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SINGAPORE: Just two weeks after it announced that adult EZ-Link cards and NETS FlashPay cards were to be phased out in favour of the SimplyGo platform for public transport, the Land Transport Authority (LTA) walked back its decision on Monday (Jan 22).
The replacement of legacy stored value cards, initially planned for Jun 1, caused a public uproar about whether it was necessary to change a system that was not broken. It didn’t help that the platform’s name lent itself well to memes and jibes online – it was “SimplyNo” for many. Commuters were unhappy at not being able to view the fare charged or card balance at the point of transaction with SimplyGo. LTA quickly explained that SimplyGo’s transactions are handled on the backend, compared to the legacy card transactions which are processed directly at the card readers. Displaying such information would cause a longer processing time and a “slow down (in) the entry and exit for commuters”. Indeed, people in Singapore have come to expect more from a Smart Nation, not a technical change that felt like a step back. What went wrong, what led to such a dramatic reversal, and what we can learn from this debacle? SYSTEMS SHOULD SERVE PEOPLE It is unusual for a government agency to introduce changes that create new challenges instead of addressing existing ones. After all, systems should serve people – and not the other way around. In the two weeks between announcement and reversal, citizens wondered why there was a need to cease the existing ticketing system when it worked perfectly well to accommodate both legacy EZ-link cards and SimplyGo, and could be used for public transport, retail payments and motoring needs. Why rely solely on a new system that would impose a less user-friendly experience? And why would the government ask the public to accept a compromise instead of working on an actual upgrade? A one-size-fits-all approach may not suit everyone. According to LTA, around two-thirds of adult card fares already use SimplyGo, which means the legacy system and its distinct features still appeal to commuters who make up the rest. Many of the commercial issues that usually drive system changes should not apply in a public service context. For example, operating cost is important and speaks to discipline in public spending, but it should not overshadow other considerations such as ease of use and cost to the user. In this case, displaying a low balance on a stored value or pre-paid card would indicate to the commuter that a top-up will soon be required, and could even be critical to those with tight finances. With SimplyGo, an insufficient balance is met only with a “card failed” message. It’s puzzling when we see that the government does accommodate different groups in other areas. Households can redeem their Community Development Council (CDC) vouchers digitally via Singpass or collect physical vouchers at community centres, for example. TECHNOLOGY AND HUMAN PSYCHOLOGY While people will always have to evolve with technology, it is imperative that the authorities do not alienate people from the merits of a promising vision like the Smart Nation by disregarding human psychology when implementing changes. It is implied that the proposed transition to SimplyGo for adult commuters is a data-driven decision. LTA said that there is “growing adoption” of SimplyGo and that it carried out market testing and focus group discussions. But customers are notoriously conservative in terms of payment behaviour. Even something as ubiquitous today as QR code payments took a long time to become mainstream. Once they become accustomed to a certain mode of payment, they are loath to change as it means wasting precious time learning something new, as well as subjecting to potential public embarrassment at the point of sale if their payment is unsuccessful. Users are likely to oppose change unless they perceive clear and meaningful benefits. For example, the initial introduction of stored-value tickets on the MRT provided an obvious and huge benefit to the public and was quickly adopted by customers. The argument that two-thirds of adult fare transactions use SimplyGo ignores the people who make up the remaining one-third. Singapore’s endeavour to becoming a Smart Nation will be compromised if a segment of the population perceives themselves as being progressively excluded, such as older folks who are not using concession cards but who may not be tech-savvy enough to manage their fares with an app. MISCOMMUNICATION AND LACK OF FORESIGHT Yet, highlighting the benefits of a new system isn’t sufficient to win over legacy users. LTA’s transition announcement focused on promoting the advantages of SimplyGo: On-the-go viewing of fare history, card top-ups with their mobile phones, and the option to block lost cards remotely and prevent unauthorised transactions. However, they failed to clarify why the legacy system will cease to exist and what the advantages are in doing so. This likely contributed to the public backlash. What does it mean to a layperson that the legacy system was “nearing the end of its operational lifespan”? If people were told that it would cost an additional S$40 million to keep the old system running, might more have agreed with the move? Would it be worth this reduction in convenience? Even if public uproar has led to a policy reversal after an unnecessary step in the wrong direction, the entire SimplyGo debacle reflects a lack of strategy and user-centricity. In a Smart Nation, it should not be too much to ask that technological advancements meet the expectations and needs of the public. Emir Hrnjic is Academic Director of UCLA-NUS Executive MBA, NUS Business School, and Head of FinTech Training, Asian Institute of Digital Finance, National University of Singapore (NUS). Gordon R Clarke is Managing Director of Monetics, a Singapore-based payments consulting firm.
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Getting certified on Web 3.0
Web3.0 is the topic changing the future of money, finance, and digitalisation TUE, NOV 02, 2021 HOLDERS of an Singapore Fintech Festival (SFF) pass can acquire a Web 3.0 Knowledge Certificate in Financial Services issued by The Asian Institute of Digital Finance (AIDF), National University of Singapore (NUS). Here are some details on the verifiable digital knowledge certification from Emir Hrnjic, head of fintech training, AIDF. 1. What is the Web 3.0 Knowledge Certificate in Financial Services? AIDF is democratising the Singapore Fintech Festival (SFF) content by converting the knowledge shared by the global leaders into a signature knowledge certificate. As the world’s largest fintech event, the festival will host keynote speeches, fireside chats, and panel discussions with top-notch global speakers. They will share their knowledge during these sessions and, thus, will provide a knowledge base for Web 3.0 Knowledge Certificate in Financial Services. There will be 45 sessions over first three days (15 sessions per day) and each session will address two questions that will be tested. The content is designed in four parts: Inspirational Openings, Basics, Deep Dives, and Global Trends. SFF participants need to pass a test for each module separately to be eligible to receive an online Knowledge Certificate by AIDF (for instance, those who pass the first module will receive Knowledge Certificate – Designing Financial Services on Web 3.0). Tests comprising 30 questions per module (total of 90 questions) on fundamentals of Web 3.0 in financial services are designed by global experts. After passing the test, successful participants will receive a certificate for corresponding module and those who pass all three modules will earn an overall certificate – Web 3.0 Knowledge Certificate in Financial Services by AIDF. SFF will host top-notch speakers from all over the world including governors of central banks, CEOs of major financial institutions, and founders of leading crypto and blockchain companies. This year, SFF will feature a more diverse set of global experts. Non-conventional experts will join conventional leaders from central banks, policymakers and finance professionals to shape SFF discussions. 2. Why were these topics selected for the certification series? Web3.0 is the topic changing the future of money, finance, and digitalisation. The certification program will contribute to building the foundation for understanding the impact of Web 3.0 in financial services. There will be following three modules across three days: Designing Financial Services on Web 3.0, Building Financial Services on Web 3.0, and Sustainable Financial Services on Web 3.0. 3. Why is this certificate useful for fintech practitioners? Fintech firms and traditional financial institutions are in need of fintech experts at various levels. As the society has been facing various challenges in digital finance, fintech applications and the demand for fintech talent have been exponentially growing. According to a recent survey, Singapore’s fintech firms are struggling to attract and retain talent. To add, 94 per cent of the fintech firms that responded to the survey stated that they’re facing a talent shortage. These knowledge certificates are aiming to help meet the growing demand for fintech talent as participants will acquire knowledge in Web 3.0 that is applicable and directly related to the industry practices. Can a CBDC Become a Global Currency? (as published in The Business Times on September 1, 2021)9/1/2021 By Gordon Clarke and Emir Hrnjic
While the overwhelming majority of central banks in the world are actively exploring Central Bank Digital Currency (CBDC), the People’s Bank of China (PBoC) has already launched the pilot of the digital yuan. The PBoC has also been following an expansionist policy for several years regarding use of its currency for settling international transactions, with around 30 offshore clearing centres around the world, as China moves to disengage its foreign trade from dependence on the U.S. dollar. According to the latest SWIFT data from 2020, most SWIFT transactions are settled in Euro (37.8 per cent) or the U.S. dollar (37.6 per cent), while the RMB (the exchangeable version of the yuan) was only used in 1.7 per cent of transactions. While it seems like a long shot that RMB could replace the U.S. dollar or Euro as a leading global currency in the near future, it is an open question whether digital yuan (or any CBDC) could bring benefits to global trade. WEAKNESSES OF GLOBAL CURRENCIES Regardless of the industry or the nature of goods and services, the weaknesses of the current system of global currencies in cross-border trade are numerous. When a country’s currency is used as an international trading currency, it has to be “out there”. In general, this implies that the country is buying more from the rest of the world than it is selling, while the balance is held and used by other nations for their cross-border transactions. This creates a fiscal deficit, which may create a problem for heavily indebted countries. Global use of a physical currency creates a huge temptation for forgers, especially for the U.S. dollar which has not traditionally been well designed to resist forgery. Hence, some series of U.S. dollar notes are rarely accepted abroad. Moreover, it creates artificial shortages of physical currency, especially for poorer countries. In the Maldives, for instance, physical dollar shortages are common because visitors draw local currency in cash from ATMs and then exchange excess amounts for hard currencies when leaving the country. Since local companies often deposit the hard currency in overseas banks, this leaves the local banking system short of hard currency for international trade. Finally, de-risking by major international banks makes it increasingly difficult for domestic banks in small countries to acquire and maintain correspondent banking relationships for major currencies like the USD, which are essential in the current system of trade settlement. More accessible alternatives would aid development. CBDC TO THE RESCUE? While blockchain-based cryptocurrencies like bitcoin have excessive volatility and dubious reputation, the blockchain technology is undoubtedly innovative and potentially greatly beneficial in circumstances where sensitive information needs to be efficiently and securely shared among large numbers of users such as in cross-border payments. Crypto company Ripple, for example, has already built up a network of 300 major banks across more than 50 countries conducting blockchain-based cross-border transactions. So, what would have to happen for one or more CBDCs to become an acceptable medium for settling international trade transactions? Just like fiat currencies, CBDCs have a central bank’s backing. They will be exchanged in FX markets, and via on-line exchanges such as Coinbase, and they can enable settlements between individuals and businesses. They can be more secure, less volatile and more energy efficient than private cryptocurrencies. Additionally, they can streamline trading via smart contracts whereby both information and payment travel together under the control of programmable governance rules. If two parties to a transaction wish to use, say, the digital yuan as the medium for settling their transaction, the only constraints are whether the buyer has access to the currency and whether there’s a mechanism for adding the transaction to the digital RMB blockchain. That’s where the constraints may arise because a CBDC blockchain is controlled by the central bank and hence the central bank has to provide access to the mechanism that adds the transaction, either directly or via the domestic banking system. If parties are in different countries, this will depend on the policies of central banks. ALTERNATIVE TO SWIFT? The cost of international funds transfers is another important factor. Using SWIFT for payments is increasingly efficient, but still expensive. Since SWIFT only provides the messaging, transfers require correspondent banking relationships to manage settlements. Ripple, for example, does not require correspondent banks, as its members settle in the Ripple XRP token and pay out in their own domestic currency. Once CBDCs are available as an alternative to SWIFT, however, we can expect major changes, even if SWIFT retains a messaging role. Since CBDCs settle directly without a third party, they would enable faster transactions across the world at low cost, thus facilitating trade. Small trading nations would be at less of a disadvantage as the global trade playing field could be levelled a little. So, the main requirements for global trading currencies can be met by blockchain–based CBDCs at lower cost, with quicker execution and less risk. Cryptocurrencies of major trading nations could be trusted as they are transparent and exchangeable at a known stable rate that can be negotiated in advance. Moreover, trading via cryptocurrencies addresses the weaknesses discussed above. It could remove the requirement for settlement using correspondent bank accounts. This in turn removes some fiscal risks of a reserve currency nation as the issue of the global cryptocurrency can be controlled without requiring an adverse trade balance. Furthermore, appropriate blockchain technology can virtually eliminate the risk of forgery and various types of fraud. Issue can be managed instantly to any central or commercial bank that needs it, so that small country physical shortages would no longer be a problem. Finally, an arrangement between powerful CBDC issuers, perhaps via the Bank for International Settlements (the central banks’ policy forum) could avoid dominance of any one currency, while a standard basket of currencies could be used for global trade. This would avoid control by a single nation and facilitate open markets. A CBDC based on the Singapore dollar, which already represents a basket of major global currencies, might be a good place to start. Regardless of numerous benefits, actual implementation would be more challenging, as there would have to be a political will among central banks and global commercial banks to reach a consensus. Rules which reduce the dominance of big players would give everyone a fairer chance, but at the moment, the big guys have too much power and prefer skewed playing field. By Gordon Clarke and Emir Hrnjic
Digital payments have exploded during the COVID-19 pandemic. The recent Mastercard New Payments Index found that there were 1 billion more contactless transactions worldwide in the first quarter of 2021 compared to the same period one year before. Almost two thirds of survey respondents claimed they have tried a new payment method they would not have tried under normal circumstances. Moreover, the report revealed that 93 per cent of respondents will consider using new type of payments such as cryptocurrency, biometrics, contactless or QR code in the next year. The common factor is that all the innovative methods are contactless. Finally, 71 per cent of people say they expect to use less cash moving forward. What is driving this rapid shift to contactless payments? COVID-19 IS DRIVING MASS ADOPTION The pandemic-induced worldwide lockdowns disrupted businesses and forced a shift to different modes of doing business including a rapid shift to digital payments. Covering 6 large countries in Southeast Asia, the e-Conomy SEA 2020 report emphasised accelerated digital adoption during the pandemic and revealed that the total number of Internet users in the region increased by 40 million to a total of 400 million in 2020. Moreover, Internet sectors surpassed SGD100 billion gross merchandise value (GMV) in 2020, while they are estimated to surpass SGD300 billion in GMV by 2025. The average proportion of cash transactions in Southeast Asia plummeted from 48 per cent before the pandemic to 37 per cent. As the increase in digital payments is likely to turn into a lasting payment habit, gross transactions were estimated to reach USD1.2 trillion by 2025. The pandemic has also highlighted the importance of hygiene. While a recent research study found that cash may carry as much bacteria as the toilet seat, the World Health Organization encouraged the use of contactless payments instead of banknotes that may potentially carry the Covid 19 virus, as well as other dangerous viruses and bacteria. INNOVATIVE TECH The customer experience of digital cash – ease of payment, convenience, and low cost – has improved dramatically. For instance, many countries in Asia have safe and efficient digital payment at zero cost. Covid-period fee waivers by Central Banks in several countries have revealed the sensitivity of digital payments to pricing. Cash and cheques are still perceived as free, despite their security and hygiene risks and their very high processing costs. Harnessing new technologies, digital payments are much cheaper for users and providers. Improving the convenience of digital payments means moving on from the current clunky smart phone technology. Screen and battery technology limitations burden users with a huge brick – almost back to the weight of the original mobile phones from 1980s. Key factors in the adoption of digital payments are simplicity of function, reliability, and ease of use. In order to make the next big step, the “form factor” of mobile devices has to be revolutionized away from “bricks” to convenient wearables. Real benefit will come from vastly improved performance for simple transactions with innovative devices such as smart watches, rings, key-fobs, bracelets, and other wearables that we can unobtrusively carry all the time. The technology for wearables has existed for a while and is widely used in the health and fitness tracking industry but not yet in payments. Payment applications need to be integrated with flexible technology and smaller power sources. Therein lies a huge opportunity for FinTechs to innovate and exploit a market that is waiting for the breakthrough. The innovations that have fuelled the digital revolution are going to continue. Dependence on cumbersome smartphones will end and voice operation of devices will become the norm. Reliability, inconsistency, and power problems will no longer be a limitation. AI-driven personal assistants will become genuinely helpful and allow extremely flexible interaction with the support of a vast range of tacit knowledge. Poor customer support from “Big Tech” and the continuous confusing upgrades that disrupt the user experience will be a thing of the past. While Google’s initial attempts at wearable technologies such as glasses and watches left much to be desired in terms of useful functionality and ease of use, there is a renewed momentum in the business. But there needs to be a lot of technological and marketing experimentation to get to the massive adoption that smart phones experienced. Real change will follow real benefits. MILLENIALS ARE DRIVING THE CHANGE As digital cash is outstripping use of paper, it has begun to generate resistance to restrictions on use of paper currency. Reduction in cash usage and the availability of cash-accepting points of sale has caused pushback from consumer groups, especially in advanced “less-cash” countries like Sweden. This is not surprising as people typically resist change, and ease of use problems await the technology breakthroughs we have mentioned. However, the overwhelming majority of Millennials in developed countries have a smartphone and are active on social media. They are driving digital trends and they prefer payments to be done via the phone. In our view, the moment is indeed coming when paper money and value tokens will cease to be in general use. Paper currency as a medium of exchange will become as obsolete as bartering cows or playing vinyl, CDs or DVDs. Yes, there will likely be residual cash, just like bartering cows still goes on and there is a small resurgence of vinyl, but the norm will be digital and contactless. As the demise of cash is coming sooner than most people think, regulators, businesses and consumers need to consider how it will affect their lives. By Emir Hrnjic and Gordon Clarke
Digital currencies are the future in Asia (as published on East Asia Forum on April 4, 2021)4/4/2021 Gordon R Clarke and Emir Hrnjic
By Emir HRNJIC
While the GameStop madness has created numerous controversies, the incident underscores the need to debunk short selling myths, says the writer In general, short selling typcailly gets singled out during crises as the public hunts for scapegoats SINGAPORE: A battle of retail versus institutional investors reached its climax when Melvin Capital Management covered its short positions in GameStop at a signficant loss and had to be rescued. As the price of GameStop soared from U$20 to almost U$500, Melvin Capital Management and other hedge funds with short positions on its shares suffered almost U$20 billion of losses. While Wall Street investors cried foul, retail investors pointed to the nefarious nature of short selling. As many celebrated hedge funds’ losses, old myths about the trading strategy resurfaced. Among the most resilient myths remained those that short selling is inherently speculative, it impedes well–functioning of stock markets, and it destroys targeted companies. Activists called for short selling constraints or outright bans arguing that short selling depresses stock prices and thus the constraints would increase them. In general, short sellers typically get singled out during crises as public looks for scapegoats. Indeed, a number of European regulators imposed various short selling bans during the COVID-19 pandemic. But is short selling really nefarious activity? And how accurate is the typical narrative about short selling? More specifically, can the three main myths about short selling be debunked? INHERENTLY SPECULATIVE Early theoretical finance literature developed opposing predictions with respect to short selling. While some researchers developed models whereby informed short sellers contribute to converging of market prices to firms’ fundamentals, others argued that prices can become less accurate due to manipulative short selling. In order to solve the controversy, subsequent research dived into the empirical data and uncovered strong evidence of informative trading by short sellers. For instance, an early research study found that short sellers had trading advantage stemming from their ability to analyse publicly available information. More specifically, short sellers process public news better than other market participants which enables them to make profitable trades. Another study found that short sellers use both public news and private information to anticipate earnings-related developments. Taken together, this evidence shows that, on average, short sellers are not speculative traders as they have the ability to process information better than other market participants. SHORT SELLING IMPEDES WELL–FUNCTIONING OF STOCK MARKETS Based on data from 26 countries, a seminal study found that stocks with more short sale constraints have lower price efficiency. Moreover, relaxing short sale constraints does not lead to price instability or extreme negative returns. A more recent research provided evidence that the relaxation of short sale constraints in China and the United States improves price efficiency by providing incentives for short sellers to produce information. Utilising a natural experiment in the aftermath of COVID-19 pandemic, researchers exploited differences between different short selling regulations in various European financial markets. More specifically, a number of European countries which introduced temporary bans on short selling activity in the period March–May 2020 were compared to other European countries which did not introduce short selling constraints. The study found that market liquidity deteriorated after the introduction of the short selling ban. Another study also found that, “during the [COVID-19] crisis, banned stocks had higher information asymmetry, lower liquidity, and lower abnormal returns compared with non-banned stocks.” Taken together, this evidence shows that stock markets benefit from short selling as prices better reflect the fundamental values. In contrast to the myth, short selling actually contributes to well–functioning of stock markets. SHORT SELLING DESTROYS TARGETED COMPANIES A recent research paper analysed managers who were deciding whether to abandon value-reducing decisions. The researchers found that managers of firms whose stocks are less subject to short selling constraints were more sensitive to stock price changes than managers of other firms. This is consistent with the notion that managers learn more from stock price movements when there are less short selling constraints. Another research study tapped a natural experiment whereby one-third of the Russell 3000 index were exempted from short sale constraints. The results were consistent with the notion that short selling reduced earnings management, helped detect fraud, and improved price efficiency. Similarly, another study found that banks whose securities were subject to short selling bans had an increased probability of insolvency. Finally, short selling constraints act as a limit to arbitrage and impede well-functioning of stock markets. A research study found that more short selling risk leads to less short selling and, (more importantly for this article) less price efficiency and lower future returns. While the public typically turns against short sellers during crises, academic finance literature is almost unanimous that short selling constraints or outright bans cannot stabilize financial markets during crises. On the contrary, short selling constraints are more likely to undermine the market efficiency, reduce liquidity, and lower future returns. While short selling may have costs, the myths about speculations, impediment to markets as well as destruction of companies should be decisively debunked. By Emir HRNJIC
While the story has been framed as a modern David versus Goliath tale, the incident underscores the need to educate retail investors of investment risks, says NUS Asian Institute of Digital Finance’s Emir Hrnjic SINGAPORE: In the recent battle on Wall Street, retail investors soundly defeated hedge fund billionaires at their own game and decimated hedge fund Melvin Capital Management to the tune of several billions of dollars. A group that initiated this battle and declared war on Wall Street – Reddit’s WallStreetBets forum – doubled its membership to more than 6 million members in just a week. In a sign of support, the progressive Representative Alexandria Ocasio-Cortez said: “Everyday people were finally able to proactively organise and get back at the folks that have historically had all the marbles on Wall Street.” With memories of the Great Recession still fresh in their minds, average people around the world celebrated this rare win of David over Goliath. But was that really the case? And what really happened? BATTLEFIELD GAMESTOP A video game retailer GameStop has become the centre of a battle between an army of retail investors and hedge funds over the past month. Amid an overall economic slowdown and a gradual shift to digital gaming, GameStop has announced closing hundreds of stores due to a stark drop in sales. In the mid-2020, however, new leadership took over the company. The company with declining prospects, but promising new leadership, found itself in the middle of heavy short selling by hedge funds. Short selling is a very risky strategy. When shares of the company are heavily shorted and share price starts going up, short sellers are forced to close their positions and buy shares at higher prices, thus creating buying pressure. Moreover, rising prices trigger margin calls creating even more pressure on short sellers. This leads to a self-reinforcing loop and a so-called “short squeeze”. Enter Reddit’s WallStreetBets forum – a community of self-proclaimed “degenerates” who treat stock markets like casinos and feel a sense of responsibility to stand up to financial institutions that have rigged the system. These renegade retail investors self-organised and started investing against institutional investors – self-proclaimed “smart money”. They started promoting GameStop and encouraging members to buy its shares in a potential ramping scheme designed to artificially inflate the share price and create a short squeeze. In the second half of January, price of GameStop went from U$20 to more than US$300, for more than 1,500 per cent return, while decimating short sellers in process. Melvin Capital Management suffered billions of dollars of losses, while losing more than 50 per cent of its value in January and had to be rescued. Short sellers’ losses amounted to almost U$20 billion – more than the market cap of GameStop. DAVID VERSUS GOLIATH? Business press promoted a simplified version of the story and labelled it the battle of David versus Goliath. But there is more to the story. Some data suggests that sophisticated investors with access to plenty of capital joined the buying side. In fact, even after broker apps like Robinhood banned retail buying, thus cutting retail investors’ main access to shares of GameStop, buying pressure continued. While media reports continued the narrative that retail traders were buying frantically and retail sentiment kept the buying pressure, Bloomberg reported Citadel Securities’ retail flow which looked pretty balanced. In other words, retail investors were buying and selling in equal amounts. In fact, they were net sellers for most of the last week. Moreover, GameStop’s largest shareholders were Wall Street powerhouses Fidelity Investments and BlackRock. If anything else, GameStop’s fever may have initially resembled a conventional pump-and-dump scheme that might have started on WallStreetBets’ forum, but was likely supported by much more sophisticated and wealthier investors. WHAT IS NEXT? Many wonder how this will end. What is the exit strategy for GameStop shareholders? Remember, retail investors started buying GameStop shares to put pressure on the share price and force short sellers to cover their positions, creating a self-reinforcing buying pressure and, thus, a short squeeze. A typical short squeeze often leads to a price bubble whereby stock prices are not supported by fundamentals. As is typical in bubbles, some investors are buying out of conviction that the price will keep rising. Even if investors understand that they are buying at inflated prices, they are likely hoping to sell them to “a greater fool” at even higher prices later. Nevertheless, when all shorts get covered, investors will be stuck with an inferior dividend yield, depressed cash flows, and no incentive to hold. As it becomes clear that prices are above prices justified by any fundamental pricing model, investors will find themselves holding overpriced securities. At that point, collective action will likely fail and some shareholders will start realising gains by selling overpriced shares. Once the exodus starts, the price will collapse to a more reasonable level. While early investors will have made hefty profits, late-comers to the party are in for a rude awakening. At time of writing, GameStop’s price has plunged from a high of US$325 to US$90 a share, where it has stayed for the last two days. And while some small investors might have won in the short run, investing based on social media posts is a bad investment strategy which will likely lead to an inferior performance in the long run. But some good came out of this episode. GameStop incident attracted unprecedented media attention to the short-selling and risks of investing in the stock market. The event highlighted a chief need to better educate retail investors about the investing risks. However, it is not clear that we can rely on the media for investor education. Extremely popular podcast host Joe Rogan created a video about GameStop in which he said: “It’s all so weird… because the stock market has always been this weird number thing that is based on confidence.” With two million YouTube views in three days, this statement highlights the current (mis)understanding of the issue. By Emir Hrnjic
The COVID-19 pandemic triggered a massive uncertainty in global markets and the U.S. Fed responded by cutting interests rate to 0.25 per cent. As investors started chasing higher yielding investment opportunities, the somewhat–obscure concept of a Special Purpose Acquisition Company (SPAC) came back to the spotlight. In 2020 alone, roughly 250 SPAC initial public offerings (IPOs) raised U$83 billion – roughly equal to funds raised by conventional IPOs. Moreover, SPAC IPOs in this banner year raised more capital than all previous SPAC IPOs combined. Even 2021 started with a bang raising roughly U$8 billion in first two weeks – on a pace to double the record of capital raised in 2020. Recently, Asian investors started jumping on a bandwagon. For instance, SPACs sponsored by Asia–based Antony Leung, Richard Li, CITIC Capital, Maso Capital, and Malacca Straits have raised more than U$2.5 billion, while Singapore–based Vickers Venture Partners, Japan–based Softbank, and Hong Kong–based Provident Acquisition recently filed to raise almost U$1 billion via SPAC IPOs. Even the Singapore Exchange is considering allowing SPACs’ listing due to their popularity. Furthermore, more than a dozen SPACs are holding talks with South-east Asia’s startups about potential mergers. For instance, Bridgetown Holdings approached Tokopedia – South-east Asia’s largest e-commerce platform, while Traveloka – South-east Asia’s largest online travel app – announced that it is going public with a SPAC as a possible option. Moreover, reports revealed that other Asian unicorns such as Grab, Gojek, and Bukalapak have all been recently approached by SPACs. While Goldman Sachs declared that SPACs in 2021 could even exceed capital raised in 2020 and Reuters reported that SPACs “arm up for Asian unicorn hunt”, investors are getting reacquainted with these alternative financial vehicles. SPACs 101 Known as a “blank check company” with no business operations, SPAC is formed to raise funds via IPO with an intention of acquiring a promising private company within two years. When a private company is acquired by a public firm, it automatically becomes public. Hence, SPACs provide the public an easy access to a mature private equity (PE) investments, while being more transparent than PE, but less transparent than conventional IPOs. Since investors do not know eventual acquisition target at the time of raising capital, SPAC resembles a flipped IPO process from demand–supply perspective. In a traditional IPO process, investment (company going public) is known and underwriters are looking for investors. In SPAC, on the other hand, lead sponsors find investors first and, then, search for investment (company to go public). After raising capital, SPAC sponsors promise to identify an acquisition target within two years. If they fail to find a target within two years, most SPACs return money to investors. Even if they find an acquisition target, the SPAC shareholders have flexibility to opt out and redeem their shares before the acquisition. Also known as De-SPACing, SPAC’s acquisition automatically makes a private company public and thus resembles a flipped RTO from the private–public perspective. While RTO represents the process of private company acquiring a public company, SPAC achieves the same outcome via the process of a public company acquiring a private company. On the other side of the table, acquisition target has to negotiate with only one party (SPAC) unlike a typical IPO company that deals with multiple parties including underwriters, lawyers, and auditors. SPAC IPOs VS. CONVENTIONAL IPOs Natural question arises how SPAC IPOs made such dramatic inroads into well–established world of conventional IPOs. SPAC proponents claim that the phenomenon of pricing a typical IPO below their market price – so called IPO underpricing – incurs an unnecessary (opportunity) cost for the company going public, also known as “money left on the table”. The IPO underpricing averaged over 20 per cent this year. In extreme cases, IPOs leave even more money on the table as in recent cases of DoorDash and Airbnb which soared 86 per cent and 115 per cent on the first day of trading, thus leaving billions of dollars on the table. They also argue that SPAC enables investors to avoid IPO underwriting fees that typically go as high as 7 per cent. Other factors include reduced underwriters’ ability to conduct traditional IPO roadshows during pandemic. Since SPACs are established by reputable sponsors who then search for additional investors through personal networks, there is no need to conduct traditional IPO roadshows. Moreover, the quality and reputation of SPAC sponsors have drastically improved over the years and institutional heavyweights such as Goldman Sachs, Citigroup, and Deutsche Bank jumped on the SPAC wagon. The improved quality of sponsors, institutions, and their networks greatly contributed to a SPAC boom. Additionally, many view SPAC as an accelerated IPO without strict regulatory scrutiny that accompanies a typical arduous IPO regulatory process. SPAC accelerates the process of capital raising as there are no operations, assets, or financial data. The entire process can be completed in several weeks, instead of several months. This efficiency reduces completion risk, especially in volatile markets. Finally, some spectacular success stories boosted the popularity of SPACs and attracted even more investors. For instance, DraftKings’ valuation quadrupled, while Virgin Galactic’s price jumped 150 per cent in several months after the SPAC acquisition. SHORTCOMINGS OF SPACs In contrast, shortcomings and hidden costs of SPACs are numerous. A recent research study documented that the median SPAC held only U$6.67 per share by the time of the merger – down from U$10 at the IPO stage. This drop was mostly due to dilution of SPAC shares as sponsors were rewarded with 20 per cent of the acquired company – akin to a “finder’s fee”. Another research study documented that the average SPAC IPO in the first decade of 2000s lost roughly half of its value over four years, while higher SPAC sponsors’ ownership was associated with worse performance. Similarly, the operational performance of SPACs was inferior to industry peers and conventional IPOs. Finally, research found that SPAC–acquired firms were traditionally small and levered firms with low growth opportunities, consistent with the notion that SPAC acquisitions attracted firms to go public in difficult times. A former SEC Chairman, Arthur Levitt, stated “I have never found any [SPAC] attractive. No matter what the reputation or what the sponsor might be. […] They are the ultimate in terms of lack of transparency.” Notwithstanding the banner year for SPACs, opponents warn that SPAC is inherently inferior capital–raising method. A potential reversal in market enthusiasm may come from increased opposition of target companies, opaque nature, or inferior post–performance. SPAC sponsors try to convince investors that these statistics derive from SPACs of old era, while new SPACs are bigger, better, and higher quality. Nevertheless, investors should do their own due diligence and do not rely on any sponsors’ promises. After all, sponsors’ incentives are very different than theirs. Shortcomings and Hidden Costs of SPACs (as published in The Business Times on December 23, 2020)1/15/2021 By Emir Hrnjic
As COVID-19 pandemic devastated global economy and created an unprecedented uncertainty in global markets in 2020, an alternative financial vehicle known as Special Purpose Acquisition Company (SPAC) flourished as an innovative capital–raising method. In 2020 alone, almost 250 SPAC initial public offerings (IPOs) raised more than U$81 billion – more than all previous SPAC IPOs combined. While most SPACs are sponsored by investors in the United States, Asian investors started catching up. For instance, Antony Leung, a former Hong Kong financial secretary and Blackstone executive, launched a U$1.5 billion SPAC. Additionally, SPACs sponsored by Richard Li, CITIC Capital, Maso Capital, and Malacca Straits – all based in Asia – have raised more than U$1 billion. More recently, Singapore-based Vickers Venture Partners started a process of raising U$100 million through a SPAC IPO. When news broke out that Bridgetown SPAC backed by Asian-based Richard Li and American–based Peter Thiel approached Tokopedia regarding potential merger, SPAC’s price soared by more than 30 per cent. The largest e-commerce platform in Southeast Asia, however, remained non-committal about the merger. Soon after, the Indonesian giant backed by Alibaba, SoftBank, and Temasek hired investment banks Morgan Stanley and Citigroup to advise them about going-public process and announced that it is considering traditional IPO. While Forbes claimed that the “SPAC boom of 2020 is probably the biggest Wall Street story of the year”, business press paid very little attention to shortcomings and hidden costs of these alternative financial vehicles. SHORTCOMINGS AND HIDDEN COSTS OF SPACs Notwithstanding historical popularity of SPACs and record-breaking amounts of capital, recent research study from NYU and Stanford does not support the popular argument that SPACs are a cheaper way of going public. In fact, the study documents that SPAC costs are opaque and exorbitant as the median SPAC share value starts at U$10 at the IPO stage, but the median SPAC holds only U$6.67 per share by the time of the merger. This drop is mostly due to dilution of SPAC shares as sponsors are given 20 per cent of the acquired company as a reward for their efforts in finding a target company. This is akin to a “finder’s fee” in return for leveraging their brand equity for fundraising for the SPAC. While the return to sponsors mostly comes from this reward, the resulting dilution represents the cost to other SPAC shareholders. Furthermore, investors in SPAC may have different incentives and investment horizons which may not appeal to an acquisition target. For instance, IPO investors may have longer horizons because they invest in the IPO company. SPAC investors, on the other hand, may not be vested in the future of the acquired company. A former Facebook executive, Chamath Palihapitiya, became the poster boy of SPAC boom, when he sponsored SPAC that later acquired the Virgin Galactic. Since the innovative company like Virgin Galactic will likely take a long time to generate the profit, long-term commitment of initial sponsors assumes oversized importance. For instance, when Virgin Galactic aborted a recent test flight, its shares fell as much as 6 per cent. More importantly, Chamath Palihapitiya sold 3.8 million shares worth U$98 million, thus sending bearish signals to the market. Another research study from University of Exeter dubs them “poor man’s private equity funds” because, on average, SPACs substantially underperform comparable companies. The average return in four years following the SPAC IPO is negative 51.9 per cent, significantly worse than an average return of 8.5% by comparable IPO companies. Similarly, SPACs considerably underperform the competitors based on accounting measures such as operating margins and return on sales. Moreover, SPAC performance is worse when deals are completed just before the deadline for a SPAC acquisition suggesting that SPAC managers become desperate to do any acquisition when facing the impending deadline. Performance is also worse if the deal barely meets the minimum transaction value. The overall research evidence is consistent with the notion that SPAC acquisitions attract firms to go public in difficult times. SPAC–acquired firms have lower growth opportunities, higher leverage and smaller size and thus lower quality than traditional IPO firms. SLOWING DOWN SPAC opponents claim that the boom will likely slow down. As retail investors start entering the market en masse, they argue that investor enthusiasm may lead to unsustainable overvaluations. Moreover, reduced regulatory scrutiny is a double-edged sword. Although the IPO process can be long and arduous, it was designed to provide transparency, thereby providing sufficient information for investors to make sound financial decisions. Comparatively, the SPAC acquisition process is more opaque, as investors are relying on the brand equity of the SPACs’ sponsors as opposed to carrying out due diligence by themselves. While less due diligence allows accelerated IPO process and reduces completion risk, it may fail to uncover potential accounting irregularities. For instance, the electric truck manufacturer Nikola’s stock price skyrocketed to U$93.99 before falling to U$27 due to alleged false statements about its technology. Finally, target companies are increasingly uneasy about being acquired by SPACs as evidenced by a recent example of Tokopedia. For instance, former Google executive who founded Upstart, said that “SPAC feels like reaching the next level of a video game and handing the joystick to somebody else. It’s an acquisition of [the] company despite how it might be described.” Notwithstanding the 2020 boom in SPACs, the fear remains that boom will turn into a market bubble and eventually burst. Myriad factors can contribute to the eventual slowing down such as reduced investor sentiment, increasing opposition of target companies, accounting misdeeds, eventual poor performance, or regulatory intervention. |
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