Unlocking FDI potential in growth markets with RWA tokenization

07 May 2024 Consultancy-me.com 11 min. read
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Foreign direct investment (FDI) is a driving force behind economic growth. Four experts in the field – Henrik von Scheel, Paul Lalovich, Emilija Vukovic, and Tesha Teshanovich – outline how the innovative concepts of FDI-as-a-service and real world asset (RWA) tokenization can help growth markets beef up their FDI attractiveness.

The primary objective of FDI is to secure capital for investment. When conducive conditions are in place, FDI has the potential to foster job creation and sustainable development by enhancing an economy's productive capacity.

Still, regulatory hurdles, political instability, currency fluctuations, economic uncertainties, infrastructure limitations, cultural differences, and legal issues often hinder this goal.

Unlocking FDI potential in growth markets with RWA tokenization

Overcoming the obstacles of FDI requires innovative solutions that address the needs of investors, companies, and regulators. By engaging with local suppliers and forming partnerships with domestic businesses, foreign-owned companies can create additional benefits for the host economy, such as productivity spillovers through various channels.

According to FDI Markets, companies worldwide announced over $1.33 trillion worth of greenfield foreign direct investment in 2023, marking an increase of nearly 4% from the previous year.

The growth markets opportunity

We consider growth markets among the most undervalued asset classes worldwide, characterized by strong and improving earnings growth and financial metrics such as return on equity, free cash flow yield, and dividend yield. These markets benefit from an economic growth advantage over developed ones, with growth rates in emerging economies outpacing those in developed markets.

This growth trend is not solely reliant on China; other factors contribute, resulting in an upward trajectory for economic growth in growth markets while growth in developed markets decelerates. Globally, growth economies have typically rebounded from the global financial crisis faster than more advanced economies. Consequently, it's unsurprising that companies in developed nations are increasingly seeking avenues to expand their presence abroad.

This quest for new growth opportunities has brought attention to foreign direct investment policies worldwide, offering a promising outlook for investors.

According to the research conducted by Kearney, findings indicate a strong sense of investor optimism, with the potential for further growth over the next three years. A high percentage of respondents stated their intentions to boost their foreign direct investment in the coming years, and most expressed the view that FDI would play a more critical role in enhancing their corporate profitability and competitiveness over the next three years.

The realization of FDI advantages also hinges on the purpose behind the investment. Without responsible business practices and thorough research, FDI may lead to unintended consequences for the recipient nation. The presence of foreign multinational corporations can occasionally spark concerns regarding their potential social and environmental implications, particularly concerning the erosion of labor standards and their involvement in the unsustainable exploitation of natural resources.

Bringing FDI in

Challenges facing foreign direct investment include navigating complex regulatory frameworks, cultural differences, and political instability in some regions.

Developing countries encounter significant hurdles in attracting foreign direct investment, hindering their ability to fully capitalize on the associated benefits. In the past, developing countries have struggled to attract consistent foreign direct investment that could serve as a steady catalyst for economic growth, especially in sectors beyond oil and gas.

Additionally, foreign investors have shown restrained interest due to concerns regarding regulatory and political risks and shortcomings in economic fundamentals such as infrastructure and human capital. Investors in developed nations, where most private capital is concentrated, might lack familiarity with growth markets and developing economies. Consequently, the perceived risks associated with conducting business beyond their accustomed environment could lead to higher risk premiums.

This, in turn, has the potential to render projects non-bankable or non-viable for investors. However, developing nations should remain focused on enhancing the enabling environment. By doing so, they can attract greater private investment and ensure that these investments yield optimal outcomes and returns.

This, in turn, fosters a cycle of increased investment. To stimulate increased FDI in developing countries, mechanisms for de-risking are essential. De-risking involves reallocating, sharing, or mitigating the existing or potential risks linked to the investment.

In contrast, financial de-risking utilizes financial strategies to mitigate or diminish the risks linked with projects. This often entails public entities like donor governments, multilateral development banks, development financial institutions, and climate funds incentivizing private investors to invest capital by agreeing to assume a portion of the risk. De-risking can encompass various tactics, including debt, equity, and guarantees, distributing the risk among involved parties, or transferring it to a third party.

The operational framework

FDI has been increasingly utilized as a significant service for economic development, underscoring its crucial role in driving global economic growth and prosperity.

A critical aspect of this entails reimagining the operational framework – essentially redesigning the approach through which the country attracts foreign direct investment. In numerous transformations, countries may need to reconsider their fundamental approach to FDI attraction and reassess their value proposition: identifying the appropriate target investor segments to engage with, the incentives and services to provide, and the model that can optimize FDI inflows and economic benefits.

Moreover, FDI can act as a channel for the transfer of technology and aid in expediting digital transformation. It can enhance economic integration by bolstering access to global markets. Additionally, FDI plays a crucial role in supporting economies during and after economic downturns.

FDI as a service aims to outline the structure of tasks, responsibilities, and relationships between stakeholders, allowing for clear delineation of connections between its constituent investors and host countries. Providing foreign direct investment as a comprehensive, end-to-end service enhances the potential value realized in growth markets.

When executed effectively, this service facilitates seamless processes throughout the investment cycle, establishes methods for minimizing inefficiencies and maximizing effectiveness, sets standards for processes, integrates feedback mechanisms to encourage continual improvement, and optimizes handling of exceptions.

Although the potential for FDI spill-overs is widely recognized, it's important not to assume their positive impacts. The realization of FDI benefits in the host economy relies on various factors, including the competitiveness of local producers, the strategic decisions of foreign-owned firms, and the technological disparities between domestic and foreign-owned firms, thereby affecting the absorptive capacity of local producers.

FDI-as-a-service

This is where FDI-as-a-service comes in. This strategic approach involves top-down planning to optimize the outcomes of the investment portfolio by efficiently developing and delivering projects, with the aim to de-risk projects, scale investments, and optimize the overall outcome.

Providing FDI as a service through end-to-end solutions significantly leverages tokenization to transform and democratize foreign direct investment in growth markets.

Tokenization enables the fractional ownership of real-world assets, providing increased liquidity and democratizing access to sustainable investments for a wider range of investors. This process enhances asset management by enabling the automation and standardization of key operations through smart contracts.

Unlocking FDI potential in growth markets with RWA tokenization

Crucial steps such as compliance verifications, investor credential checks, and dividend distributions are automated, drastically reducing the burdens of manual documentation and inconsistent records. Blockchain technology facilitates rapid settlement, reducing risks associated with counterparty transactions. Its transparency and traceability ensure that each transaction is logged, simplifying audits and enhancing accountability, which in turn helps prevent fraud and strengthens transactional integrity.

The efficiencies gained through tokenization make the markets more accessible, lowering minimum investment sizes, diminishing geographical barriers, and allowing a wider range of participants. This increases both market volume and liquidity. Tokenization also supports nearly instantaneous settlements, further enhancing liquidity and benefiting both investors and traders.

By converting tangible and intangible assets into digital tokens, tokenization revolutionizes access to investments. It allows for fractional ownership, enabling the division of high-value assets into smaller, more affordable units. This transformation opens up investment opportunities to a broader, more diverse audience, democratizing access and reducing entry barriers, making it an ideal strategy for attracting FDI into emerging markets.

Tokenization on the blockchain

Tokenization of real-world assets, as part of FDI-as-a-service, involves converting tangible and intangible assets into digital tokens on a blockchain. These assets can include traditional ones like real estate, agricultural products, mining commodities, financial assets like equities and bonds, or even intellectual properties such as digital art.

This process may involve assets that are simultaneously represented in traditional record systems (off-chain), or those exclusively managed on the blockchain (on-chain). The tokenization process generally unfolds in four essential steps, each critical to ensuring the asset's successful digital representation and integration into growth markets through FDI services.

Tokenization of real-world assets as part of FDI-as-a-service boasts significant advantages, notably the democratization of access which potentially enhances liquidity through the fractionalization of assets, or the division of ownership into smaller, more manageable shares. This process can simplify previously labor-intensive manual procedures, reducing costs and making investment opportunities accessible to smaller investors within certain asset classes.

Nonetheless, regulatory constraints may limit access to these investments, often restricting tokenized assets to accredited investors. Although fractionalization enhances liquidity and is an attractive proposition, the distribution of tokenized assets must achieve a much larger scale to fully realize true democratization of access.

Furthermore, in the context of FDI as a service, the blockchain technology underlying the tokenization of real-world assets ensures complete transparency and immutability regarding ownership, transactions, and crucial market data, all verifiable by any participant.

We are confident in the future of tokenized assets. One estimate suggests the market could even grow 30-fold by 2030, when it may reach a value of over $28 trillion.

About the authors
Henrik von Scheel is Advisory Council Member at the EU’s Advisory Board on Climate Change. Paul Lalovich, Emilija Vukovic and Tesha Teshanovich are all leaders at Agile Dynamics, a management consultancy operating at the intersection of strategy, organisation and technology. The firm advises numerous governments and companies on FDI-as-a-service and asset tokenization.