An IOSCO committee has completed preliminary research into crowdfunding and the programs that are being put in place by financial regulators on the international stage.
Crowdfunding has undeniably changed the way a small group of people get hold of funds/capital, offering a way to make things happen never before seen except by begging, borrowing and stealing.
Crowdfunding side-steps traditional banks and lending, and under several models includes individuals or businesses receiving untethered 'free' money, or to use that as a business investment model in peer-to-peer lending and equity crowdfunding (FR crowdfunding).
As discussed in Crowdfunding Part I, the latter is where the risks come in, since there is a 50 per cent failure rate of investments.
What everyone else is doing
Some countries are applying their business-as-usual securities framework, with some flexibility, however some have introduced, or plan to introduce, new regimes. Approaches turned out to be many and varied, but had some commonalities in theme.
One such commonality is the value placed on the balance between risks and investor protections, so no surprises there. The more interesting aspect is the understanding by most jurisdictions on the positive role that crowdfunding can play in economic recovery - possibly the first time regulatory bodies found something positive in a new social trend that uses people power and leaves large 'safe' institutions and corporations out of the playground (think Uber and bitcoins).
Most of the steps taken to foster crowdfunding had far lighter entry requirements and sometimes special caveats in their platforms. This has sometimes included limited reporting requirements for platforms.
There are also counter restrictions and/or rules regarding information integrity and the protection of investors, such as:
- there are some limitations on the services and business activities that can be conducted;
- a third party must be appointed to hold funds; and
- education programs must be in place for investors.
Restrictions may also apply to cross-border crowdfunding and fundraising, including the need for the platform issuer to be local at least in incorporation.
The major risks being curtailed include the high failure rates of start-ups. The IOSCO report explains that many members require funding portals or intermediaries to conduct due diligence on the issuer/crowdfunding offerings, which may mean a review of business plans to make sure the business idea is legit. It may also include being open about the selection criteria used to choose investments and members, and then reporting on done deals.
A platform can also be denied operations if the person or people running it are disqualified from doing so in some way, or present a risk to the business. There are also limits in place in some countries on investment amounts.
Some countries had certain rules regarding intermediaries to ensure in the case of platform failure, the integrity of stored data was upheld and published through platforms, and that proper technology systems were in place, including adequate backup facilities. Sound procedures were required to allow for the business to cease trading, but the commitments made previously be honoured.
Fraud and money laundering has been a concern, with jurisdictions using the same fraud and money laundering rules that apply to everything else. Due diligence and use of custodians are also supposed to help reduce fraud.
Liquidity risks were commonly addressed by the use of specific disclosure requirements that applied to crowdfunding specifically. These included mandatory reporting of elements that would normally go under the regulatory radar, such as liquidity risk. These documents detail liquidity risk, investors are provided with ample warnings, and in one case, the right to withdraw from the offer or sell the purchased stake if certain circumstances were met was required.
It was noted by the survey respondents that it was important that the risk to the investor was monitored and that special education materials and questionnaires were completed to demonstrate understanding of the features and risks of crowdfunding offers. In some cases, only those who have been through specific channels of warnings, including interviews, are able to invest in FR crowdfunding platforms.
Overall conclusions of the report
The report concludes that while a few global regulators have specific systems in place for crowdfunding platforms, many still haven't dipped more than a toe in with specific regulations. The platform is in its infancy and while it offers many rewards, it also comes with intrinsic risks, and IOSCO has specifically stated that they do not propose a common international response to oversight and supervision of any programs, either in place or proposed.
What it may do is monitor the various approaches and see which work the best.