Practical Considerations for IEO Exchanges

 1.         Introduction: What is an IEO?

An initial exchange offering (“IEO”) is a digital fundraising mechanism where an issuer offers digital assets to investors through an IEO platform in exchange for funds.

In regulating IEOs, the Securities Commission Malaysia (“SC”) has issued the Guidelines on Digital Assets (“DA Guidelines”). Under the DA Guidelines, an IEO platform can only be operated by IEO platform operators who are registered with the SC[1].

We offer our thoughts on practical considerations of an IEO.

2.          Practical Considerations of an IEO

2.1     Asset tokenization

Asset tokenization denotes “loading” a physical asset or contractual right into a token run on a blockchain. There are many compelling reasons to do so, including ease of transacting and settlement and transparent proof of ownership.

However, without legislation which integrates and synchronizes the physical and digital world, asset tokenization may be challenging. For example, if a piece of land in Malaysia were tokenized, who would the law recognize as the legal proprietor of the said piece of land – the person in the register document of title retained by the government pursuant to the National Land Code or the holder of the token?

In the absence of such legal framework, it is possible to construct a legal “bridge” between the token and its underlying assets via use of custodians/trustees. In such a structure, the custodian/trustee will be the legal owner of the underlying physical asset, and will recognize the token holder as the beneficial owner of such asset. However, use of custodians/trustees may nullify the promise and features of blockchain technology particularly immutability and decentralization.

2.2     Secondary trading market 

The success of IEO as a bona fide fundraising avenue in Malaysia may be heavily dependent on the vibrancy of a secondary market for digital assets issued pursuant to IEOs. One may deduce that an investor will be reluctant to invest in an IEO unless the exit path of his/her investment is clear.  

Putting aside whether there will be sufficient natural liquidity of the digital assets (this will be dependent on government policies and private sector initiatives to co-create a vibrant IEO ecosystem), two other issues bear mentioning.

First, the DA Guidelines provide that the trading of digital assets in the secondary market is not absolute – it would be subject to the approval of the SC.  

Second, SC-registered digital asset exchanges must be willing to facilitate secondary trading in a manner which satisfies SC’s requirements, without subjecting digital asset holders and/or issuers to restrictive/stringent/onerous requirements.

2.3  Accounting treatments for digital assets

Digital assets challenge traditional accounting standards. 

Currently there appears to be no agreed accounting standard in Malaysia on how to account for digital assets.

Without clarity in how to account for digital assets, entities/corporations may find it challenging to participate in any investment in IEO. The universe of subscribers/investors of digital assets issued pursuant to an IEO will thereby be unnecessarily limited to individuals.

For completeness, there are some who may have argued that digital assets meet the definition of intangible assets under the Malaysian Financial Reporting Standards (MFRS), and should be treated as such. We suspect this offers limited help to expand the universe of subscribers/investors to include entities/corporations as volatility in the price of digital assets (particularly if market depth of secondary trading is poor) could result in impairments, which in turn affects such entities/corporations’ profit and loss statements.

3.       Conclusion

IEO is no doubt an innovative fundraising mechanism which balances the need to embrace innovation and the importance of safeguarding of investors’ interests. However, in order to grow the IEO ecosystem, a coherent and comprehensive regulatory framework/standard must be put in place to address, amongst other things, the practical considerations highlighted above.