Micro Connect (Macao) Financial Assets Exchange (MCEX) officially launches today! On behalf of the team here at Micro Connect, I extend our heartfelt gratitude to all of you who are joining us in Macao in celebration of this financial market milestone for scores of micro and small businesses across China.
This auspicious event posits a few burning questions. What exactly is MCEX? Why have we opted to build an exchange? What does it do? These thoughts and many more will continue to surge as participants gather around the world to join our new market. To serve your understanding of the impact MCEX and Micro Connect field for us all, my co-founder Gary and I will use this blog to share our thoughts and ideas from time to time.
Today, I would like to address six key questions about Micro Connect:
- Why has Micro Connect built its own exchange?
- Why has Micro Connect structured MCEX’s core asset class around daily revenue sharing？
- What are MCEX’s core products？
- What is the role of Micro Connect Leadership Fund?
- Who is eligible to participate as an investor in MCEX?
- Who is eligible to raise funds on MCEX?
1) Why has Micro Connect built its own exchange?
Micro Connect aspires to connect global capital with China’s micro and small businesses. This is much easier said than done given the staunch differences between China’s international and domestic financial markets and the barriers that have historically prevented small-scale enterprises from attaining capital through traditional financial systems.
Overcoming this challenge requires a thorough understanding of the structural differences between offshore and onshore markets, a willingness to navigate the divisions between small businesses and traditional financing, and the creativity to inaugurate a new system conducive to global interconnectivity.
The best way to undertake this challenge is to learn from Hong Kong Stock Exchange (HKEX), my alma mater, which for the past three decades has methodically and successfully connected China’s domestic and international markets.
Three “Great Leaps Forward” have come to define HKEX’s three decades of remarkable achievements in building global connectivity: “First Great Leap” occurred when HKEX launched its H-share listing regime in the early 1990s, predating even the PRC Company and Securities Law; “Second Great Leap” took place in the 2000s when HKEX introduced its red-chip regime using the Variable Interest Entity (VIE) structure for listing — at a time when foreign investments were still barred from China’s internet and other industries; and “Third Great Leap” occurred after 2014 when HKEX launched Stock Connect and Bond Connect together with China’s domestic exchanges. Together, these leaps drew an accessible bridge between China’s financial systems and international markets, brought Chinese financial assets to the world, and revolutionized the landscape of global financing.
We at Micro Connect are determined to achieve the fourth “Great Leap Forward,” this time by connecting global capital with China’s enormous ecosystem of micro and small businesses. This could be an unprecedentedly difficult task, as we strive to not only connect China with the global financial market yet again but also to overcome the barriers between traditional financial market structures and the radically dissimilar universe of financing small businesses. To achieve our ambitious goals, we thereby developed an open, neutral, and central market infrastructure as a financial connector and transformer. Setting up an international exchange was our natural strategic choice, birthing MCEX today.
As a highly digital and innovative exchange, MCEX leverages China’s nationwide digital payment infrastructure that has come to create the world’s first cashless society. With this market structure, we believe that traditional financial market models will undergo changes similar to those experienced by conventional commerce (through the likes of Amazon and Taobao), rendering the benefits of “Wall Street” finally accessible to the “little guys” — the micro and small businesses.
While MCEX may look and feel like any other exchange, it has several distinguishing qualities: (I) Traditional exchanges offer stocks and bonds, while MCEX offers a proprietary financial asset, Daily Revenue Obligations (DROs); (ii) Traditional exchanges primarily serve large corporations qualified under stringent listing requirements, while MCEX focuses on micro and small businesses with digital control networks; (iii) Traditional exchanges’ primary function is the secondary market trading of listed securities, while MCEX focuses on primary market capital raising; (iv) Traditional exchanges’ revenue models are based on transaction fees imposed on secondary market trades, while MCEX’s revenue model is based on a range of service fees applied throughout the life cycle of individual revenue-sharing contracts.
2) Why has Micro Connect structured MCEX’s core asset class around daily revenue sharing?
The primary asset classes of traditional exchanges — stocks and bonds — do not perform well in the context of micro and small businesses. Traditional stock and bond investors need financial markets to deliver two essential services: accurate information disclosure and secure transaction delivery, with the former requiring significant financial professional services and the latter requiring substantial regulatory and institutional endorsement, both of which are expensive undertakings micro and small businesses simply cannot afford.
With the advent of China’s digital economy and cashless society, there is a potent solution around the corner. With the vast majority of brick-and-mortar stores in China being digitally configured, individual stores’ daily revenues can be made digitally transparent in consolidated payment systems and rerouted through sophisticated settlement infrastructures imbedded in stores’ local bank account systems.
The significance of this digital revolution is that daily revenue reporting and settlement have become so dependable that we can invest in individual stores and reliably collect returns on a digital, daily basis, making financial investment accessible to micro and small businesses while offering a remarkable opportunity to investors around the world. In recognition of the staggering potential behind China’s digital economy, we thus developed DROs — a new financial asset class premised upon investing in the daily collectible revenues of micro and small businesses under China’s commercial contract laws.
With DROs, MCEX delivers two important services for investors: (a) accurate information disclosure through blockchain-powered verification systems and (ii) secure transaction delivery via daily digital revenue collection. In contrast with traditional bonds and stocks, commercial contracts are a simpler, more flexible, and more efficient asset through which large numbers of lightweight investments can be deployed in scalable and cost-effective ways.
Despite being neither debt nor equity, Daily revenue sharing combines key features of the two, providing unique benefits to investors and investees alike. Micro and small businesses — the investees — are relieved of the financial burdens of debt and equity dilution, allowing them to retain the bulk of their returns in the long-run without worrying about looming payments in the case that their businesses fail.
Meanwhile, daily revenue sharing ensures investors’ returns are not limited by the fixed interest rates of debt investments. Furthermore, investors can compound their returns by reinvesting their returned capital, rendering their overall earnings comparable to those of equity investments. If investors hold a large enough portfolio of DROs, the diversified, abundant, and dispersed nature of their investments reduce volatility and risk, hearkening back to the financial safety of bond investments.
We can thereby safely conclude that daily revenue sharing is the best form of capital for both investors and the small-scale enterprises they invest in yielding a purely win-win solution. While daily revenue sharing today is not used to serving the unique pain points in financing micro and small businesses, there is reason to be hopeful that once fully developed, DROs will also become a highly efficient and cost-effective alternative to financing capital expenditures of businesses regardless of size.
As the world’s first exchange for this new asset class, MCEX is leading the way forward on this important and transformative journey.
3) What are MCEX’s core products?
MCEX’s core products are built on daily revenue sharing. This comes in three different formats — DRC, DRO and DRP — each representing a different phase of the transaction process, performing a different function, and being governed by different jurisdictions.
DRC stands for Daily Revenue Contract, a commercial contract under Chinese law through which Micro Connects onshore entity provides capital to a small business in exchange for a fixed percentage of its daily revenue shared over an agreed period. DRCs are the foundational underlying assets for DROs and DRPs.
DRO stands for Daily Revenue Obligation, an MCEX-issued exchange certificate under Macanese law in which all the rights and benefits of a DRC are imbedded on behalf of the international investor who invested in the DRO.
DRP stands for Daily Revenue Portfolio, an MCEX-approved portfolio of DROs whose unit interests can be invested in and traded under the laws of the relevant jurisdictions where such transactions take place.
These three different product formats of daily revenue sharing are designed to perform three different functions.
1. DRC is an issuer’s product. As a nimble, flexible and cost-effective instrument, DRC is designed to suit the unique needs of the micro and small businesses seeking international capital from MCEX, with Micro Connect’s onshore entity as the issuer’s only counterparty of a simple commercial contract.
2. DRO is a transitory product akin to a depository receipt connecting and combining two instruments across jurisdictional boundaries. The mechanism of DROs is inspired by Stock Connect, where international investors who cannot directly invest in the onshore A-share market are able to hold their interests through a nominee custody account of HKEX. This account’s onshore clearing entity holds the underlying A-shares.
3. DRP is an investor’s product whose unit interests can be purchased and traded. The asset is designed to be akin to debt, equity, or investment funds. Fixed income investors such as banks and insurance companies can invest in the senior class of a DRP; equity-like investors such as hedge funds or family offices can invest in the junior class of a DRP; and traditional asset managers can simply invest in DRP units as traditional fund products. DRPs can also be structured to channel investments in specific sectoral, regional, ESG, or other thematical categories.
4) What is the role of Micro Connect Leadership Fund?
Our journey to inaugurate a new era of financial opportunity is propelled by two essential engines: (i) a central exchange market and (ii) a proprietary investment fund that serves to develop that market.
In 2021, while applying for an exchange license in Macau and building the infrastructure that has come to be MCEX, we launched Micro Connect China Fund to build a prototype of daily revenue investment schemes. Despite the natural difficulties of launching a fund during the peak of COVID-19, we achieved remarkable success. To date, our fund has invested approximately 1.7 billion RMB in more than 9,000 stores, spanning 200 cities nationwide.
As of today, with the official launch of MCEX, Micro Connect China Fund is hereby renamed to Micro Connect Leadership Fund (the “Leadership Fund”). The Leadership Fund will be the primary operating engine of MCEX.
The Leadership Fund will perform the following functions: (i) directing onshore DRC investments; (ii) developing data analytics and algorithm capabilities for onshore investments’ valuation and risk management; (iii) investing and dealing in resulting DROs, (iv) packaging, distributing and market making of the resultingDRPs, and (v) developing rating and valuation capabilities, enabling efficient price and risk discovery of DRPs.
Despite our early success, MCEX as a market is still in its embryonic stage , and it will take time for market participants to fully understand, recognize, and effectively invest in this new market. It is therefore essential for the Leadership Fund to “lead the way” and provide essential services for investors and investees to access this new market. To accomplish this, the Leadership Fund has been evolving in accordance with three sequential models.
Model 1.0 – Proprietary Model. This was the initial development stage of the Micro Connect China Fund. In this stage, the China Fund invested in and maintained custody of DRCs, received daily cash flows of invested stores, and reinvested recovered capital. Investors involved with the fund included asset managers, family offices, and banks, which provided leverage for both the China Fund itself and its LP investors. The China Fund derived its revenue from the investment earnings of its underlying DRCs.
Model 2.0 – Dealing Model. With the soft launch of MCEX in March of this year, the fund, now named the Micro Connect Leadership Fund, became the first and, to-date, only Primary Dealer that could invest in DROs, repackage them into DRPs, distribute the DRP units to investors, and reinvest the proceeds into additional, compounding DROs. In this stage, the Leadership Fund derives its revenue from investment gains and dealing premiums.
Model 3.0 – Infrastructure Service Model. As participants in our new financial market reach critical mass and more Primary Dealers join in the investment in and dealing of DROs, the Leadership Fund will evolve into a central service platform providing investors with essential services in price discovery, valuation, credit rating, and data analytics. The Leadership Fund will increasingly derive its revenue from service and transaction fees.
5）Who is eligible to participate as an investor in MCEX?
MCEX is designed to serve the needs of all international institutional investors (funds, banks, and insurance companies), as well as corporate and professional investors such as family offices and trusts. At this moment, MCEX is not open to individual retail investors.
Given the unique nature of MCEX’s proprietary asset class and the fact that the exchange is still in early development, it will take time for traditional institutional investors to get their feet wet in this new market. The earliest participants in Micro Connect’s new financial ecosystem were LP investors working with the Micro Connect China Fund, now the Leadership Fund. These investors included banks, providing leverage at both the Fund and LP levels.
Now that the Leadership Fund is able to distribute DRPs with the launch of MCEX today, fixed income investors such as banks and insurance companies can invest in senior class DRPs; equity investors such as hedge funds can invest in junior class DRPs; and traditional asset owners such as pension funds and sovereign wealth funds can continue to invest in the Leadership Fund or vanilla DRPs.
The Leadership Fund is currently the only Primary Dealer authorised to directly deal and invest in DROs and to package and distribute DRPs. This will allow time for standards in DRO pricing, issuer quality, risk rating, data integrity, and settlement security to develop.
In due course, MCEX will introduce a Qualified Primary Dealer system, at which point designated Qualified Primary Dealers will be able to directly deal and invest in DROs alongside the Leadership Fund.
6）Who is eligible to raise funds on MCEX?
Currently, all issuers in MCEX are micro and small businesses in China, primarily brick-and-mortar stores. In due course, any businesses that can offer digitally collectible daily revenues will be able to raise capital at any scale simply, flexibly, and cost-effectively on MCEX.
Micro Connect deploys its investments into individual stores through enterprises (Connect Partners), which maintain strong digital controls over their affiliated stores. Through Connect Partners’ digital networks, Micro Connect performs initial due diligence and data analytics, maintains issuer quality, price discovery, and risk management, and achieves scalability. Typical Connect Partners include:
- Brand, chain, and supply chain companies. These companies require continuous funding for store expansions and other capital investments. They are currently the main stakeholders on the asset side of Micro Connect’s financing model. They can raise capital to fund new stores by issuing DRCs backed by revenues from existing stores or new stores once operational.
- SaaS, software, and service companies. These companies have invested considerable capital in building out digital networks and platforms connecting small-scale enterprises across various industries. They help micro and small businesses in their networks raise capital at MCEX by issuing DRCs that the Connect Partner can digitally enforce on behalf of Micro Connect for a fee.
- Commercial property operators. Commercial malls in China today typically operate on fixed rent leases. Coupled with rent security deposits and advances, tenants face substantial up-front costs and inflexible rent obligations regardless of their revenues. With MCEX’s new market, mall operators and their tenants are now able to enter variable rent leases, offering them as DRCs to MCEX investors. By investing in such a DRC, an MCEX investor pays the mall operator the present value of the lease, owns all the future cash flow from the DRC, and becomes the tenant’s “virtual landlord”. The tenant enjoys substantial relief from its up-front costs and avoids paying high fixed rent during business downturns but is obligated to perform under the terms of the DRC. This format offers a potent and equitable win-win-win solution.
- Ecosystem Platforms. E-commerce and other service platforms in China have built nationwide digital networks connecting all types of micro and small businesses in China. They are in the best position to identify and direct investments into businesses that are strategically important to their platforms and have the highest prospects of success. MCEX, through its DRC offerings, could become their platform of choice in sourcing sustainable, flexible, and cost-effective capital to fund their growth and monetise their investments.
Once again, I extend my sincere gratitude to all who join us today in Macau to witness the official launch of MCEX. Our exchange is a brand-new financial market and will take time to mature. Our products are still limited in both number and variety, but this is only the beginning of a persistent, great journey. As the saying goes, “If you want to go fast, go alone. If you want to go far, go together.” On behalf of the team here at Micro Connect, we look forward to working, creating, and innovating with all of you. I have every confidence that together we will build a more inclusive, impactful, and profitable financial market for all.