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15 October, 2016
Previsouly, we discussed how Singapore could create a flexible investment-based (or securities-based) crowdfunding landscape with practical safeguards put in place to protect investors, particularly retail investors.
On 8 June 2016, more than a year since the release of its Consultation Paper on Facilitating Securities-based Crowdfunding in February 2015 (“Consultation Paper”), the Monetary Authority of Singapore (“MAS”) announced that it will be implementing a new balanced approach for securities-based crowdfunding (“SCF”) in Singapore. Together with its announcement, the MAS also released its response (“Response”) to the feedback received for the Consultation Paper.
This new approach of permitting participation by retail investors in SCF marks a key shift from the MAS’s earlier proposals that mainly limited SCF to accredited investors and institutional investors. While the MAS’s position does not come as much of a surprise, it can be further refined in the interest of both further protecting investors and expanding the SCF industry.
In this update, we offer our views regarding the main highlights of the MAS’s new approach for SCF.
Easing of Financial Requirements for SCF Platform Operators
In the Response, the MAS confirmed that it will ease the financial requirements for SCF platform operators, as it had previously proposed in the Consultation Paper, through the following measures:
- lowering the base capital requirement from S$250,000 to S$50,000;
- removing the security deposit requirement of S$100,000; and
- lowering the minimum operational risk requirement to S$50,000.
These lower requirements would apply only for SCF platform operators who serve only accredited investors and institutional investors; do not handle, hold or accept customer monies, assets or positions; and do not act as principals in transactions with investors. In the MAS’s view, the systemic and business conduct risks posed by such SCF platform operators are limited, and the resultant impact on investors if such SCF platform operators face financial challenges would generally be minimal.
These lower financial requirements are meant to make it easier for SCF platform operators to apply for a Capital Markets Services (“CMS”) licence to deal in securities under the Securities and Futures Act (Chapter 289 of Singapore) (“SFA”). Already, we are seeing interest from existing SCF platform operators to apply for the CMS licence.
One potential concern regarding the new low financial thresholds is that while they are meant to ease the financial burden for SCF operators (who will likely be financial services start-ups with limited access to capital in their early stages), this same attribute may also attract applicants who may not be suitably qualified since their initial regulatory financial commitment is now much lower than before. Although the MAS has a robust system of checks in place to prevent non-suitable applicants from getting a CMS licence, this does not altogether eliminate the risk that a “non-suitable” SCF platform operator “closes shop” and leaves investors “high and dry.”
As a starting point, applications that merely satisfy the minimum financial requirements should perhaps deserve relatively greater scrutiny from the MAS, including into the backgrounds, qualifications and experience of the individuals behind the SCF platform operator. After the MAS scrutiny, such an applicant can be granted a conditional CMS licence for a limited period of time, which can be converted into a full CMS licence if the SCF platform operator is able to meet certain prescribed requirements, such as increased financial or capital requirements. While some may view this as stifling the growth in Singapore of SCF, Singapore should not ease up on its quality control requirements (of which adequate financial and capital requirements form a part) in its bid to maintain its “relevance” as a leading global financial centre in the new emerging financial technology (or fintech) environment.
In addition, while some may say that the potential impact on investors (accredited investors and institutional investors) if such SCF platform operators face financial challenges would generally be minimal, the definition of “accredited investor” in the SFA is somewhat arbitrary with a random financial threshold separating an “accredited investor” from a “retail investor.” An investor who just barely meets the financial threshold in the SFA to qualify as an “accredited investor,” but who does not have the corresponding level of financial experience or knowledge expected
of a sophisticated investor, should be entitled to the same protections as a retail investor.
In the seemingly never-ending obsession for numerical qualifiers, it should not be forgotten that SCF involves a greater level of risk and uncertainty as an investment than traditional lending or fundraising. This is especially so since almost all of the current SCF platform operators in Singapore are still vague and opaque about what kinds of checks and verifications they conduct on the offerors that are listed on their platforms. Just because an investor is considered to be an accredited investor or an institutional investor based on a definition in the SFA, it does not, and should not, mean that the investor can “afford to lose” the investment if the SCF platform operator goes “bottom up.”
As mentioned above, accredited investors are considered to be sophisticated investors merely because they meet the random financial threshold in the SFA, even if they do not have the financial experience or knowledge of sophisticated investors. Similarly, institutional investors invest directly or indirectly on behalf of millions of savers, pensioners and retail investors, so it cannot be said that they can “afford to lose” the investment either. There are certain instances when all investors, whether retail, accredited or institutional, need to be protected equally under the law. The nascent SCF landscape, with its greater level of risk and uncertainty, can perhaps be considered one such instance.
SCF from Retail Investors
Offerors can crowdfund by offering securities to investors, including retail investors, by registering and providing a prospectus for the offer or by complying with the conditions that apply to the existing prospectus exemptions, such as the small offers exemption under section 272A of the SFA (“Small Offers Exemption”).
Currently, under the Small Offers Exemption, an offeror can make a personal offer of securities to investors, including retail investors, subject to a S$5 million limit based on the amount of funds raised within any 12-month period. A “personal offer” is one that is made by the offeror or by a person acting on its behalf to a pre-identified individual or entity. The offer and distribution of the securities must be conducted in a discreet manner and not be subject to any mass solicitation, advertising or canvasing.
In the Response, the MAS acknowledged that the Small Offers Exemption was not designed with SCF in mind, so the current investor pre-qualification expected of licensed SCF platform operators appointed by an offeror to intermediate its offer would be refined to make fundraising from investors (including retail investors) through SCF more practicable, subject to appropriate safeguards.
SCF from retail investors appears to remain a “buyer beware” situation for retail investors. It should be kept in mind that SCF is still in its infant stages globally and the risks potentially still outweigh the benefits, especially since, as mentioned above, almost all of the current SCF platform operators in Singapore are still vague and opaque about what kinds of checks and verifications they conduct on the offerors that are listed on their platforms. That said, investors with the right risk appetite will likely be attracted to the potential for higher and better returns offered by SCF investments.
In addition, although the use of the various exemptions in the SFA may potentially help small and medium enterprises (SMEs) and start-ups access previously locked funds from retail investors, offerors need to be aware that they should still limit their number of shareholders to less than 50; otherwise, they become public companies under the Companies Act (Chapter 50 of Singapore), which are subject to more onerous requirements. Without an adequate structure to legally work around this company law limitation, some offerors may list only on SCF platforms that do not cater to retail investors. This would result in the ironic situation of shutting out retail investors from SCF even as it is opened up to them.
Simplified Investor Pre-Qualification Process
In its updated “Guidelines on Personal Offers made pursuant to the Exemption for Small Offers” (“Guidelines on Small Offers”), issued together with the Response, the MAS has refined the current investor pre-qualification process such that a licensed SCF platform operator appointed by an offeror and the offeror need to make sure proper investor pre-qualification procedures are in place to ensure that: (i) the investor possesses either sufficient knowledge or experience to understand the risks of investing in securities offered by SCF or(ii) the SCF investment is suitable for the investor in light of the investor’s investment objectives and risk tolerance.
This new simplified investor pre-qualification process is a significant easing of the previous pre-qualification test for small offers, which required the licensed SCF platform operator appointed by an offeror and the offeror to ensure that: (i) the investor possesses both sufficient knowledge and experience to understand the risks of investing in securities offered by SCF and (ii) the SCF investment is suitable for the investor in light of the investor’s investment objectives and risk tolerance.
Strengthened Risk Disclosures
In the Guidelines on Small Offers, the MAS also stated that it will strengthen the existing risk disclosures to require any licensed SCF platform operator appointed by an offeror and the offeror to provide, at the minimum, a prescribed risk disclosure statement to each potential investor and obtain the investor’s acknowledgment that the investor is fully aware of and accepts the risks associated with SCF.
This risk disclosure statement needs to be provided to, and the risk acknowledgment needs to be obtained from, the investor before the investor’s first SCF investment on the SCF platform. In addition, the risk disclosure statement and risk acknowledgment are also required immediately prior to the investor making another investment on the SCF platform if there is a material change to the information that the investor had previously provided in the investor pre-qualification process, and also on an annual basis.
Clarification on Advertising Restrictions
In the Consultation Paper, the MAS clarified that an offer of securities made in reliance on the prospectus exemptions under sections 272A (small offers exemption), 272B (private placement exemption) or 275(1) (accredited investors and certain other persons exemption) of the SFA is meant to be limited in scope and is subject to certain specified conditions, including a restriction on any advertisement of the offer (“Advertising Restriction”). An offer that does not comply with the Advertising Restriction would not be considered an exempted offer.
In response to requests for further clarifications on the scope of the Advertising Restriction for SCF platform operators, the MAS, together with the Response, issued the “Guidelines on the Advertising Restrictions in Sections
272A, 272B and 275” (“Guidelines on Advertising Restrictions”) to address the concerns and uncertainty on the manner in which SCF platform operators can publicise their services, as well as other technicalities.
Among other things, the Guidelines on Advertising Restrictions clarified that the publication of factual information on an offeror and the terms of the offer on a restricted access SCF platform would not be regarded as a breach of the Advertising Restriction, if among other things, the SCF platform operator has conducted due diligence to confirm that investors who have access to the platform are within the scope of the prospectus exemption.
Perhaps of more immediate significance to SCF platform operators, the Guidelines on Advertising Restrictions also clarified that an SCF platform operator can publicise the existence of the SCF platform through providing information about the platform and its services, including mentioning past offers that were made and completed through the platform. However, such publicity should not call attention to any offer that is still open or to any intended offer.
Removal of Promissory Notes Exclusions
Perhaps not surprisingly, the MAS, in the Response, clarified that it will be removing the promissory note exclusions for SCF by legislative amendments to the SFA, based on the fact that a promissory note has characteristics that are similar to that of any other debenture and should therefore be subject to regulation under the SFA, so that investors can enjoy the protections under the SFA.
Currently, promissory notes are excluded from the definition of “securities” under section 2 of the SFA. As such, SCF platforms which issue, or facilitate the issue of, promissory notes are currently exempted from the requirement to obtain a CMS licence for dealing in securities. In addition, promissory notes with a face value of not less than S$100,000 and a maturity period of not more than 12 months are currently excluded from the definition of “debentures” under section 239(1) of the SFA. This means that an offer of such promissory notes is currently exempted from the prospectus requirements under the SFA.
The above promissory note exclusions have resulted in some lending-based crowdfunding and peer-to-peer lending SCF platform operators facilitating the raising of funds from retail investors by using work-around structures of consolidating funds from multiple small lenders into a single entity to cross the S$100,000 threshold for excluded promissory notes without the SCF platform having to hold a CMS licence or the offeror having to meet the prospectus requirements under the SFA.
The MAS has clarified that crowdfunding through promissory notes is not exempted from the prospectus requirements, unless the promissory note falls within the promissory note exclusions, in that the promissory note needs to be issued by one borrower to one single lender and has a face value of not less than S$100,000, as well as a maturity period of not more than 12 months.
Conclusion
Generally, the MAS’s stance does not come as much of a surprise. In time, as the SCF industry grows and investors become more aware and educated (even if this means that some SCF platforms have to fail and some investors have to be “burnt” first), the MAS’s position can be further refined in the interest of both protecting investors and expanding the SCF industry.
With the proliferation of technology, it is no surprise that the crowdfunding sector has experienced rapid growth in recent years, in the neverending quest of investors, including retail investors, to seek better and higher returns on their investments. Given the retail interest in SCF, it is a welcome sign that the MAS has chosen to take a measured and practical approach in addressing the issue of retail SCF instead of keeping it away.
For further information, please contact:
Sarita Misir, Associate Director, Duane Morris & Selvam
smisir@duanemorrisselvam.com
