In January last year, the variable capital company (VCC) structure was unveiled by the Monetary Authority of Singapore (MAS) and the Accounting and Corporate Regulatory Authority (Acra). VCCs are not particularly revolutionary: they are well established in the Cayman Islands and Luxembourg, for example, and used extensively by international investors. However, their relative simplicity, privacy, flexibility and low cost structure has attracted asset managers’ interest. The previous legal options for setting up funds in Singapore were cumbersome and expensive and involved levels of transparency that made some investors uncomfortable. And the proof of the pudding is that VCCs have taken off, with more than 300 launched in the first year. The authorities have since stopped publishing figures related to the number of VCCs being created.

“For Singapore this is an important industrial strategy,” says Hugo van Kattendijke, head of financial intermediaries Asia-Pacific at UBS Wealth Management. “They identified that the corporate structures for funds were not really competitive, when you compare them to international fund centres such as Luxembourg. They identified what was needed and then they built it.” 

Irfan Ahmad, Asia-Pacific product lead at State Street Digital, says VCCs helped create a specialised corporate structure providing fund managers with flexibility in terms of operations so they can achieve economies of scale and generate savings. He explains that VCCs can accommodate traditional and alternative asset classes and can include retail and non-retail strategies. 

He adds that the initiative also aims to bring tokenised assets into legislative frameworks that borrow from the treatment of traditional assets, from an operational, tax and legal perspective. 

Mr van Kattendijke explains that the main issue pre-VCC was around privacy, where it was possible in Singapore to uncover the ownership of funds. Many investors prefer to keep that information private. The vehicle can also take advantage of Singapore’s tax treaties with other jurisdictions, which outnumber those of many offshore financial centres. 

Other important features are operational where numerous funds can sit under an umbrella structure, which handles many of the governance requirements and therefore saves costs. There are also considerations around tax efficiency and structural flexibility: VCCs can be applied to open and closed ended funds.  

Singapore studied the best practices of other VCC regimes and honed them to suit its local environment. The authorities are hoping that Singapore, with its good reputation for stability and integrity, can position itself as a more ‘respectable’ alternative to the many offshore financial centres. Also, until January 15, 2023, MAS will cofund up to 70% of eligible expenses up to a maximum amount of S$450,000 ($334,00) paid to Singapore-based service providers to establish a VCC. Singapore hopes these measures will transform it into a major Asian centre for funds, much like Luxembourg is for Europe.

The digital twist

However, the VCC structure could be about to get another boost thanks to digitisation, which is likely to further enhance Singapore’s attraction as an asset management centre. The initiative is born out of Singapore’s Financial Services Technology Innovation programme, which supports fintechs. The firm behind this latest twist on a VCC is digital securities offerings platform, InvestaX. In September 2020, MAS awarded the firm a grant to carry out a proof of concept (PoC) to digitise VCC securities. On September 30, it announced that the participants in the PoC, which included UBS, State Street, PwC and law firm CMS, were able to determine the lifecycle and workflow process behind the tokeniszation of the VCC structure.  

It is envisaged that securities digitisation will mainly apply to funds holding illiquid assets, be they real estate or private equity type investments. 

“This is a perfect vehicle for us to try to tokenise because at the sub-fund level there is no requirement for that to be held with a public registrar like Acra,” says Alice Chen, general counsel and co-founder at Investax. “Using DLT [distributed ledger technology] removes a lot of the intermediaries and everyone can have access to the same ledger, and it really provides the promise of what DLT is meant to be used for.” 

She explains that the process was further helped by an amendment to the Electronic Transfers Act, which recognised instruments in digital form and is technology-neutral. 

“With that amendment we effectively could use blockchain to represent those shares at a sub-fund level, that is, only issuing shares on blockchain,” she says. This is a step beyond simply tokenising paper-based securities, and instead sees them issued in digital form directly on a blockchain. This introduces greater simplicity and lower costs. “If you go directly to native blockchain issuance you only have one ledger,” says Ms Chen. With tokenised securities there are typically two ledgers, one for the original paper-based securities and one for the digitised version, and both need to be updated and reconciled if one is changed. Ms Chen continues: “It removes the intermediary, the back-end processes, the manual reconciliation that’s required and also provides visibility for investors and allows investors to hold their assets directly, rather than through a nominee structure.”

Matthew Nortcliff, a partner at law firm CMS, says there is a big advantage when issuing shares directly on a blockchain because the whole process starts in a decentralised fashion and disintermediation begins immediately. He explains that it also cuts out the rigmarole of tokenising paper-based securities.  

He believes there is a noticeably big cost and time benefit when it comes to secondary trading. He explains that it takes weeks to sell stakes in private equity and real estate funds set up under traditional legal structures and those shares are typically only available to institutional-type investors. “Whereas with a blockchain native security it should be as easy as buying and selling Facebook shares,” says Mr Nortcliff. 

He adds that apart from all the efficiencies derived from using blockchain technology, these funds remain properly regulated. “The groups involved in the PoC have to have governance and gold-star compliance by their nature,” he says. “I think the PoC shows that the risks are no different to any other approach, and actually the reality of doing things on the DLT is that it should actually be more secure.”

New secondary markets

According to Mr van Kattendijke, the consequences of digitising illiquid funds could be profound. “Access to these private market opportunities is typically relatively restricted,” he says. This is due to a variety of factors from high distribution costs through to regulatory investor protections such as suitability requirements. These prevent fund managers and intermediaries from offering highly illiquid, volatile or complex products to investors who do not have the required investment experience and/or significant wealth.

Digitisation effectively democratises these otherwise exclusive markets. “If you are able to attract a good population of market participants into trading that security token…  the secondary market is going to be much more liquid than the underlying asset itself,” he says. He explains that digitisation allows the slicing and dicing of the fund’s shares into smaller parts, potentially allowing lower-net-worth investors to become involved. The minimum ticket size to participate in some traditional private equity funds can range anywhere from $250,000 to tens of millions of dollars. 

Mr van Kattendijke wonders if this democratisation of the investment landscape will prompt regulators to rethink some of their suitability rules for currently excluded investors. “Do we want to exclude that person from making good investments?” he asks. “The power of tokenisation for private assets is to potentially create liquidity where there is none today and to substantially reduce the minimum price of access.” If financial inclusion is to be given greater priority, tokenisation may enable retail investors to invest a small proportion of their savings in such assets – so they can benefit from their performance – without the danger of losing all their wealth if they go wrong. 

There is a debate within the industry over using permissioned/private or permissionless/public blockchains. The latter certainly offers the best potential in terms of driving secondary market liquidity because it is open to anyone to participate. But it has the disadvantage that it is difficult to control or to make amendments due to its decentralised nature. 

Many in the industry therefore lean more towards private blockchains, where participants can be vetted, making it easier to establish common rules and to make amendments where necessary to fix glitches, for example. The use of private blockchains may be necessary as some types of investors might need to be excluded for ‘suitability’ reasons. 

In the case of the eVCC PoC, the Tezos Foundation and Hashstacs provided support as public and private blockchain protocol providers, respectively. Tezos is a decentralised, open-source blockchain network able to execute peer-to-peer transactions and serve as a platform for deploying smart contracts. 

Meanwhile, MAS is looking into granting recognised market operator (RMO) licences for platforms trading private digital securities. An RMO is one level below a recognised stock exchange such as the Singapore Exchange. 

“What MAS does really well is to be open to the concept, but also is very stringent on the requirements so the only groups that are going to be operating these platforms will have been stress tested by them in terms of compliance and protocols,” says Mr Nortcliff. “The biggest advantage Singapore has is that there will be security and comfort, and MAS is engaged with that.” 

The future

Indeed, the industry is full of optimism over the potential for eVCCs and their importance to Singapore as a financial centre. “Singapore is a regional hub for innovation in fintech, and has a rich history of fostering an environment that enables progressive change in the industry,” says State Street Digital’s Mr Ahmad. “We believe that the work we’ve undertaken in this project, to be foundational as the industry, considers the benefits of utilising digital securities and the transparent and immutable nature of the underlying blockchain technology.” 

Ms Chen believes that eVCCs help future-proof Singapore as they align perfectly with the global digitisation trend. “The eVCC project has demonstrated, among other things, a willingness among ecosystem participants to think expansively and leverage new technologies to create favourable conditions for fund creation and investment,” says Mr Ahmad. He anticipates that the regulatory changes around digitisation could foster a new breed of fund managers and fintech start-ups looking to take advantage of Singapore’s new digital financial market infrastructures.  

“There is a huge pool in Asia-Pacific of high-net-worth individuals, and they are increasingly younger. So, they are either entrepreneurs themselves, or they are second-, third-, fourth-generation wealth and they see themselves as digital natives,” says Mr Nortcliff. He adds that they are already very active in cryptocurrencies and digital assets such as non-fungible tokens and should therefore naturally take to eVCCs.   

“I think you completely open up how much capital your funds can raise and how dynamic they can be. So from our clients’ perspective, that’s why they’re looking at it, and why it is important for Singapore,” he says. 

Ms Chen explains that the first phase of the InvestaX project involved accepting fiat currencies. This nonetheless meant having separate cash and digital asset custodians, meaning that reconciliation between the two is still necessary. 

For phase two, InvestaX would like to include the use of cryptocurrencies or stablecoins to facilitate the actual settlement transaction, which would see more automation. “I think that would really answer a lot of the unknown questions that we didn’t get to explore [in phase one], in terms of delivery versus payment and the interaction between cryptocurrencies and digital securities,” says Ms Chen.

She explains that InvestaX hopes to launch a live micro-portal for eVCCs sometime in the first quarter of 2022. There is not yet a set date for phase two, with InvestaX due to submit a proposal to MAS. 

According to figures published by think tank Z/Yen earlier this year, Singapore ranks fifth among the world’s top financial centres. In a 2021 report, Deloitte placed Singapore in second place as an international wealth management centre, and praised its competitiveness, business neutrality and fintech innovation. However, it flagged weaknesses around domestic capital markets and tax policies that are not as competitive as they could be for high-net-worth individuals. VCC vehicles, boosted by digitisation, are clearly an effort to address some of those shortcomings.  

But rival financial centres are every bit as alive to the possibilities promised by digitisation and in some areas are ahead of Singapore. Though not necessarily specifically related to VCC-type vehicles, Luxembourg recognised in January the use of DLTs for issuing and settling dematerialised securities. The Cayman Islands, meanwhile, are not just a leading centre for funds, but also for those involved in digital assets. Jersey, a centre for alternative funds, is also a keen promoter of digitising finance. 

Singapore is certainly upping the ante for rival financial centres and will no doubt force others to accelerate their own digital initiatives or risk losing business. If nothing else, the city state should be able to cash in on its good reputation, its innovative bias and, possibly just as importantly, its location.