Digital Assets Series: Chapter 1
digital assets: An Emerging Avenue for Investment and Fundraising
Interest in the use of blockchain and in the investment of blockchain-based digital assets has rapidly escalated in recent years, precipitated by the rise of cryptocurrencies (such as Bitcoin and Ethereum) to become one of the most celebrated class of digital assets around the world. Malaysia is no stranger to this phenomenon, as the usage and investment in cryptocurrencies have become popular since Bitcoin’s first bull run in December 2017.
In early April 2021, the total market capitalisation for cryptocurrencies in the world had topped USD2 trillion for the first time.[1] Based on the reports provided by digital asset exchange (“DAX”) operators to Bank Negara Malaysia, Malaysia saw an estimated 450,000 active DAX accounts actively trading in digital assets in 2020. In the same year, transaction values for digital assets trading were approximately RM105 million for the month of August.
Recognising the increasing demand for cryptocurrencies and its untapped potential, most countries have promulgated certain forms of regulations to facilitate and regulate the transactions of these digital assets. Similarly, the Securities Commission Malaysia has taken a phased approach in developing the regulatory framework for digital assets, which will be considered in detail in this and our ensuing Articles.
In this Chapter 1 of our Digital Assets Series, we offer a brief introduction on digital assets and its regulatory framework in Malaysia.
BNM Foreign Exchange Policies Refinement and LOLA Framework Enhancement
1. Introduction
1.1 On 30 April 2020, Bank Negara Malaysia (BNM) issued updates and amendments to the Foreign Exchange Policies with a view to improving business efficiency and providing flexibility for corporations to better manage their foreign exchange risk exposures (“BNM Foreign Exchange Policies Refinement”). Two days prior to that, i.e. 28 April 2020, we saw the Securities Commission of Malaysia (“SC“) rolled out certain amendments to the Guidelines on Unlisted Capital Market Products under the Lodge and Launch Framework (LOLA Guidelines) (“LOLA Framework Enhancement”).
1.2 BNM Foreign Exchange Policies Refinement and LOLA Framework Enhancement are certainly initiatives welcomed by the industry, especially local business corporations or foreign business entities investing in Malaysia who face liquidity or funding issues during the Covid-19 pandemic. This article provides a quick overview on the positive impacts of such initiatives by the BNM and the SC.
2. BNM Foreign Exchange Policies Refinement
2.1 Certain amendments have been introduced as a result of the BNM Foreign Exchange Policies Refinement, the key ones include:
(a) Residents are now free to obtain financial guarantee from non-residents for any amount. No approval or registration will be required. Previously, residents can only obtain financial guarantees up to an aggregate limit of RM100 million. With this relaxation, local business entities will be able to obtain greater support from other non-resident entities for their operations in Malaysia.
(b) On the same vein, residents are now free to issue financial guarantee to non-residents for any amount, subject to certain exceptions, such as, where the financial guarantee is issued to secure:
(i) foreign currency borrowing obtained by a non-resident special purpose vehicle from a non-related non-resident entity, external borrowing limit under Notice 2 will be applicable; and
(ii) foreign currency borrowing obtained by a non-resident where the repayment of the borrowing will be paid by a resident (other than when the financial guarantee is called upon under an event of default), investment abroad limit under Notice 3 will be applicable.
Previously, residents can only issue financial guarantees up to aggregate limit of RM50 million. This enable Malaysia-based entities to better support their operations in other jurisdictions.
2.2 The refined BNM Foreign Exchange Policies further clarify that a resident is now allowed to borrow in Ringgit in any amount from a non-resident through the issuance of redeemable preference shares or Islamic redeemable preference shares or Ringgit corporate bond or sukuk pursuant to the relevant guidelines issued by the Securities Commission (referring to the LOLA Guidelines), excluding non-tradeable Ringgit corporate bond or sukuk issued to a non-resident entity outside the resident entity’s group or a non-resident financial institution.
3. Overview Of Lola Guidelines In Respect Of Issuance Of Convertible Notes
3.1 Under the Capital Markets & Services Act 2007 (“CMSA”), a person who intends to make available, offer or subscription or purchase unlisted capital market products shall seek authorisation of the SC pursuant to section 212(5) of the CMSA (“SC Authorisation Requirement”) , unless any exemptions under Schedule 5 of the CMSA is applicable.
3.2 Of such exemptions, one that is often relied on by the industry is Part I of Schedule 5, which provides that any issuance or offer made (i) to persons specified in Part I of Schedule 6 or Part I of Schedule 7 of the CMSA; and (ii) in compliance with the requirements of the LOLA Guidelines, shall be exempted from the SC Authorisation Requirement.
3.3 Therefore, previously, for any issuance of unlisted capital market products (including convertible notes) to a venture capital firm or private equity firm (who satisfies the criteria set out under Part I of Schedule 6 or Part I of Schedule 7 of the CMSA) must observe certain requirements under the LOLA Guidelines, the key ones include:
(a) identification of all responsible parties accountable or responsible in the lifecycle of an unlisted capital market product, which may include without limitation the issuer itself and a person licensed by or registered with the SC (“Responsible Parties”);
(b) lodgement concerning the unlisted capital market products must be made by a principal adviser (being a person licensed to carry out the regulated activity of advising on corporate finance and eligible to act as principal adviser pursuant to the Principal Adviser Guidelines); and
(c) use of Fully Automated System for Issuing/Tendering (FAST) and the Real Time Electronic Transfer of Funds and Securities (RENTAS) system operated by Paynet to facilitate the issuance of the unlisted capital market products on a scripless basis,
(“Relevant LOLA Requirements”).
4. LOLA Framework Enhancement
4.1 The LOLA Framework Enhancement permits any business corporation who issues conventional convertible notes to venture capital firms and private equity corporations registered with the SC under the Guidelines on the Registration of Venture Capital and Private Equity Corporations and Management Corporations (“Specific Registered Persons”) to be exempted from the Relevant LOLA Requirements, subject to certain criteria (“Eligibility Criteria“).
4.2 Such exemptions see the following benefits come into play:
(a) identification of Responsible Parties by the issuer of the convertible notes will no longer be required;
(b) a business corporate may now conduct the lodgement to the SC by way of e-mail for the launch of its conventional convertible notes without the appointment of a principal adviser;
(c) the lodgement fees payable to the SC will no longer be applicable; and
(d) the issuance of the convertible notes will no longer be subject to the use of FAST and RENTAS system, rendering the fund raising process by the business entities to be more cost and administrative efficient.
4.3 The Eligibility Criteria are as follows:
(a) the issuance and offering of the conventional convertible notes must solely be made to Specific Registered Persons;
(b) the convertible notes must not be transferable save and except to Specific Registered Persons;
(c) the convertible notes must only be convertible into shares of the issuer; and
(d) the tenure of the convertible notes must not exceed 7 years from the date of issuance, which shall be a date falling within 60 business days from the date of lodgement with the SC.
5. Views
5.1 With the introduction of the BNM Foreign Exchange Policies Refinement, it is now clarified that foreign Specific Registered Persons are able to invest in ringgit denominated unlisted capital market products such as redeemable preference shares and convertible notes in any amount without any limit.
5.2 Further, with the LOLA Framework Enhancement, foreign Specific Registered Persons now have greater options in the types of investment instruments in Malaysia available to them, in addition to the typical investment method in the form of subscription of ringgit denominated redeemable preference shares.
5.3 The BNM Foreign Exchange Policies Refinement and LOLA Framework Enhancement implemented by the BNM and the SC respectively collectively provide greater cost and administrative efficiency for local business entities to seek funding from local and foreign venture capital firms or private equity firms registered with the SC, and are definitely initiatives much applauded by the industry.
5.4 Please refer to our next article for insights relating to the matters to be considered in choosing between redeemable preference shares and convertible notes as investment / fundraising instrument.
If you have any queries on the BNM Foreign Exchange Policies Refinement or the LOLA Framework Enhancement, please do not hesitate to contact us.
This legal update is for general information only and is not a substitute for legal advice.
Published on: 12 June 2020
Redeemable Preference Shares vs Convertible Notes – Which Works Better For Your Investment or Fundraising?
1. Introduction
1.1 The Securities Commission of Malaysia enhanced the Guidelines on Unlisted Capital Market Products under the Lodge and Launch Framework (issued on 9 March 2015 and revised on 28 April 2020) (“LOLA Guidelines”) with effect from 28 April 2020. Under such initiative, business entities are now permitted to issue conventional convertible notes to venture capital firms and private equity firms registered with the Securities Commission under the Guidelines of Registration of Venture Capital and Private Equity Corporations and Management Corporation (“Specific Registered Persons”), without compliance of certain requirements set out under the LOLA Guidelines, making such fundraising process more administrative and cost efficient (“LOLA Framework Enhancement”).
1.2 The above remains subject to (i) the Specific Registered Persons satisfying the criteria under Part I of Schedule 6 and/or Part I of Schedule 7 of the Capital Markets Services Act 2007 (the “CMSA”); and (ii) the terms and conditions of the issuance of convertible notes being in compliance with certain prescribed criteria.
1.3 Please refer to our earlier article for further information.
1.4 Following the above, it is expected that venture capital firms and private equity firms will now have the option of investing via subscription of redeemable preference shares (which has been the conventional practice before the LOLA Framework Enhancement) or subscription of convertible notes. Given such development, investee companies or investor should consider which investment instrument can better serve the interest of the respective company or better achieve their commercial objectives.
1.5 Given the emergence of such options to business entities and Specific Registered Persons, this article aims at providing an overview over certain matters that an investee company or a venture capital firm / private equity firm may wish to consider in respect of its fundraising exercise or investments in Malaysia.
2. Overview of the relevant matters
2.1 Under the LOLA Framework Enhancement, the Securities Commission clarified in the FAQ on the Requirements of the LOLA Guidelines (click here) that currently only conventional convertible notes may be issued under the enhanced LOLA Guidelines, although the Securities Commission acknowledged that this may change subject to a revision to the LOLA Guidelines in the future.
2.2 We set out below a brief overview of the matters which a venture capital firm or private equity firm or investee company wish to consider when deciding between issuance of redeemable preference shares (“RPS”) or convertible notes (“CN”) as investment insturment:
No. |
Subject Matter |
Redeemable Preference Shares (RPS) |
Convertible Notes (CN) |
| 1. | Amendments to the constitution of the issuer to reflect the rights of the RPS holders or CN holders. | Required under section 90(4) of the Companies Act 2016. | Not Required |
| 2. | Priority on liquidation and return of capital |
Holders of RPS rank after the creditors of the issuer, whether secured or unsecured. Generally, the investment agreement would provide that the holders of RPS shall have priority over the ordinary shareholders of the issuer on liquidation or return of capital. |
Holders of CN rank pari passu with unsecured creditors of the issuer, and shall have priority over ordinary and preference shareholders of the issuer on liquidation or return of capital. |
| 3. | Conversion to ordinary shares |
Convertibility of the RPS into ordinary shares depends on the terms of the issuance. If permitted under the terms, RPS can be convertible into ordinary shares at such term and during such period as may be agreed between the parties. |
Yes, CN are convertible into ordinary shares of the issuer at such term and during such period as may be agreed between the parties.
|
| 4. | Redemption / Repayment |
Compulsory Redemption
Typically, in the event of default or upon occurrence of a prescribed event (if any), the RPS shall be redeemed by the issuer by paying the subscription amount of the outstanding RPS, computed at an agreed rate (together with any declared but unpaid dividend on a cumulative / non-cumulative basis).
Voluntary Redemption
If the terms of the issuance permit, the issuer may redeem the RPS at certain agreed rate by delivery of a written notice, subject to there being no event of default. Please refer to Paragraph 3 of this article concerning capital maintenance rules under the Companies Act 2016 which may impede the flexibility of redemption of RPS. |
Compulsory Redemption
Typically, in the event of default or upon occurrence of a prescribed event (if any), the CN shall be redeemed by the issuer by paying the subscription amount of the outstanding CN, computed at an agreed rate (together with any accrued and unpaid interest).
Voluntary Redemption
If the terms of the issuance permit, the issuer may redeem the CN prior to its maturity at an agreed rate by delivery of a written notice, subject to there being no event of default. Redemption of CN is not subject to capital maintenance rules.
|
| 5. | Dividend / Interest |
RPS generally carry preferential dividend (cumulative or non-cumulative). Issuer may only distribute dividends from its profits. |
CN generally bears interest at an agreed rate from the date of issuance until conversion of the CN into ordinary shares of the issuer or redemption, whichever is the earlier. Payment of interest constitutes a debt to the CN holder, the payment of which is not subject to the issuer having sufficient profits. |
| 6. | Rights to vote in meetings |
Generally, RPS holders have no right to vote on a resolution as that of ordinary shares at a general meeting of the issuer.
Notwithstanding, the preference shares may still carry certain voting rights which must be specified in the Constitution of the issuer. The RPS holders may be able to vote on matters relating to their respective class of shares provided that such rights are stated in the Constitution as required under section 90(4) of the Companies Act 2016. In addition, it should be noted that further control may be exercised by the RPS holders over the affairs of the issuer by inclusion into the subscription agreement certain protective provisions which may limit the issuer’s ability to carry out certain corporate exercises without the blessing of the RPS holders. |
Generally, CN holders have no right to vote on resolution as that of ordinary shares at a general meeting of the issuer.
However, the control exercised by the CN holders over the affairs of the issuer may be enshrined in the terms of the issuance, such as inclusion of certain protective provisions that may limit the issuer’s ability to carry out certain corporate exercises without the blessing of the CN holders. |
| 7. | Lodgement with the SC | Not required | Required |
| 8. | Requirement of a trustee | No | Yes, unless exempted under the CMSA |
| 9. | Limit on investment sum pursuant to the BNM Foreign Exchange Administration Rules |
No limit to the subscription amount.
Pursuant to the refinement of the foreign exchange policies which came into effect on 30 April 2020 (“Refined BNM Foreign Exchange Policies”), the Bank Negara Malaysia (BNM) clarified that a resident entity is allowed to borrow in Ringgit in any amount from a non-resident through issuance of RPS. |
No limit to the subscription amount.
Pursuant to the Refined BNM Foreign Exchange Policies, BNM clarified that a resident entity is allowed to borrow in Ringgit in any amount from a non-resident through issuance of unlisted Ringgit-denominated CN. However, this does not apply to issue of non-tradeable Ringgit denominated CN to a non-resident entity outside the issuer’s group or a non-resident financial institution). |
| 10. | Any concern which may arise from the Moneylenders Act 1950 | None | None (exempted under Section 2A(2) of the Moneylenders Act pursuant to P.U.(B) 219/2005). |
3. Key Matters to Note
3.1 Malaysia-incorporated companies are subject to capital maintenance rules which aim at protecting the companies’ creditors. Generally, companies are only able to distribute dividends to its shareholders from its profits. Subject to prescribed limitations and adherence to certain procedures under the Companies Act 2016, a company generally may not:
(a) purchase its own shares or redeem its preference shares;
(b) reduce its own capital; and
(c) provide financial assistance to a third party to purchase its shares.
3.2 Although the Companies Act 2016 provides that redemption of preference shares shall not be regarded as reduction of share capital of the company, redemption of RPS can only be effected if they are fully paid up and the redemption is made out of (i) profits (which would otherwise have been available for dividend); (ii) a fresh issue of shares; or (iii) capital of the company.
3.3 Pursuant to section 72(5) of the Companies Act 2016 amended pursuant to the Companies (Amendment) Act 2019, where RPS are redeemed out of profits of the issuer which would otherwise have been available for dividend, there shall be transferred into the share capital accounts of the issuer, a sum equal to the amount of shares redeemed. Further, in the case of redemption of preference shares out of capital, all directors must make a solvency statement forming an opinion that the company satisfies the solvency test for purposes of such redemption. A company is deemed to satisfy a solvency test if:
(a) immediately after the redemption the company will be able to pay its debts;
(b) the asset of the company is more than the liability of the company at the date of redemption; and
(c) either:
(i) it is intended to commence the winding up of the company within 12 months after the date of redemption, the company will be able to pay its debts in full within 12 months after the commencement of the winding up; or
(ii) in any other case, the company will be able to pay its debts as the debts become due during the period of 12 months immediately following the redemption.
3.4 Unlike RPS, payment of interest and redemption of CN by an issuer will not be impeded by the capital maintenance rules aforesaid. Having said that, as issuance of unlisted corporate bonds such as CN requires compliance of the LOLA Guidelines, it may only be commercially viable for the investors to subscribe for CN instead of RPS if the issuance of CN complies with the criteria set out under the enhanced LOLA Guidelines (such that certain procedural requirements and costs may be exempted) and the issuer agrees to effect the relevant lodgement with the Securities Commission. Please see our earlier article for more information.
4. Views
The LOLA Guidelines Enhancement is a very much welcomed initiative to the industry, as it has expanded the fundraising and investment options available to the emerging growth companies, venture capital firms and private equity firms. Be that as it may, as discussed in this article, each instrument carries with it different benefits and drawbacks. There is no hard and fast rule to determine which investment instrument better serves the interest of the investee and/or the investor. Before determining a fundraising or investment structure and the instrument to be used, the relevant stakeholders should consider the relevant factors, premised on the financial position, capabilities and commercial goals of the parties involved.
If you have any questions about fundraising by way of issuance of redeemable preference shares or convertible notes or the LOLA Guidelines in general, please do not hesitate to contact us.
This legal update is for general information only and is not a substitute for legal advice.
Published on: 12 June 2020