As founding CEO, Stein is leading Harbor's efforts to tokenize private securities and unlock access, value and liquidity for private investments such as commercial real estate, investment funds and more. He was previously general counsel and chief compliance officer at Zenefits, served as general counsel at OptumRx (a subsidiary of UnitedHealth Group), was an Assistant U.S. Attorney, a federal judicial clerk and an Intelligence Officer for the U.S. Army.
Harbor: the compliance platform for tokenizing private securities
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Hi, I’m Adam Chapnick.
And I’m Amy Wan coming up on today’s episode of Security Token Insight, in your Security Token Investing News, the European union passes the US in the security token industry growth. Plus, we’ve got an expert interview with Joshua Stein, CEO of Harbor, and more one-on-one interviews with our New York City meetup panelists. That and more is coming up on this episode of Security Token Insight.
Now it’s time for your Security Token Investing News. Up first a new study by the Frankfurt School Blockchain Center. It finds that the EU leads the United States in security token innovation as well as in several other fields. The study shows that 88 companies in the European Union are now participating in the security token industry. Germany is at the front of the pack with 20 companies involved in STOs with Switzerland coming in second at 15 the United States has only 83 companies engaged in the STO market. In other news, Tokyo based lead real estate has unveiled plans to develop condominiums and hotels in Tokyo’s popular areas such as Ginza, Shibuya, and other areas by using funds raised through security tokens. The STO is being launched in a partnership with Securitize. By the way, Securitize is a gold corporate member of the Security Token Academy. To learn more, go to our website securitytokenacademy.com, click on the directory tab and then corporate member.
And finally digital investment bank Equisafe unveiled plans to launch 15 security token offerings over the next nine months. The new STOs will include everything from tokenized debt equities to real estate. This is not Equisafe’s first venture into tokenized real estate as they were the first firm to launch a real estate STO in France for the Anna mansion.
The security token Academy is proud to present an expert interview with Joshua Stein, CEO of Harbor. I sat down with Josh to discuss Harbor’s recent announcement with ICAP equity and more in this expert interview. Take a look.
Let’s talk about your recent announcement with ICAP equity. I know they’ve raised over a hundred million dollars across four different funds with 1100 investors. Can you tell us more about the business challenges ICAP was looking to solve with you guys at Harbor?
Sure. So ICAP is really interesting and I think I would call them a reference implementation. They really show what Harbor can do and how we changed. So ICAP came to us, they did not recently raise 100 million. They’d raised that 100 million in the past over time. And so they had 1100 investors in four different funds that had come in to them through 17 different broker dealers and other placement agents. And so they were already seeing a demand for liquidity. Their real estate manager in the Pacific Northwest, they had extended the maturity of their funds, and so most of their investors were very satisfied with the return that they were getting and wanting to stay in the funds.
But some of their investors wanted to get out. And so this was a world in which all the investors had signed, everything was on paper. Their investors had no right to transfer. There was no easy way to find other people might be interested in buying. And so they came to us and they were looking for a compliant way to enable better liquidity. And so we’ve implemented the platform with them and their investors. And so there’s three components to it and I’ll end with the component that really enables the liquidity.
So one component of the Harbor platform is a fundraising platform, a way to manage the fundraising process more compliantly, more quickly, and more easily. A way to get investors through the necessary vetting checks, seeing and signing the documents and funding. The second component is investor relations management piece. And so these individual investors and their broker dealers and placement agents have logins where they can see the PPM where they originally invested, they can see their latest financial statements. And the sponsor ICAP can communicate with those investors.
And then the liquidity piece, powered by ERC-20 standard tokens, by the Ethereum Blockchain is a private bulletin board or private marketplace system. So these investors and their broker dealers and advisors can indicate if they want to buy more of these existing funds or if they need to get out. And before what would happen is these investors didn’t have the legal right to get out if they wanted to get out anyway, they would contact their broker dealer, they’d contact ICAP and someone would literally write down on a sticky and put it up on their computer monitor and if someone later said they wanted to buy, they’d match them up by email.
And so instead there’s an internal bulletin board. Individual investors can indicate whether they want to buy more of one of these funds or they want to sell what they have. It gets routed through their broker dealer RIA who posts to this bulletin board. People match, just like in any bulletin board system, manually. They find somebody who they’re interested in on the other side of the trade. They arrive at terms with the trade and then the trade goes through and it’s all electronic. It’s all powered by the Blockchain to ensure that every trade is compliant every time. But you’re aggregating interest and you’re doing it in a controlled fashion that’s not only compliant but meets the needs of that fund manager.
Well, that’s a ton right there that you guys just figured out how to solve. I know that for a long time that’s been sort of an obvious expectation that funds were going to need to handle all of those friction points that you mentioned. And I mean, other than the fact that you’re putting the sticky note industry out of business, which I think is maybe the only downside here, do you see all of these sort of private funds like this in the world eventually going to this? I can’t, I mean, it doesn’t it seem like there’s no reason not to?
I think that’s correct. I don’t think there’s a downside. Some of the nuances of why we’re offering this and why this is attractive I think are interesting to the audience is going to be watching this video. So this is on a private bulletin board systems. So this is not on an exchange where you have an order book. Where you have a bid and an ask and what’s called a depth. You can see all the orders. These things are going to trade relatively thinly. They’re not like a public security or reggae and this is not a fund manager that wants to publish their financials out to the world. What they want to do is enable more liquidity than they have today, and I would call these things semi-liquid. So we are aggregating the interest to help enable liquidity and we are automating. We’re taking something that used to take weeks now down to days and we think eventually same day.
So we’re taking a lot of the friction out, that happens administratively, but we’re not, these are not public securities and a fund manager is not going to want their LP interests or their debentures trading in an open market with a bid-ask and a potential bid-ask spread. In other words, they want to enable liquidity but not public price discovery. They want to enable liquidity amongst investors that they know and trust. So in this case, ICAP is letting their 1100 plus existing investors trade amongst themselves. They’re allowing those BDs and RAAs to bring in new buyers, but they’re not throwing it open to the public. They don’t want to deal with people that they don’t know and if new people try to come in, they have to come in through one of the broker dealers or RIAs that are already in there, or new broker dealers or RAs that want to become part of their private marketplace.
In other words, we’re providing a technology platform, but it’s their marketplace. It’s not Harbor’s marketplace, and I think that’s what’s really important. I think eventually we’ll get to what the original vision of the industry was, which is this vast sea of alternative private investments being a semi-liquid and find-able easily and there sort of being one large pool of liquidity, but I think it’s going to take a very long time to get there and I think the intermediate steps are for people to be able to have liquidity in a controlled fashion amongst a group of people that they can trust and they can open up who has access to it over time. But I think what you’ll see is early adopters, for the most part, are going to want to have that control.
That is so interesting and it’s something that only someone who’s dug in and sort of gotten into the nitty gritty of execution would really understand like you guys, I mean we talk about that a lot here in big picture, but you guys have been on the ground and are seeing sort of what the rate of adoption is going to be. To that point do you think that these funds are going to end up opening themselves in a white label environment that you’ve created to public or are they going to end up listing, in some future a situation? Are they going to end up listing on third party exchanges so that people have access to these investment opportunities?
I think it’s going to vary by fund manager. It’s going to vary by the structure of the investment in the asset class. LP interest in a private fund will always trade very thinly and that is because of the due diligence or the informational requirements to really understand the investment to get in. Those are always going to be really high. Those are generally long-term hold investments, so people want some liquidity but they’re not going to be trading in or out.
Also there are tax consequences depending on the structure. ICAP structure is, they raised money from investors as debt notes, so an investor investing in an ICAP fund has a debenture paying a set interest rate. Those don’t have the same tax and structuring implications that limit the liquidity, so those can trade as often as you want. There’s no limit on the number of investors. If you think of an LP interest in a private fund in the US there’s what’s called The Publicly Traded Partnership Rules.
That can put some real limitations on how often this can turnover and what venues it’s in. So listing it on exchange is problematic. I think of debt as a great asset class just in general on a macro level that can trade far more often. That debt I think will tend to list on exchanges over time as this builds up. I think that certain types of REITS like private REITS and others, and these funds, they will just tend to trade in these private marketplaces amongst limited groups of parties. Because there are sound business reasons why these fund managers do not want to open it up to the public at large. Whereas with debt you don’t have those same concerns.
We have the full interview with Josh Stein on our website. Be sure to check it out. Harbor is a gold corporate member of the Security Token Academy. To learn more, go to our website securitytokenacademy.com. Click on the directory tab and then corporate members.
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The Security Token Academy held another successful meetup, this time, in New York City and we want to thank everyone who attended. We had a big crowd inside the Sunset Terrace at Chelsea Piers. Security Token experts and financial services professionals were on hand for an evening of informative discussions, networking, food and drinks. I had the opportunity to speak to our panelists one-on-one to get their insights on the security token industry. Let’s first take a look at what Rika Khurdayan partner at Dilendorf Khurdayan had to say.
It’s been a difficult year. I think for security token industry. There is a lot of interest and a lot of benefits to tokenization and issue in digital securities. I am a huge, huge fan, yet we haven’t seen a lot of projects actually closing their rounds and reaching those hard caps, or soft caps. There’s definitely a lot of interests. I feel like market is picking up. We have a few projects in the pipeline that are ready to launch in the next month or so, so that’s good news. Definitely we need some more activity I think on the marketing, on the broker dealer side, we started moving on those broker dealer applications, so we’re thinking that’s going to boost the market quite a bit.
Another trend that I’m seeing that’s very, very interesting, especially in terms of providing future liquidity for this market and for digital securities is that companies and funds actually tokenizing their existing cap tables and existing LP interests and I find it very interesting. Definitely very exciting to tokenize existing private securities and then put them on secondary market for trading.
Surprisingly, what we’ve seen in the past three months is that the network and platform tokens are having some sort of a comeback. And while we’ve been focusing on digital securities, and we’ve been doing it for the past two years. That’s how we initially got into the space in 2017 at the height of ICOs who looked at this instruments who said, “Well, they’re probably going to be treated as securities in US law, so what we’ll do is we’ll work with issues on structuring it in a compliant way.” And I’m a lawyer, I love digital securities. I understand this product. If we are tokenizing equity, if we’re tokenizing income streams, if you’re tokenizing LP interests, there’s a really clear and straight forward framework for doing that in the US. And then it’s projects like platform tokens and network tokens where you are now looking at hybrid instruments.
On one hand, these projects are raising funds where security token and they’re selling these instruments in securities. On the other hand, these are hybrid instruments. They’re not traditional securities. They’re meant to be used on the platform. They’re meant to be used to tokenize development teams, to further develop the network. What do you do with this hybrid instruments? And I those have very complex projects to be honest, I love them. That’s when my kind of like, nerd side, kicks in. You really need to understand the technology, how the platform and the project is functioning. We haven’t seen many of those projects peaking interest from the investors side in 2018 and I see that trend is changing now. We’ve seen quite a few of the network projects that we’re focusing on building the product and the network and really decentralized products in the past year, year and a half, two years. They’re now picking up interest from the users and investors side. So this is going to be very interesting.
There are a lot of projects, very interesting projects, that are raising funds, and hoping from Asia that are hoping to raise funds in the US and there are a lot of projects here in the US that are hoping to raise funds in Asia. And I think once we figure out how to bridge these two markets and have a very good infrastructure in place, where we’re on the same page in terms of regulations, in terms of how regulators and governments treat these instruments and securities. In terms of broker dealer teams being able to work with these digital securities both here and in Asia, ATS and secondary trading platforms being available on both sides of the world. That’s what really will push the market forward.
Well, there are a few things to keep in mind here, right? So one is obviously the promise of liquidity, right? And the fact that they can now give this option to the investors. Another thing is the companies that are looking at tokenization of existing cap tables and products are larger companies or institutions that don’t necessarily need to raise money, but they do need to provide additional benefits to their existing clients. And that’s when tokenization comes in. And the more projects like that we’ll see, I think the more it will help develop and push the industry forward.
There are so many I wouldn’t know where to start, so I have a few favorites. Obviously the LP interest in private funds like venture funds, right? Highly illiquid instrument, very hard and expensive to transfer. Very long exit. You’re looking at seven to 10 years, right, to exit the position. That’s very interesting for tokenization and that’s actually the project that we’ve seen being tokenized. Those were one of the first projects that when on secondary market in the US, right, on platforms like Open Finance. And Securitize has done a lot of those issuances and they’re really the pioneers, right, in this space.
I’m also personally very excited about the private security space. If you look at private issuances in the US I think in 2017 the Reg D placements were one point 8 trillion dollars. That’s a huge market. And those are securities issued in a traditional way, right? If you can potentially tokenize that space, those are highly illiquid and obscure instrument. If you can add, ease of transfer. Let’s not even talk about liquidity at this point, right, because we’re a few years away, but ease of transfer is of cap table management, ease of dividend distributions and transparency of ownership. That’s just an amazing product.
I also had the opportunity to speak with Rika’s partner at Dilendorf Khurdayan, Max Dilendorf. Let’s take a look.
There was a lot of activity in this space, both in the US and Asia. We finally see that SEC and FINRA started issuing broker dealer licenses. They’re already two licensed broker dealers in the US that can sell digital securities. We expect that the trend will follow in Asia. And in fact we see that Asia is waking up Southeast Asia, Hong Kong, Singapore, and we speak to all the partners out there on the progress of their broker deal applications and ATS licenses.
So for, for the industry to really move on and develop, we need more players in the space through to market, sell, digital securities. So that’s what we see. On the issuing side. We see interest from both US issuers and non US issuers, product types, we’re talking about real estate, we’re talking about fund tokens. What I’m personally really excited about is for the company to tokenize a big real estate project in New York and for the company to go out there and raise successfully, close the offering in Asia.
But for that we need broker dealers. So we need broker dealers on the ground, marketing, selling, educating investors and that’s when we’ll see this industry growing and succeeding. And my personal sort of modest projection that this will happen sometime, like the first project raising in Asia will happen sometime in 2020s
Okay, so let’s, let’s first talk about China and we actually were in China in November of 2018 when the Central Bank of China came out and then said that we are placing a permanent ban on digital security offerings and STOs and no Chinese citizen can participate in them. So I think it’s very tricky with China.
It’s first of all hard to tokenize assets that belong to Chinese companies and it’s hard to work with Chinese investors. So very, very, difficult market. I guess the same, I’m actually not an expert in Korea to comment on them, but they are much more flexible jurisdictions in Southeast Asia that are much more open to working and developing frameworks for digital security offering such as Thailand. That’s my personal favorite. From the visual security perspective and food and in Asia. I think Singapore and Hong Kong are pretty open to sort of getting the business through the door, establishing and developing this infrastructure and environment. So yep, that’s, that’s my sort of five cents on Asia.
Be sure to check out more interviews from our New York City meetup on our website, securitytokenacademy.com. Click on the Interviews Tab and select the video you’d like to watch.
I want to remind our viewers that if you have any questions about security tokens, be sure to email us and we could answer them right here on a future episode of Security Token Insight, the address is [email protected] Be sure to include your name with your question. One more time, the address is [email protected]
All right, that’s it for today’s episode. Be sure to follow us on Twitter, Facebook, Telegram, and Medium. And don’t forget to subscribe to our YouTube page so you don’t miss out on any of our videos and expert interviews.
And a big thank you to our platinum corporate member, Merrill Lynch, and all of our gold corporate members as well. We invite you to learn more about our corporate members by clicking on the Directory Tab and click Corporate Member. I’m Amy Wan.
And I’m Adam Chapnick for everyone here at Security Token Academy. Thanks so much for watching.
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