15 July, 2015
On 16 February 2015, the Monetary Authority of Singapore (“MAS”) issued a consultation paper titled “Facilitating Securities-Based Crowdfunding”.1 Crowdfunding enables start-ups and small and medium enterprises (“SMEs”) to gain access to alternative sources of funding through offering securities (“securities-based crowdfunding” or “SCF”) to accredited investors (“AIs”) and institutional investors (“IIs”). The consultation paper is timely, given the growing interest in crowdfunding in recent years, following the 2008 global financial crisis.
Crowdfunding is an avenue through which individuals and organisations can raise funds from a large pool of investors through crowdfunding platforms, typically online portals, to finance their endeavours. Crowdfunding manifests in various forms such as donation-based, reward-based, lending-based and equity-based. Generally, the aim of crowdfunding has been to attract funding for innovative start-ups which may possess the necessary creative content to succeed but lack the financial assets or business track record needed to receive traditional bank loans or equity financing.
In this article, we highlight the trend of crowdfunding in Singapore. We will focus on SCF, where a company crowdsources for funds in exchange for securities in the form of debentures or shares to investors, and highlight the challenges and implications in regulating SCF in Singapore.
Crowdfunding And The Regulatory Landscape In Singapore
Riding on the wave of technology and the viral nature of web-based communication, crowdfunding has emerged as a multibillion-dollar global industry where billions of dollars in debt, equity, and donations have been raised.2 Prominent crowdfunding platforms in Singapore include Crowdonomic, MoolahSense, and Crowdtivate. Soon after MAS released its consultation paper, the establishment of a new crowdfunding platform FundedHere was announced and is awaiting legal approval from MAS.
Singapore’s vibrant start-up scene also presents tremendous potential as aspringboard for further SCF development. For instance, there are government-sponsored innovation hubs such as Fusionoplis and Biopolis, and countless innovative start-ups, many clustered in "Block 71”, which The Economist had dubbed “the world's most tightly packed entrepreneurial ecosystem”.3
Notably, earlier this year, the Singapore Exchange and Clearbridge Accelerator Pte Ltd announced a joint venture to develop a capital-raising platform for entrepreneurs and SMEs in Asia.
(I) Licensing Requirements
In its consultation paper, MAS proposed to ease the financial requirements for capital markets intermediaries that require a Capital Markets Services (“CMS”) licence for dealing in securities (“Dealing Licensees”). An intermediary operating an SCF platform which facilitates offers of securities falls under this regime and a CMS licence is required.
The issue arises when intermediaries interested in operating an SCF platform are limited by financial constraints and are unable to meet the financial requirements for Dealing Licensees, particularly where the SCF platform is intended to merely be a portal for offers and which does not directly offer products or participate in the transactions. To pave the way for such SCF intermediaries to apply for a licence to offer SCF investments, MAS proposes to lower the minimum base capital requirement from SGD 250k to SGD 50k and remove the requirement of lodging a security deposit of SGD 100k with MAS. MAS specifically limits this initiative to low-risk capital markets intermediaries, namely those which do not handle, hold or accept customer monies, assets or positions.
However, it remains to be seen whether the lowered financial requirements will have significant impact on the decision-making of potential SCF platform operators,given other existing restrictions on the business model, such as the limitation on advertising (which we discuss below). In addition, there are some regulatory requirements for CMS licence holders that remain to be addressed by MAS.
For example, a passive ‘through portal’, one which does not hold, deal, transmit, invest in, advise on or recommend securities, probably does not need licensed representatives. While MAS should insist on some relevant background experience on the part of the shareholders and senior management to run a web portal, and the fit and proper requirements should be rigorously enforced, having an SCF representative sit for tests on the ‘rules and regulations for corporate advisory’, ‘knowledge of securities products’ or any of the other modules seems incongruent.
Another area of concern is the admission guideline that licensed dealers in securities maintain minimum group shareholders’ funds of SGD 200m for dealing in certain unlisted products (e.g. foreign exchange or derivatives) with retail investors. Again, this is unnecessary for a ‘through portal’, and MAS should clarify that such a guideline will not apply to SCF platforms.
(II) Exemption From Prospectus Requirements
In its consultation paper, MAS also clarified the application of certain exemptions from prospectus requirements under the Securities and Futures Act (“SFA”) for fundraising through an SCF platform. Offers of securities to AIs or IIs are exempted from the prospectus requirements under ss 274 and 275 of the SFA. However, to limit the scope of such exemptions and prevent mass solicitation, s 275(1A)(b) of the SFA specifically provides for restrictions on advertisements for offers to AIs.
MAS clarified that this advertising restriction does not prohibit SCF platform operators from advertising their platforms, so long as no reference is made to any specific SCF offer listed on their platforms.
In a nutshell, the advertising restrictions with respect to AIs and IIs remain in place so long as no specific SCF offer is listed on its platform. This goes against the grain of crowdfunding which is to attract a crowd, a substantial number of investors, who would be interested in an investment opportunity. Limiting advertising for SCF to only general information about the platform, with no mention of the underlying opportunities, may materially stymie SCF’s ability to attract investors.
(III) MAS’ Regulatory Approach of Limiting SCF Access to AIs and IIs
MAS’ proposed regulatory approach to limit SCF access to AIs and IIs may have certain implications, which we highlight as follows.
(A) Ascertaining The Audience
SCF is a method of fund-raising which draws on the power of the masses to invest, providing in return, the promise of equity. The potential benefits of this financial model are, understandably, maximised when the audience is the crowd.
While prudent investor protection is important, MAS’ approach to limiting SCF investor access to AIs and IIs may clip the wings of SCF and thereby limit the potential benefits that SMEs and entrepreneurs can reap from SCF. One recalls Dragons’ Den, one of BBC’s most popular and long-running reality television shows, in which budding entrepreneurs pitch their business ideas to entice a panel of multi-millionaire venture capitalists to invest their own money in exchange for equity. It is notable that several Dragons’ Den participants, those who were rejected by the exclusive panel of investors, went on to become huge successes. Examples include Natalie Ellis, who benefited through viewers’ support and made her million-pound profit from her road refresher water bowl, and Rob Law, who benefited from the brand awareness raised through Dragons’ Den and went on to sell millions of his children's ride-on suitcases.
Besides the sheer determination of the entrepreneurs and the inherent potential of their products, to whom does the credit belong to in turning many of such failures into successes? – the power of the crowd and market validation, achieved through mass outreach, enabling access to capital. By limiting SCF to an exclusive group of people, it appears that the industry may not be able to harvest the benefits of a full-fledged SCF regime which operates based on the notion of the true crowd.
(B) Investor Protection
The Financial Conduct Authority of the United Kingdom (“ FCA”) conducted a specific review of crowdfunding websites against the existing legal standards in 2014.4 In relation to investment-based platforms, common problems identified by FCA include the cherry-picking of information to create an unrealistically optimistic impression of the investment, such as by displaying risk warnings less prominently than performance information.
The FCA review further noted a 2014 research report which showed that 62% of the equity crowdfunding investors surveyed described themselves as retail investors with no previous investment experience of early stage or venture capital investment.5
MAS highlights in its consultation paper that there are significant risks associated with SCF investments. These investments have a high probability of capital loss and are more illiquid compared to traditional securities investment models. Retail investors entering the market may not fully comprehend the high risks that come with SCF, even with risk disclosures. As the industry develops, if a reliable investor protection regulatory regime is not put in place, solicitation on SCF platforms may potentially expose investors to many risks.
It is ultimately a delicate balance of the objectives of investor protection and industry development – ensuring adequate investor protection by limiting market access to AIs and IIs may see retail investors pooling investments to gain access to offshore, unregulated and hence, riskier, SCF platforms, and may also limit the potential for SCF growth in Singapore.
Alternatives?
The regimes in Australia and the US may offer alternatives for our consideration. In Australia, the proposed framework of crowdsourced equity fundraising places an investment cap of AUD 2,500 per investor per 12-month period for any particular issuer and AUD 10k per investor per 12-month period in total crowd-sourced equity fundraising investment. In the US, the proposed regime for retail crowdfunding entails a limitation of the greater of AUD 2k or 5% of the investor’s annual income or net worth if it is less than USD 100k, with an offering cap of USD 1m. Such caps are relatively easy to verify, inhibiting abuse. They would also limit the impact of failure of any one platform, thereby limiting the potential market impact.
Further, one may consider the creation of a new class of investor, restricted to participation in the SCF market. Such class of investor may not meet the high thresholds for an AI but may be sophisticated enough to enter into a ‘semi-regulated’ offering such as provided by SCFs. As an additional safeguard, an investment cap (similar to those discussed above but perhaps of a higher dollar amount) may be considered as an initial opening of this market to investor participation.
A Balancing Act for A Fledgling Ecosystem
An effective crowdfunding ecosystem requires more than entrepreneurs, innovative business ideas and keen investors. Trust is the foundation of an effective crowdfunding ecosystem which also needs to be built upon a reliable regulatory regime. A key enabler of this ecosystem of trust would be MAS, which plays a critical role of shaping the regulatory landscape for SCF in its nascent stage of development, in regulating SCF market entrants, strengthening investor protection, providing a healthy ecosystem for all market participants and limiting the chances for market disruption. We look forward to interesting developments in this space.
End Notes:
1 Consultation Paper, Facilitating Securities-Based Crowdfunding, MAS, February 2015.
2 Crowdfunding’s Potential for the Developing World, World Bank,2013, InfoDev, Finance and Private Sector Development Department, Washington, DC: World Bank, pages 8 and 15.
3 “Altogether Now”, The Economist(18 January 2014).
4 Financial Conduct Authority, A review of the regulatory regime for crowdfunding and the promotion of non- readily realisable securities by other media (February 2015), paragraphs 53 to 55.
5 Peter Baeck, Liam Collins and Bryan Zheng, Understanding Alternative Finance: The UK Alternative Finance Industry Report 2014 (November 2014), pages 53 and 59.
For further information, please contact:
Nizam Ismail, Partner, RHTLaw Taylor Wessing
nizam.ismail@rhtlawtaylorwessing.com
Li-Ling Ch’ng, Partner, RHTLaw Taylor Wessing
li-ling.chng@rhtlawtaylorwessing.com
