Tuesday 26 Sep 2023
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This article first appeared in Wealth, The Edge Malaysia Weekly on November 30, 2020 - December 6, 2020

Local investors are a step closer to accessing a new breed of digital tokens issued by local start-ups and early-stage companies.

On Oct 28, the Securities Commission Malaysia’s (SC) revised Guidelines on Digital Assets came into force and applications were open for licences to operate initial exchange offering (IEO) platforms. The guidelines were issued on Jan 15 this year. According to industry players, there has been keen interest to participate in the new investment space.

IEO operators play a similar role to investment banks, in that they will act as the adviser, book runner and underwriter for start-ups and companies that wish to raise up to RM100 million (in 12 months) for innovative blockchain projects through the issuance of digital tokens. These tokens are defined as “securities” by the SC.

An increasing number of listed companies are moving into the blockchain and digital token space, and these include MyEG Services Bhd and AirAsia Group Bhd. In 2018, MyEG inked a memorandum of understanding — via its associate company in the Philippines, I-Pay MyEG Philippines Inc — with Cagayan Economic Zone Authority, to operate a payment gateway for cryptocurrency exchanges in the country.

Tan Sri Tony Fernandes, co-founder and CEO of AirAsia Group, announced in 2017 that he wanted to turn frequent flyer points into a cryptocurrency (or digital token) known as BigCoin. But there have been no updates regarding the initiative.

In Malaysia, two out of the three digital asset exchange (DAX) operators — entities licensed by the SC to operate an electronic platform for the trading of digital tokens (bitcoin, ether, litecoin and ripple) — have expressed their interest in applying for IEO operator licences.

Equity crowdfunding platform pitchIN will also apply for a licence, according to Kashminder Singh, its co-founder and chief strategy officer.

Edmund Yong, co-founder of boutique blockchain consultancy firm Celebrus Advisory, says various technology start-ups and companies have been enquiring about becoming an IEO operator recently.

What does tokenisation mean for investors? 

Yong believes IEOs could be a game-changer for the financial industry. For investors, they will gain access to various asset classes previously beyond their reach. These are asset classes that require high investment and are illiquid and less transparent.

Property is a good example. The minimum investment for a residential or commercial property could amount to hundreds of thousands while the transfer of ownership of a property is a lengthy process. With blockchain technology, property companies can easily break down the total value of these properties into much smaller amounts through digital tokens. Investors who subscribe to these tokens would then be entitled to a share of the capital gain when the properties are sold.

Some companies overseas have been exploring or have embarked on such an initiative. Stan Group, a Hong Kong real estate developer that manages a real estate portfolio worth about HK$75 billion (RM39.57 billion), announced its Buy-a-Brick initiative last year — a tokenised profit-sharing system for its employees. If the move takes off, employees who received digital tokens will earn returns when the tokenised building is sold.

Closer to Malaysian shores, EdgeProperty.com reported in June that Shareable Asset, a newly launched Singapore-based platform, aims to give retail investors access to real estate for as low as US$122 (RM499). The platform had attracted more than 200 potential investors in Asia to co-invest in two studio units in a students’ accommodation in Sunderland, England.

Bonds and private debt securities can also be tokenised to enable access by retail investors. Bitbond, a German company, has embarked on such an initiative since 2013. It provides tokenisation services to banks, financial intermediaries, general businesses and fund operators. Besides bonds, other assets the company can tokenise include mutual funds, alternative investment funds and investment products that require a costly and complex securitisation structure.

David Low, Luno general manager for Southeast Asia, says investors can expect to invest in a variety of digital tokens issued by start-ups and early-stage companies that are involved in blockchain-related businesses or projects.

“We think an IEO is a fundraising option that caters to a niche market, which comprises technology companies that utilise blockchain technology innovatively to generate higher revenues. We believe IEOs will continue to democratise the Malaysian financial markets, giving a very innovative option for investors to look at,” he says.

Competition for investment banks?

With their capability to raise up to RM100 million for businesses, Celebrus’ Yong says IEO operators can take a growing share of the market from investment banks over the long term, depending on various factors, including a wider adoption of digital tokens by investors globally.

To elaborate, the maximum amount raised by LEAP Market companies was about RM12 million as at August 2019. Meanwhile, two companies listed on the ACE Market recently — Southern Cable Group Bhd and Samaiden Group Bhd — raised RM71.2 million and RM29.35 million, respectively.

“The maximum amount that can be raised by IEO operators is comparable to that raised in the ACE Market. It is also an attractive fundraising platform for companies that want to break up their lumpy assets into more affordable units and attract a broader class of investors,” says Yong.

The IEO operator licence is more suitable for established companies rather than smaller financial intermediaries that help start-ups and early-stage companies to raise funds from retail investors.

“Looking at the maximum amount that can be raised, an IEO operator will need connections with institutional investors for fundraising activities to be successful. Smaller players that raise funds from retail investors, let’s say RM2,000 per person, may struggle,” Yong explains.

Luno’s Low believes IEOs will succeed as businesses can raise funds through the issuance of digital tokens without giving up equity to investors.

“Historically, most start-ups and companies that raised funds through IEOs did not give up equity in exchange for funds. The issuers merely created their own digital tokens, and programmed these tokens in a manner in which the token holders could use them to redeem the specific business products or services offered by the issuers,” he says.

For instance, an airline company can raise funds through the issuance of digital tokens and token holders can use these tokens to pay for their flight ticket at a better rate, Low explains.

“So, issuers will not lose control of their businesses [during the digital token fundraising process]. They can keep their equity for further fundraising campaigns via the equity crowdfunding or IPO route.”

These digital tokens can also be easily liquidated on a secondary market when they are listed on DAXs and actively traded.

Low disagrees that big institutions are better candidates to apply to be an IEO operator. He says the minimum fundraising amount is not specified in the SC’s guidelines, and it can go very much lower to an amount suitable for start-ups and early-stage companies.

“There is no minimum fundraising amount stipulated in the guidelines. They mention that businesses would require a minimum shareholders’ funds of RM500,000 to raise funds through an IEO. They also note that the maximum quantum of funds permitted to be raised [within 12 months] is 20 times the issuer’s shareholders’ funds.”

Low believes the high maximum fundraising cap is partly to accommodate potential inflows of foreign investment. “Historically speaking, IEO projects are marketed globally, and exciting projects tend to receive huge investment amounts from overseas,” he says.

IEO operators, he reckons, are unlikely to compete with investment banks as they are expected to raise funds mainly for start-ups and early-stage companies that want to leverage digital tokens and blockchain technology to grow their businesses.

Investor protection

Despite the potential that can be unleashed by the IEO initiative, there are still uncertainties surrounding regulations, investor protection and investor perception of this new asset class.

Digital tokens are recognised as a form of securities, which include unit trust funds, bonds, warrants and options, according to the SC’s guidelines. Hence, issuers of digital tokens must comply with the existing requirements, as set out by the SC and Bursa Malaysia.

The SC’s guidelines on digital assets must be read together with other relevant laws and guidelines, including payment services and foreign exchange administration laws administered by Bank Negara Malaysia.

This means that investor protection is in place despite some uncertainties in other areas of law, says Low.

“Digital tokens [offered by licensed IEO operators to the public] for investment and trading purposes are governed by existing laws surrounding securities, including the anti-money laundering and anti-terrorism financing act. The issuers of digital tokens are also subject to other Malaysian laws.

“Investors will have legal recourse if issuers have contravened the law,” he says.

IEO 101 

Initial exchange offerings (IEOs) are a fundraising method that evolved from the initial coin offering (ICO).

In the case of an ICO, a company that wishes to raise funds from the cryptocurrency community creates a digital token. The token is distributed to investors in exchange for mainly bitcoin or ether, which can be easily turned into cash.

The company also publishes a whitepaper, a document similar to a prospectus, containing key information, including the founders’ profile, company structure, mission and vision, products and services and business plans.

The whitepaper contains information such as the name of the digital token, token value, total supply of tokens, distribution of the tokens and how the tokens can be utilised after the fundraising campaign is completed.

The ICO issuer will then market and distribute its digital tokens directly to investors for mainly bitcoin and ether. For instance, company Alpha would issue 100 Alpha tokens to investors in exchange for one bitcoin. Once the fundraising exercise is completed, the issuer makes a commercial arrangement with a digital asset exchange (DAX) to list its digital tokens for trading on the secondary market.

The difference between an IEO and ICO, however, is that the former involves a third party during the fundraising process. In an IEO, the fundraising exercise is conducted by an IEO platform on behalf of the issuer. And the IEO platform can also be a DAX that facilitates trading activities of digital tokens on the secondary market.

“The IEO platform typically does due diligence on the issuer and its whitepaper. It also conducts the issuance of the new digital token, markets its projects, undertakes the collection of funds from investors as well as list the newly issued digital tokens.

“In some instances, the IEO platform may even issue and list the new digital tokens immediately on a DAX and investors who want to invest in the tokens can trade them immediately on the exchange’s order book.

“In summary, in an IEO exercise, the IEO platform acts as the administrator of the fundraising campaign, which is similar to the function of an investment bank during an IPO,” says David Low, Luno general manager for Southeast Asia.

He adds that the concept of the IEO emerged from the 2017 ICO mania, during which many investors in ICO projects lost their money investing in scams or poor businesses. It was believed that an additional layer of due diligence conducted by the IEO platform on issuers could help filter out the bad apples.

However, in recent years, there have been fewer good IEO projects than ICO projects, based on the market observation of Zhang Lechi, the business development director of blockchain technology company Polymath overseeing Asia-Pacific.

Moving forward, Zhang believes the world will increasingly regulate the digital token space, including IEO operators. This will provide individual investors with better protection and may gradually attract more institutional investors.

“The lines between regulated and unregulated players in the digital token industry are starting to blur. And they will eventually converge,” he says.

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