IPOs Finance Significant Job Creation

Source: Venture Impact 2007, 2008, 2009 & 2010 by IHS Global Insight, IPO Task Force August 2011 CEO Survey

Certainly, there are signs that change is on the way as seen with the announcement that INX is about to float, having received regulatory permission from the SEC in the US. Indeed, INX will, itself, be the first Security Token Offer (STO) which can be sold to private investors in the US. Interestingly, the cost to INX for carrying out its IPO was only $6 million (i.e. just over 5%) compared to the average price of an IPO being 9% to 24% according to PWC. Clearly change needs to come given these massive IPO costs and the decline of IPOs. It is not just in the US that digital exchanges are being given permission to launch. In August 2020, the FCA in the UK granted approval to Archax and Gemini to offer regulated exchange services for Digital Assets. The ability to buy Digital Assets on a recognised exchange was one of the key parts of the regulatory infrastructure which has been missing for asset managers. Gemini is already trading in a variety of jurisdictions such as Canada, Hong Kong and Singapore, with Archax meanwhile claiming it has 35 assets that it wishes to start trading. As a result, Archax will enable these to be traded digitally and made available for external investors, which will potentially make the assets easier to invest into by third parties.

An alternative to an IPO is when a company carries out a ‘private placement’ and typically sells some of its equity, not via a public offering but through a private offering, to a small number of selected investors. This method of raising capital usually negates the need for an underwriter thus involving less costs but, even so, as the chart below indicates it is still potentially 40% more expensive than carrying out a STO.

The cost of a STO v traditional private placement over 5 years

Source: Survey of Entoro Capital, STO legal counsel, S&P and Pitchbook

One of the biggest cost savings claimed above is ‘Ownership Transfers.’ These refer to the costs required for a transfer agent who keeps a record of share transaction and dealing with shareholders i.e. issuing, cancelling, handling lost share certificates and investors mailings (such as sending copies of interim and annual accounts). This is a good example of how digitisation helps disintermediate traditional advisors, thus saving companies’ and, ultimately, shareholders’ money. Possibly it is of even greater significance, digitised securities allow exchanges and regulators to be able to monitor shareholder activity in real time. Therefore, in theory, using smart contracts regulators can identity suspicious activity and report directors dealing i.e. bring far greater transparency. Currently, if you wish to see who the owners of a publicly traded company on any stock exchange in the world are you are required to wait until the stock exchange (where the shares are traded) is closed, the share registrar updated and the records adjusted for any transactions having occurred during the day…… 

Advantages of STO v IPO

Source: Mark-network.com

There are several reasons why an STO is seen as being more favourable than an IPO, which include:

• reduction of issuance costs - STOs are launched using Blockchain technology, meaning Smart Contracts are used. This eliminates many of the traditional intermediary fees whilst improving the compliance controls and reducing risks, as many of the steps required to raise capital can be automated and inspected on a real- time basis;

• direct access to investors - STOs enable companies to deal directly with investors as opposed to being reliant on asset managers and investment banks, which not only reduces the costs of issuing fresh equity but disintermediates the process. STOs rely on Blockchain technology, which offers greater transparency and automated pre -investors certification, potentially enabling companies to target a wider range of investors as opposed to simply the high net worth and institutional clients; 

• access to international investors - investors into IPOs are usually targeted within the jurisdictions in which the business is based, thus ignoring other investors around the world. STOs can potentially resolve this by investors conceding to be treated as local persons or entities under the jurisdiction of issuance of the token. For example, if EU citizens wished to invest in EDSX, which is based in Switzerland, they would have to give consent to be treated as a local Swiss resident and undergo Swiss KYC checks;

• digital engagement - younger investors are much more digitally ‘savvy’ and would often rather transact remotely on a mobile device as opposed to dealing via traditional stockbrokers or wealth managers;

• ‘goodbye to trading hours, hello 24/7/365’ - STOs can trade 24/7/365, as they are designed to be digitised and automated. This means that many of the traditional paper-based administrative regulatory requirements usually carried out by the listed-company, financial analysts and brokers can be replaced using smart contracts which operate around the clock.

The activity of the IPO market in the US and Europe has been declining over the last few years while the emergence of STOs has been seen as a means of raising capital. As we witness greater institutional engagement (on the back of more digital exchanges and custody and banking services being launched), it will become easier for asset managers be more active and help increase liquidity, which will be vital for STOs to thrive.

There have been numerous consultation papers, reports and analyses written by various central banks and global financial institutions such as the International Monetary Fund (IMF), the European Central Bank (ECB) and the Bank of International Settlement (BIS). Indeed, the BIS cite that, as of July 2020, thirty-six central banks have carried out in-depth analysis into the ‘pros and cons’ of issuing a CBDC of their own. The BIS has reviewed summarised various reasons central banks cite for looking to issue a CBDC.

Motivations for issuing a CBDC

Source: CPMI survey of central banks; Boar et al (2020).

The BIS also examined three jurisdictions which have introduced a CBDC:

• China - reported to be using a mix of centralised and distributed ledger technology (DLT) designed be used alongside physical cash. The majority of Chinese citizens already pay via AliPay or WeChat pay, so these could be the competition not cash that the China’s CBDC needs to overcome. The Chinese have publicly stated their desire to have greater insight to the cash in circulation within their economy and to know ‘who, what where and when’ it is being spent. There it would seem that anonymity of who is spending what is to not be allowed!

• Sweden - given that many Swedish shops do not accept cash and Swedes use very little cash to pay for transactions, the Swedish Central Bank is using the company R2 Corda to carry out a proof of concept for a Swedish CBDC. The current intention is that the transaction will remain anonymous.

• Canada - this is interesting, as it has previously been written about in Digital Bytes that the Canadians claim they have no intention of issuing a CBDC. However, extensive trials are being carried out as a contingency in case the citizens wish to adopt one as the use of cash declines, or in response to private cryptos or stablecoins forcing them to respond. The Bank of Canada have also confirmed that it would not have access to digital retail transactions, so anonymity of who and what is being spent would remain

It was proposed in a paper written by the ECB that a CBDC could be seen as a third form of money, the first being overnight deposits lodged with the central bank, the second banknotes. A major constraint for CBDC is that it disintermediates many of the incumbent players so who are likely to resist change. The ECB report also high lights some potential advantages of introducing a CBDC

Overview of benefits that some have associated with CBDC, and related factors or requirements

Source: ECB. Eureop.eu

A working paper from the IMF - “A Survey of Research on Retail Central Bank Digital Currency” - was keen to highlight that given; “most of the major central banks and monetary authorities considering CBDC” this report had been written “not to advocate for retail CBDC issuance, but to take stock of recent research, central bank experiments, and ongoing discussions” This report believes the reason central banks are exploring CBDCs are primarily:

• to improve financial inclusion;

• to maintain the central bank’s relevance in the monetary system. 

Notwithstanding these reasons, there are other objectives such as the security required and  costs of physically handling cash, improving the efficiency of national and global payments, to assist in the battle against nefarious activities, the ability to issue “helicopter cash in a more targeted manner while also being able to introduce negative interest rates as a way to stimulate spending.

However, the IMF report does identify certain risks that central banks may wish to consider before they proceed

CBDC Risk Landscape

Source: IMF

While many central banks wring their hands and contemplate the ‘whys and wherefore’s’ of issuing a CBDC, the People’s Bank of China (PBC) has pressed ahead. China is currently testing its CBDC for small retail transactions in various regions such as Hong Kong, Macau, Shanghai and Beijing with a view to the new Chinese Digital Currency being available for all its citizens in the future.