Some platforms have tried to expand access to private markets but it’s not easy. The risk profile of private markets, coupled with their illiquidity and regulatory constraints are often significant hurdles.
ADDX, a VC-backed private markets exchange, is one platform trying to solve these issues by using blockchain technology. Set up in 2017, ADDX went into operation in 2020 after becoming one of the first digital securities exchanges to graduate from the Monetary Authority of Singapore’s fintech regulatory sandbox.
(Courtesy of ADDX)
Already, the company—which counts Singapore Exchange and the Development Bank of Japan among its backers—has tokenized funds from investors including Investcorp, Partners Group and, as of last week, Hamilton Lane. It hopes to do more.
We sat down with ADDX’s recently appointed CEO Oi-Yee Choo, a former head of investment banking for UBS in Singapore, to talk about the role that blockchain technology has to play in private markets and where it may lead in the future.
PitchBook: Tell us about how you came to develop a private markets exchange?
Oi-Yee Choo: A lot of private market deals are very difficult to access not just for retail but even for the mass affluent. One of the reasons for this is structural, the other is regulatory. Private markets are just not really designed for high net worth investors. Blockchain presented a solution that potentially could change that and is one of the most cutting-edge solutions we could see building the platform with that in mind.
Private markets products are designed with a 10-year horizon in mind; they are not designed for the individual. An individual would want multiple private market investments and therefore will prefer a smaller ticket size.
Secondly, individuals have very different financial life cycles; they cannot hold on to an asset for 10 years. So we present a liquidity solution if you need the money, for example, after five years. These are the two biggest pain points for individuals and why they have not had access. With a technological platform, you can solve a number of these issues.
PitchBook: What are the advantages of using blockchain technology for this?
Tokenization presents a solution for the lifetime of a security where the security itself is managed on a platform with code, relatively minimal manual reconciliation and workarounds.
We can design smart contracts of security, for example, a bond, and we can automate a lot of the things that happen to a bond in its life cycle as a product: coupons, when you issue the bond, when you redeem the bond, whether it is a partial redemption or a full redemption. All these processes traditionally worked through many intermediaries, but with smart contracts, they can be automated.
There are a lot of business models that are distributors, and they don’t present the trading capability or the exchange capability. It’s also about scalability. The distributed ledger technology we use itself is extremely scalable, and that’s kind of where we see the very core advantages.
PitchBook: What would you say are the advantages of expanding private markets to a broader class of investors?
I think there are two sides to this. From the investor side, every investor from a sovereign wealth fund down to the mass affluent, want to expand their portfolio diversification tools. It is no longer about the 60/40 rule, where one just invests in stocks and bonds. Today a portfolio might be 20% alternatives, 80% public markets. That’s the new mantra and we need to facilitate that.
The second aspect is that PE and VC themselves observe the potential democratization of the private market. Meanwhile, there are those in the public markets setting up alternative private market teams. There are going to be more and more product sets that are designed for private markets, and they will need to explore the boundaries of what type of investor these products should be developed for.
PitchBook: How significant are the regulatory hurdles?
There are significant regulatory hurdles. It takes the right construct to be able to get past it. For example, the MAS saw the wave of digitization and they needed to be very clear that this new wave of digitization, or tokenization, is properly aligned within the regulatory framework. Anything that’s tokenized with a blockchain is a digital security, which is the equivalent of a security—it’s like aligning electronic shares in the traditional book-entry system as the equivalent of the underlying share.
But not every country has had that equivalency in their regulatory regime—different countries have different standards. So if I have a tokenized version of, say, a Hamilton Lane fund, every country should recognize that equally as a unit of a fund, but not every country recognizes that. That’s one hurdle we would like to see removed in a manner that is harmonized across different countries.
The second regulatory hurdle is that at that moment, we operate under accredited investor exemptions, which are similar to sophisticated investor and institutional investor exemptions. We believe that private markets actually have a space in everyone’s portfolio but that will take quite a lot of time to develop with the regulators.
PitchBook: How easily can this model be replicated across other markets?
Traditional securities already face quite a lot of cross-border hurdles. For example, you have to understand whether you can sell a particular offering in Japan, or a Thai investor can buy an offshore product. There are a number of regulatory complexities that are out there and we are constantly trying to solve that.
What is encouraging is we’re seeing a lot of international investors open accounts on our platform. The only country we don’t accept is the US, as it is just very complex, but every other country can come to our platform, and sign up through the traditional KYC and AML processes. So we already see a microcosm of an international investor base on our platform and we know that there is demand.
What we’ve done quite successfully, as a proof of concept, was to work with Tokai Tokyo to distribute the funds into Japan. It took quite a long time for the regulators in Japan to give the nod for Tokai to do that. But we think that will expand, and hopefully that relationship will deepen and broaden with different products. That’s the same as Thailand, but it does take time to get regulators comfortable with the process by which we issue these tokens. We’ve already gotten quite far ahead. But that’s also because we started quite early.
PitchBook: Do you see private market access expanding to include retail investors?
Our investor base has certain demographics. They are probably in their late 30s and early 40s, and are already comfortable using web applications, putting together a portfolio on our platform and making trades. Now we have started to have institutions talk to us because they see this use case for their end clients. We’ve sort of had a pre-soft launch a while back of a B2B initiative called ADDX Advantage to help wealth managers to expand into private markets.
The technology we have already allows for retail investors, so in theory, we could break down the investment size to $500; there really is no limitation. However, a lot of these products are designed for sophisticated investors. If we were to open up to retail, I think we need to think quite hard about the type of products that make sense for retail. We need to think about the risk range of products. We can’t have something that allows for very volatile products to be sold to retail. I think that is a long way off in terms of development.
But there are a lot of products in the space that could potentially become available for retail. For example, if you look at Hamilton Lane or Partners Group, these were very thoughtfully designed, and I think it has potential for retail because it’s a very diversified exposure in those funds. The question is, do we invest in a legal team to help with documentation, the process and the design that is suitable for a $500 investment? I think that’s where, over time, it could happen.
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