The case for VCC security tokens

Singapore

SINGAPORE'S Variable Capital Company (VCC) vehicles have allowed more flexibility for investors, with family offices and alternative asset managers setting up VCCs to take advantage of a streamlined structure that can make it more efficient to set up shop here.

But the structure, formally introduced in January 2020, is by nature missing prescribed administrative protocols, which makes it hard for units of such funds to be traded.

Enter Singapore-based digital securities platform InvestaX. Global financial institutions UBS and State Street, among others, have partnered with InvestaX to see if it can find a beneficial way for VCCs to issue their shares in security tokens.

Hailed as a game-changer for Singapore's fund management industry, the VCC is a flexible corporate entity targeted at a wide range of investment funds. As at December last year, more than 160 VCCs have been incorporated in Singapore.

It can operate as a standalone or umbrella entity with multiple sub-funds, giving fund managers more room to pursue multiple strategies and segregate investments between different pools of investors - all without having to set up an entirely new fund.

Unlike a private limited company, a VCC is not obligated to make its shareholder lists publicly available. Traditionally, most funds in Singapore were set up as private limited companies, which are required to maintain physical certificates and a register of shareholders with the relevant authorities. A VCC also does not have to make financial statements public.

The absence of such administrative protocols led InvestaX to work on a proof-of-concept study with partners including wealth manager UBS, fund administrator State Street, legal adviser CMS Holborn Asia, and tax adviser PwC Singapore.

The study, known as the e-VCC project, aims to make it easier for traditionally illiquid private market assets to be traded, said InvestaX's co-founder and chief legal officer Alice Chen.

"On the primary market side, tokenisation reduces operational and administrative inefficiencies including reduction of intermediaries, fixed costs, removal of redundant processes and increased transparency," she said.

"For secondary markets, a tokenised VCC model would allow private market investments to be broken down into smaller fractions thereby giving investors with smaller minimum investment capacity access to alternative investment opportunities, and enables greater diversification and potentially improved risk-return."

In this form of "tokenisation", a VCC would be able to create a security token that is issued on the blockchain. It can be programmed with unique characteristics and ownership rights. In the case of the e-VCC project, each token would represent direct ownership by investors.

A typical VCC fund would operate in a two-tier structure, where a nominee director holds shares on behalf of the beneficial owners. Such a structure will remain even if shares are tokenised. This means the exchange's registry and the custodian's registry will have to be reconciled periodically after trades have been executed.

So the VCC's framework makes it conducive for tokenisation because its register of members is privately maintained. This allows tokens to be issued and registered directly on the blockchain, with updates to the register automatically captured and synchronised across networks.

The team behind the e-VCC project found in their proof-of-concept that there is "nothing explicit in existing regulations" that prohibits blockchain-native security tokens.

That said, some "regulatory certainty" could help to empower the e-VCC framework. This would mean enabling provisions which specifically cover the use of decentralised ledger technology to issue native securities. It would also include allowing VCCs to keep digital records of such securities, and for them to be treated as book entry securities which do not require any transfer instrument in the event of transfer.

It also remains unclear if stamp duty would be applied if the secondary trading of e-VCC shares is allowed. The InvestaX team suggests a specific exemption for securities transferred on the blockchain, as has been granted for the Central Depository for the transfer of securities listed on the Singapore Exchange.