Episode 5: Asset Management | The State of Digital Assets

In the fifth episode of our series, host Adam Rodricks, National Lead, Digital Services is joined by Kareem Sadek, Partner, Technology Risk Consulting; Mitchell Nicholson, Senior Consultant, Technology Risk Consulting; and Katie McGarry, Partner, Audit, Financial Institutions for a conversation on the intersection between asset management & cryptoassets, as well as Canada’s unique ETF offerings.

Episode Transcript

(00:00):
Hello everyone and welcome back to KPMG in Canada’s state of cryptoassets podcast series. After a brief break, we are back and excited to dive into all things digital assets with you. Before we get into today's episode, I want to remind our new listeners to also check out episodes 1 through 4 of our series, which were released through the summer months. Now without further ado, I am pleased to welcome back Kareem Sadek and Mitch Nicholson and welcome Katie McGarry, who is joining us for her first appearance on the podcast. To start off, could each of you introduce yourself and your role at KPMG? Kareem, let's start with you.

(00:36):
Thank you so much, Adam. Very, very excited to be with you here today. I'm Kareem Sadek; I’m a Partner in our Risk Consulting Advisory practice and I happen to co-lead our crypto and blockchain practice across Canada. Excited to be with everyone today.
Thanks for having me. I’m Mitchell Nicholson; I’m a Senior Consultant at KPMG and I work closely with Kareem on the cryptoasset practice here.

(01:02):
Hi everyone! I’m Katie McGarry and it's my pleasure to be a guest speaker on this podcast today. I am a Partner in our Financial Services Audit practice and I lead our asset management digital asset audits here at KPMG.
Sincerely Katie, the pleasure is all ours. Thanks everyone. Now I know we have a lot to cover today, so I'm going to jump right into my first question; it's for you, Katie. We've discussed this in previous episodes; crypto and digital assets have entered the mainstream and they've become something financial service organizations across Canada are getting more involved in. Can you walk us through how these organizations are evolving their service offerings in the space?

(01:43):
The crypto industry has grown tremendously, reaching almost over 2 trillion dollars in market capitalization. This growth has really led to the adoption by institutional investors, such as hedge funds, family offices, corporate treasuries and even large insurers. I think also, in parallel, we've seen growing adoption from traditional financial services firms, ranging from custodians and fund administrators to asset managers and even professional services firms, like us, KPMG. We've seen several traditional asset managers launch crypto asset products and services and many more indicate to us that they're researching and experimenting with cryptoassets. We've also seen the launch of new products such as digital asset ETFs, which have really caught the attention of investors.

(02:40):
You know what, Katie, maybe I'll just jump in for a second because I really love how you framed it. I always like when we start quantifying - what does this really mean when you're talking almost 2 trillion dollars in market capitalization? This is great growth and I truly believe and we believe as a team, it's just going to continue to grow. I love how you touched on the traditional financial services. So, maybe just to add on a little bit; demand for these institutional investors continues to rise. As competition between the financial services intensifies, I really believe there's going to be more adoption from traditional finance. I think that's the key when you're talking about adoption from traditional finance. With all these changes, the new entrants into space, this will help the industry just to mature overall as policies and procedures will be adopted to meet the requirements of these traditional service providers. So all in all, I think a lot of adoption and a lot of happening in this space.

(03:44):
It certainly does seem to be trending in that direction. Thank you so much, Kareem. Mitch, we just heard Katie mentioned a buzzword for many investors out there and that buzzword is ‘regulated investment products’. In Canada, what regulated investment products are available to consumers who are interested in dealing in the crypto space?
Yeah, there's actually quite a few options now in 2021. For the longest time, the first form was privately issued regulated investment products. So these were closed ended funds, which are publicly tradable but over the counter rather than on marketplaces. More recently now in Canada, we’re actually the 1st country to permit ETFs, exchange traded funds, where the underlying asset is Bitcoin or Ethereum. These funds own the crypto assets directly and they are allowed to be held in tax advantage accounts, for example, so there's some unique benefits (which we'll talk about more later) of the ETFs over other products in the market.

(04:49):
Globally, across all of the regulated investment products, the total AUM nearly exceeds 50 billion dollars. I just want to add that the close ended funds cannot have redemption unlike the ETFs. We've seen in the past where there is either a premium or more recently a discount in the market price of the close ended funds relative to the net asset value, the amount of underlying cryptocurrencies held. With the Canadian ETFs, they will always trade close in line with the net asset value because of the redemption mechanism, which allows for more direct exposure to crypto assets. One trend we've seen in the US is a rise in the number of ETF prospectuses filed and they range in approach from holding crypto directly to using derivatives, such as futures.

(05:46):
Thank you Mitch. Not only is that helpful, it segways beautifully into my next question which is for Katie. We heard Mitch touch on some of the Canadian ETF regulations. Katie, could you walk us through some of the benefits of the Canadian ETF structure, both for consumers as well as organizations?
Thanks Adam. Yeah, sure. I'm happy to give my thoughts. So first off, I think the permission to issue cryptoasset ETFs by regulators here in Canada really provides legitimacy to the industry as the issuers have met the requirements outlined by regulators. This should provide some comfort to investors looking to enter the crypto space. These ETFs are regulated investment products issued by Canadian asset managers that investors are already familiar with. The product itself is the amount of structure that investors are already comfortable with and they already likely hold ETFs for other parts of their portfolio.

(06:48):
It's a very easy product for investors to gain exposure to crypto currencies quickly and there is no concern over things like misplacing your password, which would be necessary if cryptoassets are purchased through crypto currency exchanges for example. As regulated investment products, the ETFs are eligible to be held in a registered account like a TFSA or RRSP. In contrast, holding actual crypto is not eligible for any tax benefits that way. I guess another thought on this is - these products are very liquid for investors, will be it the underlying assets are quite volatile. I really think being first to market in Canada on these products is something that the Canadian asset management industry can really be proud of here.

(07:41):
Totally agree. Thank you so much, Katie. You know, it's fascinating to hear how the Canadian ETF structure has become a global leader. Kareem, for individuals and organizations that are looking for exposure to cryptoassets, what are some of the other approaches that they could take?
So, I’ll talk about ETFs because there are a lot of benefits to ETFs, but there are many other ways to gain exposure to the cryptoasset industry. I always start by saying, I'm very excited about this and I'm very enthusiastic about this because I honestly just think it's just going to get better and better. To get a little bit creative - one example is owning equity of publicly traded companies with crypto exposure. Like, if you think about minors, exchanges, funds, data analytics companies, there are many others that are out there so owning equity in these companies is another way. And then quite frankly, another thing is just owning the coins directly. You can either do it through self custody, which we've seen a lot of people do that. I actually do that myself, but you can also be using exchanges or a custodian. That's a few things that I could think of.

(08:53):
To add to that and jump in with some other approaches. One is using regulated derivatives, such as futures or options, which many institutional investors are already familiar with. And they can actually be traded on platforms that they're already familiar with using for other asset classes. In addition to public equity, it’s also possible to make private equity investments into growth companies that are involved in the cryptoasset space. Lastly, you can rely on professionals and become a limited partner in a private equity or venture capital fund that allocates to the cryptoasset industry on your behalf.

(09:32):
Mitch, from what you're saying, it certainly sounds like there is no shortage of avenues for both organizations and individuals who are interested in increasing their exposure to crypto assets. With that said, as we begin to wrap up today's episode, what are some of the considerations for those investors if they are investing in cryptoassets?
Thanks, Adam. I'm happy to give a couple thoughts on what organizations need to be thinking about. So, the first thing I would tell you is you really need to think about what type or what method are you going to use to gain your exposure and what are the pros and cons of those methods. For example, maybe you want to own the cryptoassets directly. You can gain exposure through the purchase of a fund or an ETF. Maybe you are a pension fund and it makes sense for you to invest directly in a private equity investment and that investment itself would be the one to own the cryptoassets.

(10:34):
Another item to really consider is if you are going to hold the crypto, how will you safeguard the private keys? That is a critical internal control component entities really need to be thinking about. How will you assess the reliability of vendors that you're using for custody if you're outsourcing that? How will you assess their liquidity, the research, and data?

(11:00):
Lastly, given I am an accountant after all, how are you going to account for the holding of these crypto assets? There's a couple of options, but you really need to do a detailed assessment to make sure you’re selecting the right IFRS, for example. And there's always tax to think about given what the purpose of holding these assets are. So, lots to consider.

(11:26):
You know, Katie, I'm very happy to be part of these discussions with you cause it's always very insightful. Certainly, a lot of questions that you raise, things to think about. If I were just to add something that's specifically for asset managers, I think that the main thing is to remember that you can't really rely on the existing or maybe I'll call it the financial plumbing for Bitcoin ETFs like what you would do for stocks or bonds. Honestly, it's just for a simple reason. If you think about contributions and the redemptions, the way they work for crypto inside the ETF itself, they must be settled on the blockchain. You have to remember that.

(12:19):
Again, the nuance to that, what that means for the organizations, is that you'll have to integrate your new systems and controls into your existing business lines. It's something to definitely think about; not to any plug in or anything but fortunately, we're here to help support throughout the entire journey. So I sincerely say, as you're thinking through that, please do reach out to us to have more discussions around that.

(12:52):
Those are great tips. Thank you all. Unfortunately, that does bring us to a close today. We are out of time for our episode. Join us next time on KPMG in Canada's series on the state of cryptoassets when Kareem and I will be joined by John Armstrong and Ken Viegas for a discussion on banking and cryptoassets. Bye, everybody.