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“Macau will forever be irreversibly in the food chain of this financial innovation”

By

 José Carlos Matias

EXCLUSIVE INTERVIEW

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By José Carlos Matias

Photos by Wong Sio Kuan

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Connecting global capital with small businesses in mainland China through Macau. Micro Connect boss Charles Li, former HKEX chief, delves into the rationale, outcomes, and ambitious plans of innovative financial market MCEX

One year after the official launch of the Micro Connect Macao Financial Assets Exchange (MCEX), Charles Li, former Chief Executive of the Hong Kong Exchanges and Clearing, shares his vision and aspirations in an exclusive interview with Macau Business, Business Intelligence, Macau News Agency, and MBTV.

Sitting on the verge of what he describes as the ‘Amazon moment’ for financial services, Charles Li, founder and chairman of MCEX, explains the workings of the digital age-driven and enabled financial instruments at the heart of MCEX. As a Macau-licensed market, MCEX allows professional investors to acquire a fraction of a business’s revenue for a fixed period, securing rights to future income. Li anticipates that, in terms of capital raised, MCEX could rival the Hong Kong stock market in a few years’ time, paving the way for a new generation of digital franchised national markets to be adopted globally.

“Our mission is to connect global capital to small and micro businesses in China”

One year ago, we witnessed the official launch of the Micro Connect Macao Financial Assets Exchange (MCEX). Could you tell us about the journey over the past year?

Charles Li: Initially, we were the principal investors, but now we have seen a significant increase in participation. To date, we have invested in over 15,000 stores across 200 cities in mainland China, deploying RMB 4.2 billion altogether already. What we refer to as the “Macau style IPO” is now occurring daily. It’s been going really well.

Q: Why Macau? You could have selected Hong Kong or other mature capital markets. Tell us about the backstory regarding being based in Macau.

C. L.- Our mission is to connect global capital to small and micro businesses in China as a starting point. Therefore, while the capital funding side operates outside [mainland] China, the asset side operates within [mainland] China. The market operator that issues these underlying certificates needed to be international. Consequently, we were not going to do it in mainland China.

Between Hong Kong, Singapore, Macau, and other possibilities, we had discussions with quite a few jurisdictions. People need to understand how this product works because the underlying product is daily revenue contracts in China. However, when it becomes international products, they become Daily Revenue Obligations (DROs).

But most regulators ask the question: Is that a security? Or is that futures, or is there any other traditional financial product? It is none of those. It is a completely innovative digital age-driven and enabled financial instrument.

So, while the conversation continued with all the other jurisdictions, it all boiled down to which boxes to put you in. When we had the conversation with the Macau authorities, they instantly recognised that this is something they are very familiar with because they have been doing this for decades. When a casino opens, as long as there’s revenue every day, the government goes in there and literally takes the daily revenue tax directly from the casino.

The government is able to do that by issuing a casino licence to the operator, which entitles the government to collect taxes on a daily revenue basis.

We, in a very similar manner, provide capital to a small shop, which entitles investors to a daily revenue contract entitlement. So, it’s that similarity that gave Macau authorities an instantaneous understanding of what we are really talking about, and particularly how risk can be easily managed because of this daily feature of this new financial innovation.

“DROs are a completely innovative digital age-driven and enabled financial instrument”

“This will hopefully become a digital franchised new generation of national markets.”

How was the exchange with Macau’s authorities, and what do you make of their approach?

C. L.- I was quite impressed with the local authorities in two aspects. One, strategically, a long-term macro view and a clear vision that Macau needs to transform into something very different and needs to really move into the digital age.

And they need to modernize many of its societal needs, particularly given its traditional industry focus. Financial services will naturally fit in that direction. So there is this tremendous strategic focus and vision for the future, and that translates into a really strong mindset of being open, being innovative, and being receptive, and that is coming through loud and clear. Secondly, at the technical regulatory level, we were also immensely impressed with a mindset that we never had a real, you know, big traditional ecosystem for traditional finance, but that most people take that as a reason not to be able to do anything because we never had the ecosystem.

Everybody’s already way ahead of us, but the mindset instead is, ‘Well, let’s turn the absence of an ecosystem into an advantage.’ The fact that you have a plain white piece of paper means that you can actually draw your future with greater freedom and flexibility. And that sort of mindset allows regulators to embrace new digital revolutions and understand the potentials and implications that the digital age brings without being constrained and burdened by a lot of the old ways of thinking and doing it.

Your main office is here in Hong Kong and you have an important presence across the border in Shanghai, Beijing, Chengdu. Tell us about your physical presence in Macau in terms of your operation. Some people may ask: What will Macau benefit in terms of GDP, employment and so on? 

C. L.– In this new way of investing, the asset side is in China. In the future, it could be global. The funding side currently outside China. It’s global, international, but one day there could also be funding from China as well. The exchange-licenced venue is in Macau.

People sometimes ask me how Macau fits into all of this. I would usually describe it this way: big finance is usually in the banks and the big insurance companies. They are not going to change that. They’re not going to go into this new way of investing, on daily revenue. They basically focus on either fixed income bonds, debt, loans, or equity; that’s all. Let’s imagine big money is saying, “I only eat bread,” which is fixed income, or “I eat noodles only,” or “I buy noodles only,” which is equity.

Both bread and noodles are like securities, traditional financial products. But what we are doing in China, at least now, are really contractual commercial contracts that are inconsistent with securities. So, we call it the daily revenue contract in China. That’s almost like growing wheat; we’re actually growing the crops there. But the big money is saying, “I don’t understand what a crop is. What is wheat? I only understand bread or noodles.” So they’re not going to want to look at it. So, we have to find a way to bring  domestic wheat or contracts. First of all, give them an international identity paper. That’s why the daily revenue obligations came into being. A daily revenue obligation (DRO) is a piece of paper issued by an international market operator, the Macau Exchange. And that DRO is stapled together with the DRC (Daily Revenue Contract). Whoever buys the DRO in the international market receives all the benefits of that DRC. So the DRO is almost like in Macau we need to dry the wheat into flour. That’s why we give them an international paper, put them into an investible format. A DRO International certificate is flour, but still, big money in Hong Kong or Singapore, or the US and London would say, “I don’t understand what is flour, I only understand bread and noodles”. So, we need to package all the DROs, which are individual contracts, into DRPs, – Daily Revenue Portfolios.

And then you give the banks the senior tranche of it that’s more like bread now; that looks like a security; that looks like a bond.

Macau is now a very important part of the future supply chain or manufacturing chain of this new form of financial product.

And in Micro Connect, we bring the wheat into Macau and put it into flour, and then that flour turns into bread and noodles. So, in the future, Macau will be forever irreversibly in the food chain of this new [financial] innovation because Macau becomes the central flour grinding mill for all the future financial products for the little guys in China.

“MCEX is going to be the world’s first daily revenue contract market”

How is that reflected in terms of tax income for the Macau SAR and highly skilled and innovative jobs for locals in Macau, or to attract foreign imported talent also into Macau as part of this operation?

C. L. – Now that there is an extraordinarily important segment of this production line that is centred into the conversion of the wheat into flour,And the most important part of all of that is individual contractual, daily data disclosure, and publication. So there will be a tremendous amount of investor interest in the underlying composition of the flour. They will be, you know, reading agencies, analytical companies, and data companies. All of them need to really go around the underlying assets because, ultimately, the investor needs a full range of services for that.

This is also going to be different from the Hong Kong, Singapore, New York, or London exchange markets, where traditional finance requires everybody to bring money to you, all the regulatory entities to you, all the people to you, and all the regulations. Therefore, there are only a handful of financial centres in the world today. And once money gets into one place, it doesn’t really go away. It doesn’t change.

But MCEX is going to be the world’s first daily revenue contract market. It is digital, which means that we can become a global exchange, but it’s all digitally connected. So we become the new generation of concentration of capital, not necessarily physical capital, but really all the data behind the capital, and where the price allocation, the price setting, and all the valuation determinators of those underlying assets. So I think people need to think not through how many people we are going to have in Macau, and how many bank branches will open. We should be thinking that we become the nerve center, the data center, the real information, and gathering that will require a lot of traditional intellectual people and capital. But we are not going to be the heart of global finance because the heart is where the money actually flows. We are going to be sort of the global nerve where the money is coming from, where the money is supposed to go, and how that money is calculated, how that money is evaluated, and how transfer prices are determined. That’s a much better place to be.

For a small shop to be part of this, what are the requirements in terms of data sharing and transparency?

C. L. – We need to go through what we call “connect partners” because we are not able to really find a way to learn about the revenue of an individual small shop on the street.

So we need to go through an existing network that has already been put into place by a ‘connect partner’. The typical examples are chains or brands that already have a few hundred shops. They are connected already. They have a system. The parent of that chain is already collecting money. You already know that they have already finished all the cat-and-mouse games of catching the cheaters and all of that. Only then will you put your collector on their own existing system, because we are not going to be able to go back and replicate a new national system. It’s really tapping into existing connect partners. And typically, it’s all digital.

Based on our experience with commercial real estate property operators, we started realising they are also a great connector partner because the shops have direct control of them today. If the landlord becomes your partner, what you can do is to say, put your lease listed in Macau as daily revenue contracts. In exchange, you need to put digital control over the shops inside your mall, in which case you can actually have your lease financed.

 You can also start to finance other CapEx of the shops within your mall as long as you keep an eye on the shops because, in many other countries, you still have a lot of physical cash.

And they have a cash box there. You need to ensure that the investor is aware of the amount of cash in that box on a daily basis. So even though we may not be able to get our hands on the cash every day, we know how much is in there. You can do a weekly or biweekly settlement that can be done by having a landlord be a local partner.

And within that model, the landlord’s interest is completely aligned with those of the investors, because if the landlord fails in its job, investors know that shops in that mall are uninvestible. You are out.

So for them to want to have continued access to financing in their mall, they really want to make sure that they help investors build this sort of digital plus enhanced physical cash collectability. And that can be done with the landlord. And if successful, you can do it in markets like Southeast Asia or even Macau or Hong Kong, where there’s still a lot of physical cash.

This brings me to the Market Accepted Protocol, introduced earlier this year. Could you unpack this tool and share with us the market’s feedback?

 C. L.- Investors will need to buy thousands and thousands of little cash flows. There needs to be a way for everything to be standardised. Say, for instance, I’m selling you watermelon, I’m selling you corn, I’m selling you potato, whatever I’m selling you, there needs to be a centralised and standardised way to say, five apples and one watermelon, and maybe a few corn equals… So essentially you have to create a standard of currency. Therefore, every contract, no matter what you do—your noodle shop, your hair salon, your auto mechanics—is  so standardised that we have certain parameters. So, you are almost creating a currency that everybody’s using.

Tell us about these 15,000 shops. Who are they, and where are they located in the mainland?

They are everywhere. The 15,000 of them are all over China in 200 cities. Sichuan has the biggest number of shops. The average size of the investment per shop is 300,000 yuan. The shops belong to four industries: retail, food and beverage, services, and culture and sports activities. For instance, within food and beverage, we have casual food, fast food, foreign cuisine, dessert, and bakery, you know, catering, and so on. If you look at services, then you have, I see which service you want, beauty service, residential service, and medical service, travel service, well service, residential service, automobile services. If you look at some of the cities, from tier one to tier five, the biggest increase in tier four and five cities was during the Chinese New Year’s holidays. Everybody went home and spent money home.

“From a capital raising perspective, it is going to be just as good and strong as a traditional market”

“This is about more inclusive financing. This helps the little guys a lot”

This market is for institutional and professional investors. How about individual investors? Would they be able to participate somewhere down the road?

C. L.- Probably not in the foreseeable future. Because remember, one day, if the noodles can be purchased by Hong Kong-listed companies, then individual retail investors can buy their stocks. But they are coming over here because we don’t believe that individual retail investors understand how each store works. And also, that’s a single exposure to a store. The reason this thing works is because banks and other big money institutions want it. It is because there are so many of them that the diversification is such that people actually feel that the quality of return is much higher. So, I think in the short term, we probably don’t want to have retail investors yet. And also, not raising funding from China and investors inside mainland China.

Would you anticipate raising money in the mainland in the longer-term future?

C. L.- In the future, yes. But that would require the Chinese regulator to become comfortable after all the aftermath of the internet financing peer-to-peer (P2P) financing, all this financial innovation, which is really about aggregating money away from retail investors and then telling them a story, and eventually everything becoming a Ponzi game. China needs a lot of time to absorb the painfulness of that failure.

We are a great innovation. We believe we are fundamentally different from any one of those, but we want to give the regulators the time and space to sort that out first until they have a much better understanding of what we do, until we are much more established, so that they have greater confidence that this is different.

With regards to the actual shape of China’s economy, there have been mixed signals and some level of scepticism concerning the robustness of the country’s post-pandemic recovery. Some investment funds and consulting firms have expressed doubts over the future development of the whole economy and domestic demand. What’s your take on all of this?

C. L.- Clearly, the economy is going through cyclical and structural changes, and that brings pain. But from an investor’s perspective, the reason you have all that scepticism or pessimism is not about the real economy itself. It is really about how they are evaluating the situation. It is about how traditional finance is looking at issues because they’re looking at issues because the traditional way of investing is to invest in companies and then invest in their equity. And whether the equity you’re going to make money with or not is a function of not only how the company is doing your profit, but it’s really the multiple. The valuation is the multiple. And when you have a valuation multiple, it’s essentially about what they collectively are feeling. Is the economy good? Then maybe this company is worth 15, 20, 30 times price-to-earnings (P/E) ratio. But if nobody likes it, if everybody thinks the economy is weak, the company would be eight times P/E then the price is going to go down. You lost something, but the underlying company you bought, the profit may not necessarily have changed or not changed as much. The multiple change is the one that creates the perception in the investor’s mind that you’re losing money or you’re making money.

But for us, you’re investing not in the perceived future of a big company, of any company, or of any shop. We are only looking at this particular shop in this particular location. Is the revenue going to be enough for me to collect my money back? It’s a very different way of looking at the universe. Let’s say a noodle shop, a shark fin expensive noodle shop. Quite expensive, but not super expensive. If today’s economy and consumption are coming down, you are in this moderate-to-expensive noodle shop business, you’re going to lose some customers because they cannot afford what you are selling. They will be going to cheaper noodle shops. But don’t forget that the guy who was eating the really expensive noodles before can’t afford that either, it coming down to you. So actually, you don’t feel it. The only person feeling it is the shark fin noodle shop guys. That’s why today, if you are in the most expensive part of the economy, if you’re banking on people always travelling and spending big money, it’s getting tough. But if you’re just like 90% of everybody else, your business remains pretty much the same.

“We are going to be the global nerve where the money is coming from, where the money is supposed to go, and how that money is calculated, how that money is evaluated, and how transfer prices are determined”

Will MCEX join the Champions League of financial markets? When could that happen? What’s the prospect?

C. L.-The prospect? Well, let’s just compare ourselves against the Hong Kong exchange first. 
First of all, people remember Hong Kong largely because of the secondary market trading of the equities. For our business, we are more of an investment market than a secondary trading market. So from a trading perspective, we are apples and oranges, but from a raising capital perspective, we are apples and apples.

Hong Kong exchange every year has about 100 to 200 new listings, raising capital, each raising, on average, let’s say, one billion Hong Kong dollars. So together, we are talking about HKD 200 billion.

In five years, if everything goes as planned, MCEX could have 100,000 small shops coming every year, each raising a couple hundred thousand yuan. So essentially, it’s similar to HKD 100–200 billion in capital raised. Whether we achieve that in five years, in eight years, I don’t know. But we will be there and we will be there. Once we are there, it is going to continue and continue.

From a capital raising perspective, it is going to be just as good and strong as a traditional market, giving us time.

But in terms of geographical coverage into the future, we are likely going to become a franchised market, to have partners everywhere, as long as they are able to generate local needs into local stores, then we can bring them to a list in Macau (MCEX).

Have you had this kind of feedback elsewhere in the region?

C. L.- Oh yes. People are looking with great interest, and people are coming to us. Because this is all about a standard. We give them a protocol. So instead of forcing everybody’s money to come here, you are exporting the standards. You’re exporting a protocol; you’re giving them a chip. We create a mainframe here, but then you replicate the chips, and they give it to them. They do a little thing, but it’s listed here so that more money can go there and their own money can go to other places. So it’s more like a franchised financial market where we are becoming the centre for listing, digital disclosure centre, and standardisation centre.

We have the MAP – Market Accepted Protocol. If you accept that protocol, it’s like an internet standard. This will hopefully become a digital franchised new generation of national markets.

Before we conclude our talk, let’s go back to the rationale behind this undertaking. Considering all your expertise and experience at the top echelons of financial markets, what’s your mission here?

C. L.- This is about more inclusive financing. This helps the little guys a lot, but it’s not charity. This has to be a sustainable business. So why does this give me the kick? It’s really two things. One, you start realising the Amazon moment of finance is here because of digitalisation. Because in the past, before the internet, everyone would go to the department store to shop. And the department store would decide how much inventory they put in there, and then you could only buy whatever’s there. So only tens of thousands of merchandise in the department stores.

And then Amazon came, Alibaba came, e-commerce came. Now we can buy millions of merchandise. They don’t need to be put into a department. So we don’t need to go to the department store. We are able to buy it online. Alibaba and Amazon sorted out the delivery and the cash.

Today’s traditional finance is like the pre-internet era. This change, like e-commerce, helps little guys big time because they were never part of this.

That is ultimately why finance people like me enjoy this, because we finally make finance relevant to people.

https://www.macaubusiness.com/macau-will-forever-be-irreversibly-in-the-food-chain-of-this-financial-innovation/

Micro Connect, the UFO

It is one of the most innovative fintech companies in the world and is named after Macau, despite its headquarters in Hong Kong and offices in Shenzhen.

 

On November 30, 2022, an 'unidentified flying object' landed in Macau, coming out of nowhere.

This UFO has a name (Micro Connect or MCEX) and a familiar face (Charles Li, former director of the Hong Kong stock exchange) but everything else is surprising to say the least.

First of all, the operating model that seems to have no benchmark as a reference in the financial world: to trade financial products known as daily revenue obligations (DROs) that give investors the ability to purchase part of the future revenues of China’s small and micro enterprises, brick-and-mortar stores.

But unlike what happens with investment in shares, the MCEX model does not require the investor to be the owner of part of the company: there is an initial investment in the expansion of a store or chain of stores, for example, and he will receive a part of the profits when they arise (via DROs, operated on a blockchain-enabled technology platform).

No less surprising is the choice of Macau as the company's headquarters and not Hong Kong or Shenzhen, where, in fact, Micro Connect has an office and its operational base, respectively. The official address is 8 Connaught Place, Central Hong Kong.

That's why Macau Business tried, persistently, in recent weeks, to obtain more information from the company, not only why they chose Macau but how they can contribute to GDP or bring other benefits to the city. Unsuccessfully.

The Macau Government's has collaborated with the project but, in general, the attitude appears to be 'wait and see'.

On November 30, the Chief Executive signed the authorization to establish and operate Micro Connect (Macao) Financial Assets Exchange Co., Ltd. "for services related to the trading of financial assets," through Executive Order No. 47/2022.

From then on, there were few references, for example from Ho Iat Seng to this fintech platform.

Last October, during the Third Belt and Road Forum for International Cooperation, the Chief Executive highlighted his role in facilitating the installation of MCEX in Macau.

The caution mentioned in this story is also visible in the reaction of the Monetary Authority (see text on these pages).

Sources contacted by Macau Business explain the situation as follows: if the project goes well, it will bring Macau a reputation as a city where fintech business takes place.

For now, the numbers are good (12,300 shops across 33 provinces and 270 cities had so far received funding via the MCEX, and an additional 3,200 are now in the pipeline, according to the most recent data), but the project doesn't even have two years of operation – it was launched officially in August 2023.

It is worth adding that Micro Connect announced six months ago that it made the first investment in Macau by providing funding to Hao Yue Catering Group Company (specifically for the 'Joy' restaurant), which thus became the first local business to secure its financial support from MCEX.

“With our investment debut in Macau, we hope to improve the digitalization level of Macau's consumer industry, facilitating the deep integration of the digital and physical economy, and driving the digital revolution of the Macao economy,” Gary Zhang, one of the platform's founders fintech, said at the time.

Some of Macau's main banks have so far supported the project.

[HEAD/part2]

“Risk management”

Macau Business asked the Monetary Authority (AMCM) what is the legal/administrative framework for the operation of the exchange platform MCEX in Macau and the response is came in these terms, emphasizing the issue of the “risk-based” principle:

"Micro Connect (Macao) Financial Assets Exchange Co., Ltd. (also known as the “MCEX”), a financial asset trading company permitted to operate in Macao, undergoes continuous supervision by the AMCM with the “risk-based” principle. The operational model of MCEX, which encompasses the generation, trading, funds clearing and settlement, as well as information disclosure of the underlying assets of traded products, is obligated to strictly adhere to the stipulated risk management and internal control guidelines. Furthermore, it is mandated to operate in accordance with statutory regulations. For cross-boundary activities, compliance with the respective local legal frameworks is also imperative and essential."