Earlier this year in March, the Securities Commission of Malaysia (SC) announced the approval of two operators to conduct Initial Exchange Offerings (IEO). This is an exciting and consequential development because IEOs create a whole asset class for investors with new financial instruments.
Just as SC became the first to regulate equity crowd funding (ECF) in Southeast Asia in 2015, IEOs are poised to launch our local capital markets into the digital asset age.
However, public interest seems subdued. The public is largely unaware of what IEO is, without much investor education or media attention out there. Some just think this is another ECF clone.
Or maybe the news got overshadowed by the digital banks announcement that came weeks later. Furthermore, since IEOs are digital assets which are similar to cryptocurrencies, there is a certain stigma to overcome.
This three-part article series aim to explain IEOs from the perspectives of (1) the investor who buys these assets, (2) the issuer who sells these assets, and (3) the operator who runs the platform that brings investors and issuers together. Hopefully this can simplify, in ordinary business language, some of the technical concepts related to IEO investments.
It also presents some of the challenges and limitations of IEO in its current state which smart investors like you may consider before coming onboard.
What Are Initial Exchange Offerings?
Basically put, these are privately issued assets in the form of digital tokens. Privately held businesses, which must be tech-related and can be of different maturity stages, can issue these tokens and sell to the investor public for the purpose of fundraising of up to RM100 million. This activity can be only performed through the IEO operators within a regulated setting.
You’d be surprised that the IEO name itself is somewhat misleading as there is no exchange involved. None of the digital asset exchanges (DAX) in Malaysia are allowed to place out IEOs. The commonly used name is Initial Coin Offering (ICO), but this has a negative connotation as it conjures memories of scams back in the day.
For ease of understanding, an IEO works like an Initial Public Offering (IPO) – where a company that wants to go public will issue and float its shares in the open market. In the context of an IEO, digital tokens are used instead of shares.
Wait, Digital Tokens Are Not Shares?
Our domestic law makes it very clear that digital tokens are neither shares (equity) nor debentures (debt). It should also not be confused with unit trusts. In other words, please don’t expect to get payouts in the form of dividend or interest when you invest in these tokens. You also don’t get to have voting rights or attend annual general meetings like normal shareholders do.
Since this is not debt, you are generally not considered a creditor to the company that issued the tokens to you. And assuming that your tokens are not secured to assets of the company, you won’t know what your priority of repayment is if the company goes under. Therefore, it is important to ascertain the exact nature of your rights before you invest.
If digital tokens are not shares, what are they? That’s a good question.
They are prescribed as securities, which are defined in the Capital Markets and Services Act (CMSA) 2007 as shares, debentures or unit trusts, or “any right, option or interest in respect there of”. The latter sentence will presumably take on an expansive meaning depending on how creatively structured the tokens are.
One thing to remember: It is always sensible to approach and analyse these tokens like an investment contract. What underlying asset is your money going into, what is being represented and promised to you, and what are the downside risks including the worst-case scenario?
Are These Investment Products Legitimate?
Being legitimate is not necessarily the same as being legal. Digital tokens have the legitimacy as a regulated financial instrument, and they are handled by recognised market operators (RMO) with the oversight of SC. The legal certainty of it, however, is another matter.
Digital tokens are not legal tender, and each token offering is different based on its own set of facts. As and when disputes arise, they will have to be brought before the judicial courts to decide on the legal merits.
According to the landmark case Luno Pte Ltd & Another v Robert Ong Thien Cheng, it was decided (and affirmed on appeal) that digital assets like bitcoin can be used as consideration to seal a contract between parties. There is value attached to digital assets in the same way as value is attached to shares.
Nevertheless, there are questions with respect to how digital tokens, which use ‘smart contract’ code, can effect legally binding signatures between two parties. It is also important to note that the rights in contract differ significantly from the rights in property which are more complex. Whether digital assets can represent legal and beneficial interests in real property have not been ascertained yet.
In fact, courts around the world are ruling on whether digital assets, in their intangible or incorporeal form, can be rightfully considered ‘property’. There is no legislation in Malaysia to recognise them as such. There is also an insufficient body of precedents here and in other Common Law jurisdictions to make a conclusion at this stage.
Ultimately it depends on the financial engineering of the tokens, for example, whether the tokens represent ownership of property assets, or are backed by them as collateral, or are merely claims. You will need to read the fine print carefully.
Who Are the Target Investors?
While retail investors can participate in these offerings, they are limited to RM2000 per issuer and a grand total of RM20,000 within a 12-month period. If Alice picks Company X, she can only invest a maximum of RM2000 in its tokens. If Alice has more cash to spare, she will have to spread it to other companies.
This way, Alice can limit her exposure to Company X and stop-loss at RM2000. But it also means she cannot meaningfully participate in the upside of Company X if its tokens eventually grow by leaps and bounds.
The objective of this regulatory limit is to protect ordinary folks like mom-and-pops from putting too much money on these investments which are intrinsically risky. On the other hand, accredited investors and those with high net worth have no such limits imposed on them.
Can I Sell and Trade Digital Tokens?
At this point, IEOs are offered only at the primary market level, that is, between the issuer and the end investor. There are no guidelines from SC to open up the secondary market yet for trading among investors.
In other words, Alice cannot transfer her tokens to Bob. Eventually this will be facilitated by the four registered digital asset exchanges (DAX), which will need to comply with the admission rules for listing IEO tokens.
Given that IEO platforms have not even started operating, and have been given nine months to prepare, you will not see the trading of tokens in the immediate future. Which means that investors will not have the options to exit freely in the open market yet.
In a sense, investing in an IEO can be less liquid than investing in a close-ended fund (CEF). There are no new tokens issued and no new investors onboarded once the offering closes. Investors can neither redeem their tokens from the issuer nor expect repurchase or buyback.
Even if the tokens are listed, there is also the question whether the secondary market and price discovery process will be vibrant enough to make it worth their while.
In the next two articles, we will dive into how tech businesses can capitalise on IEOs, the benefits compared to conventional funding strategies, and the potential problems. While IEOs can democratise venture capital (VC) investing for ordinary investors and change the way entrepreneurs raise funds, the Malaysian context is quite unique from global practice and needs to be taken into account.
About the Author
Edmund Yong is the managing partner of Celebrus Advisory and appointed by MDEC as part of its Talent Expert Network (formerly known as Digital Expert Panel) for blockchain technology. He is also the resident consultant for GLT Law, a multi-award-winning legal practice with specialisation in digital assets. All opinions expressed are the author’s own.
 Capital Markets and Services (Prescription of Securities) (Digital Currency and Digital Token) Order 2019.
 Robert Ong Thien Cheng v Luno Pte & Another (Civil Appeal No. 12BNCVC-91-10-2018), Shah Alam High Court.