This article first appeared in Personal Wealth, The Edge Malaysia Weekly on March 2, 2020 - March 8, 2020

Investors have been turning to the private markets in search of opportunities and returns in this “lower for longer” interest rate environment. However, many of these investment vehicles are designed with the institutional investor in mind.

“The private markets are generally built for large institutional investors with a long-term investment horizon such as insurance companies, pension funds and sovereign wealth funds. These players can afford the huge minimum investment amounts and are able to tolerate the lengthy lock-up period,” says Choo Oi Yee, chief commercial officer at Singapore-based capital markets platform iSTOX.

The private markets are rapidly growing, she adds. According to the McKinsey Global Private Markets Review 2020 report released on Feb 1, the assets under management (AUM) of these markets had grown 170% or US$4 trillion in the past decade. The AUM rose 10% last year alone. The private equity (PE) sector outperformed the public markets by most measures over the past decade, although the variability in performance remains substantial. 

The success stories in and the growth of the private markets have attracted high-net-worth individuals (HNWIs) . However, the high minimum investment amounts of many of these investment vehicles are a barrier to entry for many of these investors.

Recognising this issue, Singapore-based ICHX Tech Pte Ltd has developed iSTOX, a blockchain-powered capital markets platform. It is the first regulated capital markets platform in a major financial centre to support the one-stop issuance, custody and trading of digitised securities. The firm is backed by the Singapore Exchange, Heliconia (a subsidiary of Temasek Holdings that focuses on investments in fast-growing companies) and Japan-based Tokai Tokyo Financial Holdings, among others. 

By allowing buyers and sellers to connect directly, the platform removes long-standing obstacles that have prevented many HNWIs from fully tapping the opportunities offered by the private markets.

As the platform allows investors to buy fractional amounts of these offerings, they are able to diversify their investments across various assets, says Choo. “Let’s say a HNWI has S$2 million (RM6.04 million) to invest. Instead of putting S$1 million in a hedge fund, he can now break it into chunks of S$50,000 and have holdings in different hedge funds or real estate. This changes his risk profile immediately.”

The digitised securities on iSTOX may include PE, private debt, exclusive funds and other alternative investment products such as collective investment schemes, structured notes and asset-backed securities. This sets the platform apart from its competitors, which may only have the licence to deal in private securities.

All of iSTOX’s transactions — such as issuance, custody and trading — are enabled by its in-house-developed blockchain system, which helps to enforce automated compliance using smart contracts. This means investors subscribe to, hold and trade assets in one place, and do not need a separate account for custodial or other purposes. 

Although the platform utilises distributed ledger technology (DLT), it is not a cryptocurrency exchange, says Choo. All tokens issued in the primary market will be done via security token offerings (STOs) and can only be bought using fiat money. 

“One of the advantages of blockchain in our use case is the ability to break these investments into smaller pieces. Not everybody can afford a minimum investment of S$1 million. We will work with the entity issuing the product on our platform to break it down to bite-sized pieces, say S$15,000 per investment,” she says. 

“The ledger itself keeps immutable records, so we know exactly what and when a transaction is done. As our settlements are done almost instantaneously, activities in the secondary market are quite seamless.”

Providing freedom and flexibility 

The platform was started by Danny Toe, founder of ICH Group, the parent company of ICHX. ICH Group is an investment firm that invests in unique and promising enterprises across the globe directly and through PE and venture capital funds. 

Toe wanted to establish iSTOX to meet the demands of the next generation of investors and issuers, who were calling for a shift in the capital funding process. “iSTOX is based on a simple idea — that investors deserve more than what is available to them in the current financial markets. Among other things, we believe this means giving them the freedom and flexibility to engage with industries, technologies and causes that fire their passion, providing them with exposure to potentially transformative developments in technology and society and allowing them to improve the world around them,” he says.

“We also believe in giving investors the ability to access opportunities that were previously out of reach to all but a few. iSTOX allows different types of issuers to raise funds on the platform, hence giving issuers the flexibility they desire and investors more choices. As we see it, emerging innovations such as DLT combined with innovative business models and forward-looking regulations here in Singapore, have provided us with a unique opportunity to make this a reality.”

Established in 2017, ICHX was accepted into the Monetary Authority of Singapore’s (MAS) Fintech Regulatory Sandbox in May last year. The sandbox provides companies an environment to experiment with innovative financial technology (fintech) products and services in a clearly defined space. 

According to iSTOX head of compliance Lim Mei Shern, having digitised securities as well as the end-to-end capital markets infrastructure built on the blockchain is a new concept, both in terms of technology and operating model. The sandbox has been useful as it allowed the platform to test these out in a “live” environment, with real issuers and investors. 

ICHX onboarded its first batch of investors and issuers last year, before commencing with the trading of digitised securities in the sandbox environment. The focus was to deploy and develop the iSTOX platform in the sandbox to better serve both investors and issuers. The firm completed its first issuance and secondary market listing late last year.

On Feb 1, ICHX graduated from the regulatory sandbox and was approved by MAS as a recognised market operator and a capital markets services licensee. It is now authorised to host primary offerings for accredited and institutional investors, act as the custodial agent and operate an exchange for users to buy and sell digitised securities. 

“Graduating from the sandbox was a huge milestone for both iSTOX and — we believe — the financial industry as a whole. We started this project a little over two years ago with a vision of what investing could be in the 21st century. We have now emerged as the first capital markets platform using DLT to feature integrated issuance, custody and trading of digitised securities to be approved and licensed by a major regulator,” says Toe.

MAS imposes several regulatory requirements on financial institutions that serve to ensure that their products are safe for investors and issuers, says Lim. The key requirements include technology risk management, maintaining confidentiality of user information and handling of customers’ assets and money.

“As a technology-based platform, iSTOX takes technology risk management and cybersecurity seriously. We strive to make the platform safe with regular vulnerability assessments and penetration testing, security patches and monitoring of network traffic, among others. iSTOX also provides users with cybersecurity tips on how to keep their online interactions secure,” says Lim.

“All money transferred into iSTOX accounts are held in a customer segregated account with a bank in Singapore. Customers’ asset ownership and financial transactions are recorded on our immutable proprietary distributed ledger to ensure a reliable record.” 

iSTOX is open to accredited investors globally, but they are subject to MAS’ definition — individuals whose net personal assets exceed the value of S$2 million (or its equivalent in a foreign currency) or whose income in the preceding 12 months is not less than S$300,000 (or its equivalent in a foreign currency). Choo says the platform is not looking to open its platform to other investors anytime soon, although she does not discount the possibility of this happening in the future. 

Investments on iSTOX can only be made using Singapore dollars. The platform may support other currencies later in the year. Also, it is only available as a web app. However, a smartphone app is being developed. 

The platform is still in the process of onboarding clients. Choo says it may take longer than other digital investment platforms as it involves processing accredited investors. Most of the applications so far have been made by Asian and European investors. 

“I think there is a general curiosity that has driven the interest of these investors to participate in the private capital markets space. In the current environment, where returns in the traditional public markets are muted, it is not a surprise that investors are looking at these alternative assets to find yield and mitigate risk,” she says.

iSTOX offers low or no minimum investment amounts. Choo says that prior to the STO, ICHX will discuss with the issuer to determine the minimum investment amount, if any. In the secondary market, investors are free to sell their assets at any amount. They can even break it into even smaller pieces, making it more affordable to other investors on the platform. The minimum investment amount to trade on the secondary market is S$100.

“If an issuer wants to issue a bond, for example, it may not want to make the minimum investment amount too small to avoid not being able to raise enough money. So, it may want to set the amount at S$250,000 per token,” she says.

“Later, in the secondary market, the investors are free to break it down further to sell at a price far less than that amount. The secondary market will largely become a demand-and-supply marketplace.” 

iSTOX is able to accommodate a variety of issuance structures, including equity-linked products, fixed-income instruments, interest in units of a fund as well as real assets. This means investors may be able to invest in emerging technology unicorns or high-growth pre-IPO start-ups.

“There are a lot of high-growth companies in the region that need capital. Investors should diversify and take a view across 10 to 15 opportunities to determine which ones appeal to them best,” says Choo. 

Investors can also exit their investments whenever they like, she adds. If an investor has bought into a 10-year development fund and wants out after three years, he can do so — something that cannot be done on other platforms. 

iSTOX sifts through its potential issuers using a robust screening and approval process to ensure that only quality investments are offered for issuance and trading. The platform accepts issuers from all over the globe, provided that they meet the criteria set, which depends on the type of issuances they want to list on the platform.

For example, issuing an investment fund requires its assets to be worth at least S$5 million. Also, the fund management company must have been in operation for at least five years. Alternatively, the persons responsible for managing the investments of the fund must be reputable and have a track record of at least five years. 

“Apart from looking at how long the issuers have been managing that certain type of portfolio or product, we also look at the performance of some of their other products. If they have been in the top quartile with a consistent track record, then it is quite easy for us to onboard them,” says Choo. 

While there are no fees associated with opening an account on iSTOX, investors are charged between 0.2% and 0.5% of their investment amount to subscribe to the primary issuances of digital securities on the platform, depending on the products issued. Investors will also be charged about 0.2% per transaction to bid in the secondary market. In the future, as the platform develops further and sees different use cases, the fees may change depending on the products issued, says Choo. 

Valuation and education

iSTOX is one of the companies trying to disrupt the capital markets space by leveraging blockchain technology. Choo points out that while the capital markets have seen many changes and innovations over the years in terms of products and offerings, the underlying core infrastructure has not really changed since the advent of electronic trading decades ago. 

“Do you remember old trading floors, where there were a lot of people shouting at each other? When electronic trading came about, this was no longer a common scene. Technology has made everything more efficient than it used to be, creating a great impact on how trading is done,” she says.

“Many have tried to replicate this in the private capital markets, but not many have succeeded. We think players like us have to think outside of the box to introduce something that can actually create a bigger impact.”

Choo says it will not be difficult for investors to adopt the system developed for iSTOX as they are generally quite used to online trading. The education provided by the platform would then focus more on the different types of products, what these entail and how similar products have performed before. 

“For example, real estate funds. Do the investors understand investments in data centres? Do they know the difference between funds that hold income-producing assets and funds that hold assets that are being built? What are the risks? How can they evaluate the risks to make an investment decision? These are the ones I think will take more time as investors typically have never had the chance to invest in such products before,” she says. 

Valuation is one of the main challenges in private markets for investors. Generally, in these markets, companies are not required to abide by certain financial disclosure requirements. Hence, there may be a lack of transparency and information required to accurately value whether an investment is worthwhile. 

iSTOX does not provide advisory services on issuances. Investors are advised by the platform to carefully read the offering documents and seek advice from appropriate parties before making any investment.

“After the issuance, in some cases, we will encourage the issuer to work with the market maker to provide some liquidity. For example, we may ask the issuer of a debt fund to announce the net asset value quarterly, or monthly if they want. This is on top of the results announcement that they will need to make every six months,” says Choo.

“It is always easier to discuss valuations when it comes to asset-backed funds such as those backed by real estate of infrastructure because there will be valuers involved. For hedge funds, we can track its daily price. I think the more difficult ones are the issuances relating to PE and potential unicorns as these are not as straightforward.

“We are looking to work with research houses, but since it is the private capital markets, there is generally a lack of analyst coverage. However, it will definitely help investors to understand the valuations more.”

The firm is currently reviewing several applications for issuances. According to Choo, it is taking more time as the applicants will need to work on incorporating a Variable Capital Company, which is a new legal entity structure for investment funds in Singapore. One of the issuances underway will provide investors with the opportunity to be exposed to one of the world’s top hedge funds, among others in the pipeline. More information is expected to be made available in the next two to three weeks. 

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