In this final part of our article series, we explore the viability of the new IEO model. Two IEO operators have been announced so far.
From the aspect of the platform, how will these operators perform as a capital formation channel i.e., how will they raise serious money? This has traditionally been the domain of licensed investment banks, so all eyes are on these operators. The business community is eager to hear its first success stories.
And from the aspect of the market, how will these IEO assets be structured to appeal to investors? These are exotic financial products that befit a narrow risk profile. They have often been compared as alternatives to IPO. Suitable investors who are seeking digital asset exposure in their portfolios might consider this.
Given that IEO is a major innovation, there are bound to be problems when we look under the hood. They are not operational yet, generally high risk, and involve novel points in law. Many things could change, including regulatory positions over time. Hence our opinions too are tentative.
The IEO operators’ role is to draw investors into the platform. But they do not underwrite raises. In other words, they do not guarantee results.
When you do the math, you will understand that this is not retail play. Here is a simple back-of-envelope calculation: Retail investors can only invest up to a limit of RM2000 per project. If a project has a RM100 million target, it will need to raise from at least 50,000 retail investors – assuming every single one of them maxes at RM2000, passes background checks, and nobody backs out during the cooling off period.
Imagine the sheer marketing cost and investor relations effort needed to convert such a large group. Imagine the due diligence work to onboard 50,000+ names.
And there is a further rub: According to the Securities Commission (SC), the total number of investors that have collectively used ECF and P2P financing platforms since 2017 is only about 31,000 investors!  So IEO operators – if they focus only on the retail segment – will need to be able to recruit new adequate investor bases to cover the demand, presumably within Malaysia itself.
This is the reason why institutional participation and sophisticated investors will be crucial to the success of IEO. They are the main target.
But it remains to be seen whether the IEO operators will take an active role in building the order books i.e., sourcing investor demand; or whether they will merely facilitate the offering like an ECF model.
Rather than setting a blanket investment limit on all retail investors, the regulators should consider marketing restrictions and ensure IEO operators perform suitability assessment on all investors. This could ease the fundraising burden of IEO operators. Even with the investment limit, vulnerable investor groups like the elderly and financially illiterate can still be indiscriminately targeted by IEO marketing.
At first thought, the local digital asset exchanges (DAX) may seem to provide some low hanging fruits and serve as the addressable market for IEOs. The number of DAX accounts has been growing phenomenally and may well cross 1 million this year.
But investors who are used to trading highly liquid digital currencies like Bitcoin and Ether might not have the same appetite for tokenised private securities like IEOs.
The biggest impact will come from the restriction on the use of crypto (or digital currencies) to pay for IEO investment. This effectively turns off the crypto segment and the entire trillion-dollar global crypto capital pool. While it is possible to cross-sell IEOs to third party DAXs in Malaysia, DAX customers cannot use their crypto holdings to invest in IEOs.
Foreign-based crypto investors including hedge funds and venture capitalists will have to convert into Malaysian Ringgit, wire through the correspondent banking system, and be subject to exchange control rules.
Why is crypto restricted? Perhaps from a compliance viewpoint, this mitigates the money laundering and terrorist financing (MLTF) risks associated with crypto. Unlike DAXs, the IEO operators are not equipped to screen and surveil illicit cross-border flows in crypto.
There are other substantive implications. In a standard ICO or IEO, the crypto received is used to activate the ‘smart contract’ for the automatic distribution of digital tokens to investors. Without the crypto element, this step is removed.
In the Malaysian modified version, it is basically just an ‘asset tokenisation’ process. What this means is that digital assets are programmed and recorded on a blockchain ledger and issued as tokens.
Also, there will be no need for digital asset custodians (DAC) as there are no crypto funds received and handled. The digital tokens, minted by the IEO operator on behalf of the issuer, don’t require custody as they are proprietary, remain in a closed loop, and all settled in fiat currency.
The reality is, IEOs without crypto is a rather hollow proposition. IEOs may end up like another vanilla ECF platform – but with more investor risks!
If digital tokens are not well-defined legally, it will be tough for both aggrieved investors to litigate and for regulators to prosecute. In our opinion, the current taxonomy does not provide sufficient clarity on the status of stablecoins, DeFi lending, and non-fungible tokens (NFT) – what more private tokenised securities that can be designed in so many ways?
It will be good to have legal certainty and a path of recourse if things go awry. Having to go to court to enforce an ambiguous investment contract is the last thing any investor wants. In the absence of such, you can expect IEO operators to prop up the legal paperwork.
Despite the use of ‘smart contracts’ for IEOs, it is very likely that investors will be required to physically sign subscription agreements, including the acknowledgment and acceptance of all instrument risks, and even limitation of liability!
Conflicts of interest need to be properly disclosed if any, where the IEO operator approves the project, develops the token, promotes to the public, and gets paid in tokens. Whose interests is the operator beholden to – the issuer, investor, or its own? If the tokens purport to be asset-backed, the collateralisation agreements and prudential policies should rightfully be shown.
For the smart investor, this is the Achilles heel of IEOs: Wouldn’t he or she be better off putting their money in normal shares or loans (via ECF or P2P), where there are more legal safeguards, investor protection, and formal dispute resolution?
For the impatient investor, please be reminded that there is currently no linkage between the primary (IEO) and secondary markets (DAX) locally. The digital tokens are unlisted products for time being. Angels and early investors cannot take money off the table. Investors cannot transfer their tokens between one another.
Note: Remarkably, the IEO guidelines do not state any prohibition of foreign DAX listings, which could be something to watch out for.
The race for global crypto capital has become heated. The major economies in ASEAN have rolled out crypto licensing regimes which are capital-friendly, competitive, and compliant. Regulators expect market operators to keep the pace of innovation, sustain the interest of investors, and remain relevant.
The face of global crypto capital is also evolving rapidly. IEOs can already be offered on normal centralised exchanges like DAXs (in Singapore), through licensed intermediaries (like ICO portals in Thailand), or without going through DAXs at all e.g., through an Initial DEX Offering (or IDO) on open decentralised platforms. There are even DAICOs where decentralised autonomous organisations are created as the token issuer.
Investors and issuers will be spoilt for choice as this space matures. IEOs will morph into the next in-thing. There will be more regulatory uniformity and cooperation across jurisdictions. New bespoke laws will be created instead of relying on extant securities laws. This article series surely won’t outlive its purpose.
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.
 Securities Commission of Malaysia, Capital Market Masterplan 3: 2021-2025 (2021).