This article first appeared in Wealth, The Edge Malaysia Weekly on June 26, 2023 - July 2, 2023

A slew of new investment products will be entering the market this year with the launch of two initial exchange offering (IEO) platforms, which allow start-ups and businesses to raise funds of up to RM100 million through the issuance of digital tokens to finance innovative projects.

There is speculation that these tokens could be utility tokens that provide holders with early participation rights to use and pay for products and services offered by the issuers. They could also be security tokens whereby holders would be shareholders or creditors of the issuing company.

These digital tokens could be listed on licensed secondary exchanges, known locally as digital asset exchanges (DAXs), if they are approved by the Securities Commission Malaysia (SC).

The two licensed IEO platforms are pitchIN, which is also the largest equity crowdfunding (ECF) platform in Malaysia based on the total fundraising amount; and Kapital DX Sdn Bhd (KLDX). Investors can set up an account with each platform at the time of writing.

Several projects are already in the pipeline, but the first is only expected to be launched in July or August.

Sam Shafie, co-founder and CEO of pitchIN, expects one of its earliest projects to be a utility token issued by an auction house. By accumulating a certain number of tokens, holders would have early access to specific items that will be auctioned off by the issuer.

“You will have priority access to knowledge of the deals that are going to be listed [on upcoming auction events]. You can also pay certain [auction] fees by using the tokens. The main intention is to have more and easier engagement with clients.

“We are now submitting [the documents of] our issuers to the SC. Once the green light is given, we will make an official announcement,” he explains.

pitchIN’s first few IEO projects are expected to be utility tokens, as the structuring of security tokens involves more complex legal processes. They are likely to be fan-based tokens primarily subscribed by followers of a company and its products or services.

Would a fan-based project be able to raise several million ringgit?

Kashminder Singh, co-founder and chief investment officer of pitchIN, says it is possible. “Imagine if Disney wanted to raise RM100 million, it should be able to achieve this. The local equivalent could be something like Upin & Ipin (a Malaysian animated series).”

These utility tokens can then be listed on the DAXs for secondary trading once they meet specific criteria and receive the SC’s approval. As the fan community grows, so will the demand for these tokens. Token holders could then opt to sell their tokens on the secondary exchanges for a profit, Kashminder adds.

After the first project is rolled out, pitchIN has several more “exciting issuers”, says Sam.

In contrast, KLDX remains tight-lipped on its upcoming projects. Its founder and CEO Selvarany Rasiah would only say the platform has a pipeline of products that it is working on.

“We will start bringing them out in the third quarter of the year, and add more to the market by then,” she adds.

While it is still too early to tell what type of projects will be rolled out locally, investors could make some assumptions based on digital tokens already issued in Singapore and other countries.

Alta Exchange, a private securities exchange regulated by the Monetary Authority of Singapore (MAS), had issued security tokens as early as 2021 through its partnership with Singapore-based boutique corporate finance firm PrimePartners Corporate Finance as well as investment and wealth management firm Phillip Capital.

Willie Chang, chief operating officer of Alta, says the digital tokens are tokenised asset-backed securities (ABSs) based on a collection of exclusive casks of single-malt Scotch whisky. The collection is curated by Diageo, the world’s second-largest distiller.

How does it work? An ABS was first created based on six casks of whisky. The ABS was then tokenised and traded on Alta, restricted only to accredited investors who had a minimum income of S$300,000 (RM1 million) in the past 12 months, among other criteria set out by MAS.

An investor who subscribed to the digital token through the exchange would own a bottle of single-malt Scotch whisky derived from one of the six casks.

“Each of these casks has a predefined bottling date and we know each cask is going to yield a certain number of bottles. That gave us an opportunity to fractionalise and tokenise them. We can say how many tokens we can offer, with one token representing one bottle.

“Investors are free to trade their tokens at any time on our exchange. And when the bottling date arrives, the token holders would be eligible to receive the physical bottle or they could opt for cash instead. We can sell those bottles to a third-party whisky distributor for cash,” explains Chang.

The beauty of tokenisation is that it allows investors to buy high-quality whisky in smaller amounts — a bottle, in this case — when it is usually only sold as a cask. They can also trade these digital tokens conveniently via Alta.

Chang says third-party service providers are involved in the process, including an auditor who inspects the casks stored with the manufacturer once or twice a year to make sure the products are well kept.

Alta is looking to tokenise other ABSs such as artworks. The question is, how can it be done when an artwork cannot be sold in pieces but only as a whole?

“We can’t chop up the art and sell a chunk of it. So, what we do is just like the example of the whisky, whereby we set a maturity date for the security tokens. We list those tokens on the exchange before the date,” says Chang.

“Then, we appoint an art manager who not only looks after the art, but is also capable of selling it on the market for a good price. With the terms and conditions set out, the manager would sell the art upon the maturity date. For instance, the manager would sell it as long as it generates a 10% return for investors. Or we could even [utilise the blockchain technology] to allow token holders to vote on whether to sell the art or not.

“Finally, if there’s no sale during the lifetime of the art on the exchange, the auctioneer (or seller of the art) would buy it back from investors at a fixed price which, for instance, could yield them a 5% return. So, investors know that there would be some kind of return at the end of the day,” he continues.

Alta, Chang adds, is looking to introduce its products and services to investors in Malaysia next year. “There’s a huge opportunity for us to extend and expand what we are doing here. Whether we apply for an IEO or DAX [licence], these are the things we are considering right now.”

The Security Token Report 2021 produced by Cointelegraph Research, a research firm specialising in blockchain-related topics, provides information on the various security tokens launched overseas. There is a long list of things that can be tokenised, including profit participation rights, revenue participation rights, ownership of tangible or intangible assets, subordinated loans or structured products, special purpose vehicles as well as shares of private and public companies, it states.

The report lists out all these tokenised assets and elaborates on them with examples. For instance, it uses Overstock.com, an e-commerce company listed on the Nasdaq, as an example of tokenising shares of a publicly traded company.

Patrick Byrne, dubbed the anti-Wall Street renegade by the report, tokenised Overstock.com’s shares and launched the first security token in 2019. Digital dividends were subsequently paid out to its token holders through a security token exchange known as tZERO.

Shares of well-known companies such as Apple and Tesla had also been tokenised and issued by blockchain start-ups and were quite actively traded by investors, according to the report.

However, there are mixed views among market players on whether IEOs provide value to the fundraising ecosystem, and on the kind of projects and businesses that are most suitable for the platforms. Some concerns are centred on fundraising cost and legal compliance.

According to an industry player familiar with digital token regulations, the IEO platform was first conceived and designed as a fundraising platform for technopreneurs to kick-start innovative projects that solve real-world problems, underpinned by the blockchain technology.

“The platform is designed for fundraising, not for one to issue or buy a token and immediately flip it for profit. It is a vital part that most people don’t understand,” says the industry player.

The best example would be Russian-Canadian computer programmer Vitalik Buterin, who spent years developing the Ethereum blockchain, which has enabled a plethora of real-world functions today. The project was partly funded by the issuance of digital tokens or cryptocurrency known as Ether embedded to the blockchain.

From just US$0.31, the price of Ether has since shot up to US$1,934 (RM8,993) as of July 5.

“These projects that utilise IEOs don’t necessarily need to involve technology companies. But they can use blockchain to come up with innovative solutions,” says the industry player.

It is also worth noting that digital tokens could be structured as a security instrument such as equity, debt, ABSs or utility tokens, which are non-debt, non-equity instruments.

“An IEO is meant to complete the fundraising chain [for entrepreneurs and businesses]. If you are a technopreneur with no income and can’t raise funds through equity or debt, you can do it through IEOs,” the industry player explains.

Retail investors are protected by the SC’s Guidelines on Digital Assets, which state that retail investors can only invest up to RM2,000 per IEO project and up to RM20,000 a year in several projects, among other regulations. The issuer must have a minimum paid-up capital of RM500,000 and shareholders’ fund of RM500,000 maintained at all times.

Yau Khai Ling, a corporate lawyer and partner of KhaiLing Yau Chambers who advises clients on IEOs and digital tokens, says IEOs are suitable for more established start-ups looking to raise Series A or Series B funding, which are typically for business and revenue expansion.

Her view resonates with KLDX’s Selvarany as well as David Low, former general manager of Luno in charge of its Asia-­Pacific business.

Big-size companies can raise funds through an initial public offering (IPO) while start-ups can do it via ECF and peer-to-peer (P2P) financing. But what about the more established start-ups?

“When you look at the middle [part of the fundraising chain], it’s empty. When these start-ups want to look for Series A funding at a higher amount and with a more innovative structure and a tech-driven platform, IEO is the place to go,” says Selvarany.

IEO platforms can provide these start-ups with more innovative fundraising options such as project financing, which is a form of debt instrument whereby the financing repayment is solely based on the cash flow generated from a specific project, she continues.

Low adds: “IEO regulations are designed primarily for start-ups, SMEs (small and medium enterprises) or organisations that have a large following and seek to raise capital to further their primary or core activities. The requirement for a minimum capital of RM500,000 rules out most early-stage start-ups.”  

Should established companies, such as property developers, raise funds from IEO platforms? There has been talk of the tokenisation of real estate and property in recent years.

An industry observer says this may not be the best use case for IEO platforms. He sees little need to tokenise real estate and property as investors are already allowed to invest in the sector through existing instruments such as real estate investment trusts (REITs), unit trust funds and interest schemes.

Edmund Yung, a partner at bespoke blockchain consultancy firm Celebrus Advisory, opines that it remains to be seen if IEO platforms can take off locally, especially security tokens.

Whether it is in the form of equity, bond or ABS, Yung says the legal processes that businesses are required to undergo to issue security tokens, plus the additional tokenisation cost, could pose a challenge to wider adoption among the business and investment communities.

Adding to that is a lack of legal precedence in the courts to recognise digital tokens as properties that accord ownership to its holders. While digital token holders can resort to contract law and securities law for protection, the level of protection isn’t as strong, he says.  

“There is no legal registered title on the underlying assets, and the link between the tokens and the assets could be quite nebulous. If anything goes wrong, all the token holders would have are claims against the parties to the investment contract. The remedies available for investors under contract law are limited,” he notes.

Businesses and investors would rather fall back on existing instruments to raise funds and to invest, says Yung.

Corporate lawyer Yau points out: “There is no existing law that clearly spells out that a company is allowed to issue a digital token that deems its holder a shareholder. Until that is done, we have to fall back on documentation to effectively create this. It is based on contract law and how you structure it. Structuring is very important.”

Diving deeper into security tokens, Yau says a debt-based token should be easier to structure. “It is more of a contractual obligation. If a company enters into a contract with you saying it owes you X amount of money, then the debt exists, as long as there’s sufficient evidence.”

Equity-based tokens are harder to create, as the Companies Act says that the issuance of a company’s shares requires approval from shareholders and board members. Names of the new shareholders would also need to be registered with the Companies Commission of Malaysia.

“If you were to issue tokens which allegedly carry equity rights, all these processes must be complied with,” says Yau.

She adds that the process of creating an ABS and its equivalent tokens, at least locally, is even more challenging and costly than equity-based ones.  

Both Yung and Yau agree that the regulator should provide more clarity on certain legal issues pertaining to IEOs.

“Currently, we see different levels of disclosures imposed on IPOs and IEOs. In terms of accountability, the responsibilities of the directors of IEO issuers are expressly encapsulated in the digital asset guidelines [issued by the SC], and not directly under the Capital Markets and Services Act (CMSA), like prospectus issuances.

“So, if there’s a misrepresentation in the white paper (akin to an investment proposal drafted by the IEO issuers according to specific criteria set out by the regulator), what is the consequence of this? Can investors hold the directors to the same level of responsibility as directors of a company that issued a prospectus to the public under the CMSA?” asks Yau.

The overlapping of different legal acts is another concern for Yau. For instance, if a company were to tokenise real assets like a hotel or durian trees, would it have to comply with the Interest Schemes Act 2016 that also allows companies to perform similar functions?

“I think there will be an overlap,” she says, adding that complying with different laws will add to the cost of the IEO fundraising exercise, with investors potentially bearing the higher cost.

Given that the concept of IEOs as a fundraising avenue is still new in this country, it will be interesting to see how far and how fast they can take off.

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