crypto assets, brought fair value measurement with changes recognized in net income. That framework applies to specific crypto assets held by an entity, not necessarily to fund units represented as tokens. Finance teams will need to assess whether the token itself, or the underlying fund interest, drives the accounting treatment. The answer is likely to depend on the legal structure, which varies by jurisdiction.
What the practice note does signal clearly is that the move to a tokenized model changes who holds what data and when. That has direct read-across to disclosure requirements, fair value hierarchy assessments, and the supporting evidence available for audit.
Reconciliation: Where the Efficiency Case Is Strongest
The paper makes a pointed argument about reconciliation. In traditional fund administration, multiple parties, including the depositary, fund accountant, and custodian, each maintain their own records and reconcile them against the central shareholder register. Breaks happen. Investigating them takes time and cost.
Real-time ledger access changes the control environment
Under a fully tokenized model, each participant, whether a fund accountant, depositary, adviser, or platform, holds a node on the DLT network. They access the same underlying ledger directly. The central shareholder register, and by extension the reconciliation against it, is no longer needed. The paper is explicit: depositaries and fund accountants reconciling books to the shareholder register will no longer need to do so, because they will have direct access to DLT records through their own node.
For accounting firms and internal audit teams, this changes the control environment materially. The three-way reconciliation that currently sits at the heart of fund administration controls is replaced by a single source of truth. That should reduce operational risk and error rates, but it also means that the audit procedures designed around reconciliation breaks need to be redesigned. Firms that are already thinking about crypto compliance reporting frameworks will want to incorporate these structural changes now, rather than retrofitting when client mandates arrive.
Platforms and advisers also benefit. Via their nodes, they gain real-time visibility of investor holdings without the delays that currently accumulate through intermediary chains. The paper notes that retail investors may have nodes configured differently from institutional investors, but the principle of direct access applies across the board.
Embedded Compliance: AML, KYC, and ESG Inside the Token
Perhaps the most structurally significant element of the paper for compliance-focused teams is the description of embedded compliance. Under a tokenized model, AML and KYC obligations, along with ESG data and governance parameters, can be written directly into the token itself or into the underlying protocol.
What embedded compliance means operationally
In a traditional fund, KYC and AML checks are conducted each time an investor subscribes, typically through manual or semi-automated processes. Under a token-based model, those checks can be encoded so that a transaction simply cannot complete if the counterparty has not passed the required compliance gates. The token carries the compliance history with it.
This matters for fund managers, brokers, and their compliance officers for several reasons. First, it shifts AML/KYC from a periodic, human-driven process to a continuous, protocol-level control. Second, it creates an auditable, immutable record of compliance status at each transfer. Third, it raises questions about what happens when compliance status changes after a token is issued, and how the protocol handles revocation or restriction.
The paper also notes that tokens can carry ESG data, enabling ongoing measurement of fund performance against its stated objectives and constitutional documents. For managers subject to SFDR in the EU or equivalent disclosure regimes, that on-chain ESG data layer could eventually support regulatory reporting in a way that is significantly more verifiable than current approaches.
Firms navigating the FCA's finalized UK crypto regulatory framework or operating under MiCA's mandatory CASP authorization should be tracking how embedded compliance in tokenized funds interacts with their existing AML obligations. The architecture described in this paper could support compliance obligations, but it does not discharge them automatically; the legal responsibility remains with the regulated firm.
Settlement Speed and the Custodian's Evolving Role
The paper identifies T+0 settlement as a potential outcome for tokenized funds, contingent on the nature of the underlying assets. Current fund settlement cycles involve multiple handoffs and cut-off times. A DLT-based model, where the ledger updates in real time and ownership transfers atomically with payment, makes same-day settlement technically achievable.
Custody of private keys as a new control area
For custodians, the role evolves. In addition to safekeeping assets, a custodian in a tokenized fund would hold investors' private keys, oversee the process of approving transactions, and update the ledger. That is a meaningful extension of the traditional custodian function and brings its own operational risk considerations: key management, access controls, and disaster recovery procedures become critical audit points.
Transfer agents, by contrast, step back. Without a central shareholder register to maintain, their role in the tokenized model is substantially reduced. Firms advising fund administration clients on technology and staffing strategy should factor this shift into their planning.
The Hybrid Model and What It Means for Transition
The paper describes a hybrid fund structure where one share class operates off-chain in the traditional manner while a second share class operates on-chain. This is explicitly framed as a possible interim step. From an accounting and audit perspective, a hybrid model creates complexity: two share classes within the same fund, one with a central register and one on a DLT ledger, each requiring different reconciliation procedures and potentially different audit evidence standards.
Finance teams should expect this hybrid period to generate additional work rather than less. The efficiency gains of the tokenized share class will be offset, at least initially, by the cost of running two parallel systems and maintaining competence in both. The long-term trajectory, as the paper describes it, is toward fully on-chain operation, but the path there requires careful transition management.
What does the practice note series cover going forward?
The Investment Association has indicated that future papers in this series will go into technical depth on specific aspects of the tokenized fund model that the industry needs to resolve. This first paper focuses on fundamentals: definitions, the value case, and the high-level operational model.
Does tokenization change how a fund's NAV is calculated?
No. The valuation method stays the same. NAV is still determined by the fund's underlying assets. The only change is the unit of measurement: NAV per token replaces NAV per share. The token count, like a share count, changes as subscriptions and redemptions occur.
How does embedded compliance interact with existing AML obligations?
Embedded compliance in a token can automate the enforcement of AML and KYC gates at the protocol level, preventing non-compliant transfers from completing. However, it does not replace the legal obligations of regulated firms. The fund manager, broker, or CASP remains responsible for ensuring that its compliance programme meets regulatory requirements. The token-level controls can support that programme but do not substitute for it.
What happens to the reconciliation function in a fully tokenized fund?
The central shareholder register disappears, and with it the need to reconcile books against it. All participants access the same DLT ledger through their own nodes. This should eliminate many reconciliation breaks, but it also requires finance teams and auditors to redesign the controls and procedures that currently depend on three-way reconciliation as a core check.
How should auditors approach evidence-gathering in a tokenized fund?
The immutable and transparent nature of the DLT ledger means that transaction history is, in principle, continuously available and tamper-evident. Auditors will need to assess how to obtain and authenticate ledger data, whether through direct node access or through a third-party confirmation process, and how to evaluate the integrity of the smart contract code that governs token issuance and transfer. Professional standards bodies have not yet issued specific guidance on this, and firms should monitor developments from standard-setters accordingly.