In June 2025, the Malta Financial Services Authority (“MFSA”) issued a position paper examining an innovative application of distributed ledger technology (“DLT”) within the investment funds industry, which included the possibility of using tokenised fund units as collateral in financing arrangements. The document reflects the MFSA’s broader commitment to supporting technological innovation in financial markets while ensuring that regulatory safeguards, investor protection standards and market integrity remain fully preserved.
The concept of tokenisation has gained significant traction globally as financial institutions increasingly explore the use of DLT to modernise traditional financial infrastructure. Tokenisation refers to the digital representation of an existing financial instrument on a distributed ledger. In the case of fund units, this process does not alter the legal characteristics or rights attached to the underlying investment. Rather, it introduces an alternative technological mechanism through which ownership, transfers and operational processes may be recorded and executed.
Importantly, the MFSA reiterates that tokenised fund units remain financial instruments within the meaning of the Markets in Financial Instruments Directive (“MiFID II”). As a result, the regulatory obligations governing the distribution, marketing and suitability assessment of such instruments continue to apply in full. Where tokenised fund units are marketed to investors, distributors must therefore ensure that the appropriate suitability and appropriateness assessments are conducted in accordance with MiFID requirements, particularly given that such instruments may be classified as complex products for certain categories of investors.
Tokenisation as a Technological Enabler
The MFSA’s position paper highlights tokenisation primarily as a technological enabler capable of improving operational efficiency across the lifecycle of financial instruments. By recording ownership and transactions on a distributed ledger, tokenisation has the potential to streamline administrative processes, reduce settlement times and enhance transparency within financial markets.
One emerging use case explored by the MFSA is the utilisation of tokenised fund units as collateral for financing arrangements. Under this model, investors may pledge tokenised fund units to regulated lenders such as investment firms, brokers or credit institutions. The digital representation of fund units on a distributed ledger can facilitate faster transfers and near-instant settlement, significantly reducing the operational delays traditionally associated with collateral management processes.
DLT also enables real-time visibility over pledged assets. Lenders may monitor collateral positions continuously rather than relying on periodic reporting cycles. This enhanced transparency can contribute to improved risk management, particularly in situations where collateral levels must be adjusted in response to market movements.
Smart Contracts and Automated Collateral Management
Another important feature of the proposed model is the use of smart contracts to automate certain aspects of collateral arrangements. Smart contracts are programmable, self-executing digital agreements deployed on a distributed ledger. Within a collateral framework, these mechanisms can be designed to restrict the transferability of pledged tokens during the collateral period, enforce margin requirements and automatically trigger liquidation procedures if predefined thresholds are breached.
In practical terms, this allows collateral arrangements to operate more efficiently and with reduced reliance on manual processes. Once the conditions embedded in the smart contract are met, the system can execute predetermined actions without requiring additional intervention. At the same time, the MFSA emphasises that robust governance and oversight mechanisms must be in place to ensure that smart contract architecture functions reliably and securely.
Maintaining Regulatory Oversight Through Hybrid Structures
While distributed ledger technology introduces new operational possibilities, the MFSA proposes a hybrid architecture designed to preserve legal certainty within the existing regulatory framework. Under this model, tokenised fund units are recorded and transferred on a distributed ledger, while the official share register of the fund continues to be maintained by the recognised fund administrator.
This structure ensures that the legally determinative record of ownership remains within the traditional regulatory framework established under the Investment Services Act and the rules governing collective investment schemes. The distributed ledger therefore operates as a complementary transactional layer rather than replacing the official register.
Collective investment schemes adopting tokenisation are expected to remain fully compliant with existing regulatory requirements. In practice, such funds are likely to be structured as a SICAV, a widely used vehicle within Malta’s funds industry, which refers to an Investment Company with Variable Share Capital. The fund administrator continues to perform its transfer agency functions and retains responsibility for maintaining accurate records of investors and transactions.
Interaction with Decentralised Finance
The MFSA also acknowledges the potential for tokenised fund units to interact with decentralised finance environments. In certain cases, collateralised lending may be facilitated through decentralised protocols operating within permissioned markets. These structures would require strict governance controls, including the use of whitelisted participants and approved liquidators capable of executing liquidation events if borrowers default on their obligations.
Even within such arrangements, regulatory oversight remains central. The transfer agent would continue to coordinate the execution of on-chain actions to ensure consistency between the distributed ledger and the official share register. This approach reflects Malta’s regulatory philosophy of enabling innovation while maintaining accountability and transparency within financial markets.
Addressing Technological and Operational Risks
Despite the potential advantages of tokenisation, the MFSA emphasises that the adoption of distributed ledger technology introduces new categories of risk that must be carefully managed. Cybersecurity threats represent one of the most significant concerns, particularly in environments where digital wallets, smart contracts and network nodes form critical components of the infrastructure.
Smart contract vulnerabilities, coding errors and interoperability challenges between different systems may also create operational risks. Because blockchain records are generally immutable, correcting incorrect data entries or flawed smart contract logic can be complex and may require sophisticated governance mechanisms.
Valuation considerations also present practical challenges. While distributed ledger systems allow tokenised assets to be transferred in real time, the valuation of the underlying fund units continues to follow the valuation cycles specified in the fund’s documentation. For funds holding illiquid assets or relying on model-based valuations, this difference in timing may create discrepancies between real-time collateral monitoring and periodic net asset value calculations.
To mitigate these risks, the MFSA emphasises the need for robust governance structures and comprehensive risk management frameworks. Entities deploying tokenised structures should implement strong cybersecurity protocols, secure key-management practices, independent smart-contract audits and well-defined incident response procedures. Oversight of third-party service providers involved in the distributed ledger infrastructure is also essential.
A Carefully Regulated Path Towards Innovation
The MFSA’s position paper reflects a broader shift in the financial services industry toward integrating digital technologies within established regulatory frameworks. By allowing tokenised fund units to be used as collateral under carefully controlled conditions, the Authority signals its openness to innovation while reaffirming its commitment to investor protection and market stability.
For Malta’s financial services sector, this development further reinforces the jurisdiction’s reputation as a forward-looking regulatory environment that actively engages with emerging financial technologies. At the same time, the MFSA’s cautious and structured approach ensures that innovation does not come at the expense of transparency, governance or regulatory compliance.
As distributed ledger technology continues to evolve, tokenisation may play an increasingly important role in modernising financial infrastructure. The collateralisation of tokenised fund units illustrates how traditional investment products can benefit from technological advancements while remaining firmly anchored within the established legal and regulatory framework governing financial markets in Malta.