Investing into ASEAN’s emerging markets: a snapshot from the venture capital perspective
April 2017 | EXPERT BRIEFING | FINANCE & INVESTMENT
In 2011, Gideon Rachman, the chief foreign affairs commentator of the Financial Times, proposed in his book, Zero Sum World, that the global financial crisis in 2008, coupled with the rising economic prominence of Asia, would lead to the adoption by the biggest economies of the world of a zero-sum logic when approaching international relations. Barely five years thereafter, in what is perhaps the greatest validation yet of Rachman’s zero-sum narrative, the world saw, in the span of one year, the United Kingdom voting to withdraw from the European Union and the ascension of a new, protectionist rhetoric in the US – one that will result in walls being built between national borders, immigration bans and reversals of trade liberalisation policies.
This zero-sum logic however, does not seem to apply to Asia. In spite of the protectionist sentiment prevalent around the western world today, key Asia economies (especially the Association of South East Asian Nations (ASEAN) member nations) seem to be opening their doors now more than ever before, from the economic perspective at least.
On a broader level, there is the China-led regional comprehensive economic partnership (RCEP), a regional economic agreement between the 10 member nations of ASEAN and six of the partners with whom they have free trade agreements (China, India, Japan, South Korea, Australia and New Zealand). The RCEP, when established, will be a major step toward the establishment of a Free Trade Area of the Asia Pacific (FTAAP), something that the Asia Pacific Economic Cooperation (APEC) (which counts as its members the US, Russia and Canada) has been advocating with renewed vigour since 2014.
On a geographically narrower but no less significant level, we have the ASEAN bloc. In December 2015, the ASEAN Economic Community (AEC) was formally established, paving the way for the development of a single economic market among the ASEAN member nations, allowing the lowering of trade barriers and promoting the flow of goods, services and business in general across borders. ASEAN is by no means a new creation – it turns 50 this year – and from an initial group of five countries in 1967, ASEAN has grown to comprise 10 member nations today with a combined population of approximately 630 million and a gross domestic product of approximately $2.43 trillion. Combined, it ranks as the sixth largest economy in the world and the third largest in Asia. ASEAN’s five largest emerging economies, Indonesia, Malaysia, Philippines, Thailand and Vietnam, have an aggregated population of approximately 548 million, or 87 percent of the total population of ASEAN. These countries have an average GDP growth rate of between 4 and 5 percent. Together, these markets represent tremendous growth potential for businesses, especially those with the ability (and foresight) to scale across borders.
Of the various macroeconomic indicators that can be used to track and predict the growth of economies, one stands out in particular in relation to the ASEAN economies: population age. Key to the ASEAN growth trajectory is the fact that the populations of ASEAN’s five largest emerging economies are young, with a large majority being millennials. As they enter the workforce, there will be a higher demand for jobs, and consequently, ASEAN economies will continue to remain a cost-competitive option for labour-intensive industries. Millennials also form the majority of the burgeoning middle class population in these emerging markets. Millennial consumerism trends and millennial spending, buzz phrases in the consumer world today, will see these markets quickly becoming key to global retail businesses.
Another interesting statistic closely linked to population age, is technology and internet adoption. During the ‘economy SEA’ event held in May 2016 in Singapore, organised by Google and Singapore’s sovereign fund Temasek, data published by them suggested that Southeast Asia is the world’s fastest-growing internet region with an existing internet user base of 260 million, which will grow to approximately 480 million users by 2020. The consequence is that the Southeast Asian internet economy is expected to grow to approximately $200bn by 2025. The industries that are contributing to this growth are led by the first hand e-commerce market, followed by online media (including advertisements and gaming) and online travel. One of the factors unique to Southeast Asia that is contributing to this growth, according to Google and Temasek, is a burgeoning young population. Approximately 70 percent of people in the Southeast Asian countries are under the age of 40. Other factors include the lack of big-box retail stores in Southeast Asia, and a growing middle-class population. Illustrative of these projections is the fact that three out of the eight Southeast Asian unicorns – the term used in the startup world to refer to a company with an investor valuation of above $1bn – are in the e-commerce marketplace sector (Lazada, Tokopedia and Traveloka), two are in gaming and online media (Garena, VNG and Razer, in a related industry) and three in online travel (Traveloka, Grab and Go-Jek ).
Following the growth of Southeast Asia’s emerging markets and the startup space is the flow of venture capital into the region. For example, Southeast Asian unicorns have seen hefty investments by government-linked investment funds, such as Singapore’s Temasek, and blue chip public market funds such as Sequoia Capital and Softbank Capital. Some startups, such as Grab, have had access to such blue chip financing from as early as Series A. In addition to funds from traditional institutional sources, such as investment funds and venture capitalists, startups in Southeast Asia have also seen an inflow of capital from other mature startups. In February 2017, it was announced that China-based FinTech giant Ant Financial Services Group had invested into Mynt, a wholly-owned subsidiary of Philippine’s Globe Telecom. Mynt is a mobile payments and remittance platform which also provides loans and business solutions. This was Ant Financial’s first foray into the Philippines. In November 2016, Ant Financial entered into a strategic partnership with Thailand’s Ascend Money, another FinTech company that offers e-payment services and micro loans, similar to Mynt. Ascend Money has operations in Indonesia, Philippines, Vietnam, Myanmar and Cambodia. This trend of consolidation and strategic partnerships through mergers and acquisitions seems poised to continue, as increasing numbers of foreign companies seek to penetrate Southeast Asia.
Investing in ASEAN’s emerging markets, however, presents challenges. These countries are culturally diverse, and doing business in any of these markets requires an intimate understanding of hard-letter law, as well as ‘softer’ customs and practices. Rule of law is not always obeyed, and ‘grey’ areas are sometimes the rule, rather than the exception. Foreign investment conditions, often applied by legislators to protect certain domestic businesses, are often highly prohibitive (with outright restrictions in some cases), leading to the adoption and use of nominee arrangements, where local nominees ‘front’ businesses that are effectively controlled and beneficially owned by foreigners. Such structures are frowned upon by regulators and are often seen as going against the spirit of the law. Some of the Southeast Asian jurisdictions have sought to impose sanctions against the use of such structures. The Philippines, for example, has enacted an ‘anti-dummy’ law which effectively criminalises both locals, as well as foreign persons acting in concert to bypass laws protecting nationalised industries.
Applications for investment licences are also challenging, particularly when the application process still requires businesses to be pigeonholed into established ‘traditional’ industry categories. For example, an e-commerce marketplace may be regarded as comprising up to five different business lines in Vietnam (retail, distribution, advertising, storage and delivery functions), of which at least two (retail, distribution and advertising) are still considered conditional sectors for which business licences will take up to six months or more to be granted. Based on the World Bank’s doing business report in 2017, it takes an average of three to four weeks to start a business in the top five ASEAN emerging markets, as compared to two and a half days in Singapore, and one and a half in Hong Kong.
Corruption is a begrudgingly-accepted norm of doing business in Southeast Asia. Despite the best efforts of the governments of the biggest ASEAN emerging markets, most of these countries (with the exception of Malaysia) rank in the bottom half of Transparency International’s corruption perceptions index. ‘Lobbying’ and payments of ‘facilitation’ fees are common, as are kick-backs and commissions, often seen as an essential part of doing business and not as corrupt practices. The issue goes quite a fair bit beyond paying. Navigating the complexities of corruption has become a business itself, with business consultants charging fees for essentially advising on who to pay (and who not to pay), how much to pay and how to pay.
The administrative authorities and lawmakers are not entirely consistent or reliable either. Take Indonesia’s Go-Jek for example. In 2015, the transport ministry of Indonesia issued a letter to regional governments and national police banning taxi and motorcycle hailing apps citing that such services do not conform to Indonesia’s transport laws and regulations, effectively making Go-Jek illegal overnight. The ministry had to hastily backpedal after president Jokowi issued a statement a day later that Go-Jek offered a service that the public needs and that the government should not be restricting innovation.
Despite the challenges of doing business in ASEAN’s emerging markets, the potential that these markets represent make them difficult to ignore. For startups grown organically in ASEAN, such challenges are par for the course. These businesses are very aware that the process of fundraising from foreign investors requires, first and foremost, an acknowledgement of such challenges, followed by a prescription of solutions (often in the form of legal structures) that address the typical concerns of foreign investors. Foreign holding company structures are the quickest fix, provided that the foreign investment restrictions do not prevent the consolidation of the local company’s equity into foreign hands. Singapore has become a choice location for holding companies, due to its tax efficiency (low corporate income tax, one tier dividend tax, double taxation agreements with most of the ASEAN nations), transparent corporate governance rules and business and investment friendly legislation.
The governments of ASEAN’s emerging markets have also acknowledged their systemic shortcomings. In a bid to be more progressive, it is not uncommon for regulators in ASEAN to engage with startups in order to better understand their businesses, the gaps that they are trying to fill, and to thereafter craft appropriate legislation and regulations to ensure proper conduct of business. This is particularly obvious in the FinTech sector where central banks and monetary authorities in the region have adopted a ‘wait and see’ approach, through various sandbox initiatives. Meanwhile, as the regulatory authorities play catch-up, the startups will continue doing what they do best, innovate and if necessary, improvise.
In conclusion, assessed as one would an investment deck, it is apparent that the product that is the ASEAN emerging markets is beyond the nascent beta-testing and minimum viable product stages. ASEAN emerging markets will still have some way to go before becoming the next Silicon Valley but perhaps it is now the time to consider, a Series A investment into ASEAN.
Brian Ng is a partner at Rajah & Tann Singapore LLP. He can be contacted on +65 6232 0387 or by email: email@example.com.
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Rajah & Tann Singapore LLP