Interview Q&A - Tsering Namgyal , MLEX HongKong with Capital Exchange Founder Arifa Khan (also known generically as Capital Exchange, Decentralised Global Capital Markets Platform)
- Wonder what you thought about the blockchain idea of HKEX?
Exchanges have been the first to wake up to the immediate relevance of blockchain to their operations. Nasdaq, along with others invested USD 30 million in a blockchain startup and Nasdaq started testing the trading of shares in private companies in 2015. If HKEX does throw open its new private exchange to small companies for pre-IPO it is like acquiring or extending another Over The Counter Exchange for customers who are currently too small to use HKEX. Customers of the private exchange will become IPO clients of HKEX tomorrow. This is just in line with keeping up with efforts across several industries to use blockchain for improving operations and business models. Note, it is nothing disruptive.
Exchanges have been vying for global domination for a while. NASDAQ made a bid to acquire Swedish exchange OMX for USD 3.7 billion which would have given it control over companies with a whopping market capitalisation of USD 5.5 trillion! However, even that size would be just short of 10% of the global market cap of USD 57 trillion for the securities market.
What would be truly disruptive is if exchanges reinvent themselves, and see where blockchain can re-architect the whole system - like getting rid of Central Securities depositories or Clearing and Settlement processes entirely using blockchain. Which is what Capital Exchange attempts to achieve. We are re-imagining the entire securities industry landscape and building up a simple system from the ground-up. And we are not burdened by the thought of incumbents or having to preserve their continuity. So, a large number of players simply do not warrant inclusion in our new model.
The entire securities industry, of which exchanges are just one spoke in the wheel, is ridden with opacity, large duplication of intermediaries, and unnecessary complexity which has no place in today’s technological stack.
- Will our platform will just be for pre-IPO financing? And what are some of the main challenges it would address?
In the current system, pre-IPO financing is met by several fintech models: peer to peer crowd-funding, Equity crowdfunding by institutions, Angel syndications like Angel List, incubators, even smaller offbeat exchanges like Over-The-Counter exchanges, and most recently the Initial Coin Offerings - ICOs.
Capital here encompasses equity, debt and even syndicated loans. So we are not talking companies of a certain size or stage or even of a certain jurisdiction. But almost every entity that taps the global capital markets, of any size, of any nationality, and for any form of a simple security.
Himalaya Capital Exchange’s vision is to offer a new age architecture for the entire securities industry, not just in pre-IPO stage, namely in :
1. Pre-issuance of capital
2. Issuance - the raising of capital, and
3. Post-issuance - the servicing of investors
The Pre-issuance process overlaps not just the exchanges, but also the role of investment banks in book-building, and in determining the issue listing price. The processes here are eminently suited to being replaced entirely by smart contracts. This is the easy part to replicate in Himalaya Capital Exchange.
The Issuance phase: This deals with matching of needs of investors with issuers. This presupposes access to an investor database, which currently only the banks and exchanges are able to provide because of their hegemony in the market. This is a more challenging part of Himalaya Capital Exchange’s vision because we have to build a two-sided marketplace with adequate traffic of investors and issuers. However, once this model takes off, the network effects will be so huge that savvy future customers might prefer to entirely transact on a digital platform like Himalaya Capital Exchange.
There are other highly sophisticated centralised mechanisms involved for matching order books, allocation of shares, clearing and settlement of securities, and moving securities physically to investors/owners, which are quite simple to manage in the new framework.
Post-Issuance: Distributing dividends, performance reporting and other admin tasks can be performed by smart contracts much more easily and cost-effectively. This is again easy to achieve with Himalaya Capital Exchange.
The problems I see in the current system are manifold:
1. In the pre-issuance phase, banks have conflicts of interest and are not entirely aligned with maximising client value. This leads to over-indicating the issue price during beauty pageants in order to give themselves favourable chances of winning a role, and under-pricing the issue later so as to make it easier on themselves to fill the order book. Clients have almost entirely no control over this process of book-building or setting the issue price. They are dependent on feedback of banks. As we all know, banks have several masters to serve. Their research and origination departments have to work in tandem, no matter what the Chinese Walls have you believe so there is no reliable and transparent information that clients can use for their advantage! They are at mercy of banks. The best they can do is to maximise competition between banks, before selecting some of them for lead manager and book-runner roles. But the entire system as it stands today disadvantages the client, from a game theory point of view.
So customers have no control over issuance price.
2. In the issuance phase, clearing and settlement are rather tardy with a 2-3 day timeframe.
Clients do not know who their customers are, so they do not control the entire interaction, messaging and communication with their clients barring for roadshows. This is a great foregone opportunity to build relationships with clients in one of their significant moments - when they have decided to become your shareholder.
Clients have no control over which investors get allocation of shares, and how.
- HKEX announcement says that it is outside the securities laws. What regulatory hurdles that you might face? I read a report on the Internet which says that you are currently only targeting one jurisdiction? I wonder if that would be India or anywhere else?
Currently, very few jurisdictions like the State of Delaware, USA are blockchain friendly as far as decentralisation for securities issuance is concerned. We foresee having to register for various licenses in several jurisdictions. However, the licensed entity will be a decentralised organisation which will be optimising client welfare, and definitely not centralised as the current incumbents who have to maximise their shareholder interests. For a successful network, the client base is the public at large, so what can serve customer interests better than an entity that espouses decentralisation in letter and spirit.
Logistically, it is easier to start the operations from one jurisdiction which is most regulation friendly, and then expand to others. Even the biggest platforms like Facebook or Uber started from one place. For us, the starting point is likely to be some place in and around Europe rather than India. Though India has one of the world’s most sophisticated equity capital markets, the Indian consumer is simply not at the same learning curve as in other parts of the world. Many governments are quite protectionist in their thinking. By protectionist, I mean they intend to protect the incumbent institutions and not the common man. So, we are offering decentralisation to the common man, which completely gets rid of opacity and any rent-seeking made possible by opacity and proponents of opacity. However, when large countries like India adopt a new technology, the technology is sure to reach its inflection point and truly reach the common man. So a good test for any philanthropist who claims that his technology is here to offer redemption for the poor, is to see how it fares in countries like India.
We are creating something that has never been conceived before, so there will be regulatory hurdles, which we will cross step by step. A multinational exchange of this sort befuddles even the regulators as was seen when NASDAQ was trying to acquire control in NSE.
There is no doubt that a technology such as this benefits the ultimate consumer hugely, and threatens the status quo of incumbents a great deal. So this deserves to be brought to life, and I am ready to commit myself to seeing this vision come true, no matter what the hurdles. There will be resistance and opposition from large entrenched incumbents, and many unforeseen hurdles on our way, but nothing is going to stop me!
- ICO and what funds you are looking at. And when the project will go live?
Our ICO is scheduled to be completed later this year, and the platform will be live sometime in 2018. Given the complexity of the system that we are trying to replace, and the multiple interwoven aspects that need to be considered, a centralised player would take anything like an year or more. However, we are radical blockchainers so we aim to bring it to the masses in 2018.
I gave a talk in Kiev earlier this year where I asked - Are we as a society ready for decentralisation? A few months later, I am surprised to find the answer is yes, in most industries!
We will utilise this time-to-launch to build a global community of staunch believers in decentralisation as the way forward for societies.
We have a well laid-out technical roadmap which envisages building of a decentralised exchange, as part of the architecture comprising several smart contract modules. Since the processes in securities issuance are similar, the same architecture can serve the debt securities like the corporate bond market, Treasuries and syndicated loans.
Once the technology platform is built, we then have to operationalise through regulatory licenses, which entails applying for licenses in multiple jurisdictions which is an expensive process.
We are looking at raising USD 50 million for the ICO.
Some aspects like deciding on the right blockchain protocol may take longer than some others. Because existing blockchain protocols all have some limitation or the other that render them each inefficient and inadequate for handling the volumes, throughput and security required for the scale and volumes of current centralised exchanges. For example, Visa has far in excess of 2000 transactions per sec, whereas Ethereum the best blockchain available can process 30 transactions per sec as of now. However, the blockchain industry has attracted some of the most astute and aggressive research and we can expect ongoing improvements. We are also not looking at replacing an Over the Counter exchange entirely with a decentralised one overnight. So, we will have lead time to improve on system and process efficiency once the platform is launched. For example, we expect that the decentralisation believers will be delighted to be able to transact directly without a bank in the middle and do not care if their security purchase gets confirmed in a minute rather than in a milli second. High frequency algorithmic trading and AI driven trading are still a way off for us.
We have identified a Blockchain protocol that is most suitable for our platform. It has been conceptualised by well trusted and respected thought leaders of crypto. However, the protocol has not been built and Himalaya Capital Exchange might be the first to begin building this. Our technical roadmap takes into account several stages, and in the final stage of the solution we would be able to match even the speed and throughout of current exchanges! Matching the speed and volumes of centralised systems was one obstacle that had not been overcome by Blockchain platforms earlier, which this new protocol would solve. The concept has been full laid out in detail and peer-reviewed, and once we have the ICO funding we will execute the platform.