Crowd Funding: Policy and Regulations

April 25, 2020

Crowd Funding: Developing a Policy and Regulatory Framework

(Published in the Financial Express in December 2018)

Dr. Shah Md Ahsan Habib[1]

As the crowd funding industry grows, several legal issues, risks, and implication issues came up.  Experiences with crowd funding arrangements in emerging economies are also coming up with several lessons. Stakeholders are also keen to know emerging markets consideration about when, why and how to launch a crowd funding campaign. It is to be understood that crowd funding is much more difficult than most entrepreneurs anticipate and is not for everyone, and there is involvement of opportunity costs. Running a successful campaign requires significant human and financial resources, and entrepreneurs should obtain information on other crowd funding campaigns in similar sector or geographic areas to understand the involvement of opportunity costs of crowd funding compares with other available sources of capital. It is crucial for the entrepreneurs to assess realistically how much capital can be raised from crowd funding platforms from the targeted groups/ geographic areas. Practically, debt and equity platforms that tend to enable larger amounts of funding are often not available in many developing markets.

Platform choice by the fund raisers depends upon certain factors. Most leading international crowd funding platforms often set restrictions on who can launch campaigns and use payment systems that block investors from developing global networks. Locally originated platforms are believed to be most suitable in the developing world. Developing connections with the targeted contributors is always very crucial. Entrepreneurs should spend efforts and time for building a contact base with the targeted contributors and promote the campaign. Practically, entrepreneurs that are having pre-networking with the targeted contributing group stand a better chance of meeting fundraising goals through such platforms. Other complementary sources of funds may be required to meet the total fund requirements.  Entrepreneurs should tap into complementary resources and organizations to increase their likelihood of success. Crowd funding arrangement and platforms can offer additional benefits related to business and products. In addition to capital, crowd funding helped several businesses increase credibility and market awareness, which sometimes resulted in partnerships, sales or investment. Feedbacks of the contributors might be important information for the entrepreneurs to refine their products or business models

Some financial risks associated with P2P funding and other crowd funding arrangements are identified in some recently published documents. Solvency risks in P2P operations can be increased due to greater asymmetry of information between entrepreneurs and investors, given that there is no regulation specifying what information is to be shared between them. It is possible that one party in the financial operation might not obtain the necessary liquidity to assume their obligation is one of the main financial risks in traditional operations as well as in crowd funding arrangement. Credit risk and operational risks would always be there. Credit risk is based on the possibility that one of the parties in the financial operation may fail to assume all of the obligations agreed between the entrepreneur and the investor. And there is the possibility of experiencing losses resulting from failures in processes, information, and internal systems of the platform as well as losses resulting from human error or the consequences of events external to the operation that affect its process, such as reputation risks for instance. Regulatory risks and concerns remained critical. Although new regulations and rules are beginning to be created to regulate crowd funding operations, a degree of uncertainty persists with respect to the application of certain local rules in the global context in which crowd funding takes place. Moreover, poor coordination between the regulators in different countries may cause fragmented markets that are big barriers in the rise of crowd funding. In regard to regulations, one of the main financial risks characterizing crowd funding platforms is that they operate in shadow banking. In fact, the less stringent regulation of this alternative market and the degree of informality with which many of the platforms operate increase the liquidity and solvency risks faced by the investors.

Regulatory issues are taking shape to encourage crowd funding in different countries. To address regulatory concerns, specific regulations are beginning to emerge in some countries with the objectives of on one hand, to protect unqualified investors and, on the other, to make it easier to access funding for startups or small businesses, which hardly get access in the conventional financial market. In 2012, the Jumpstart Our Business Startups (JOBS) Act was passed in USA as a measure to ease key regulatory burdens on entrepreneurs seeking to raise startup capital, with the goal of encouraging small business and startup funding throughout the nation. The act has removed several barriers for such efforts by allowing companies to promote and advertise the merits of their stock offering to the general public, rather than being restricted to sharing that information only with accredited investors which gives entrepreneurs a new avenue for raising funds though potential reach and sharing power of the social web. In a growing number of OECD countries, policymakers are designing specific regulations for lending-based crowd funding platforms. In 2018, as a part of its Fintech action plan, the European Commission presented its proposal for the EU-wide regime. To evaluate these new regimes, this study collects information about the regulation of lending-based crowd funding platforms in 17 OECD countries and proposes a theoretical framework to reflect about different regulatory regimes. In the context of developing countries, the idea behind regulating crowd funding is to enable small businesses and startups to leverage the advertising power of the internet to raise small amounts of money from large amounts of people in cost-effective way. With platforms providing top-notch crowd funding services in India to NGOs and individuals, crowd funding is very much legal. However, it is the kind of crowd funding that puts the law under question. SEBI’s consultation paper on crowd funding released in 2014, recognizes four kinds of crowd funding models: social lending/donation crowd funding, rewards crowd funding, equity Crowd funding and P2P Lending. While the first two (donation and rewards) are clubbed under community crowd funding, the latter two (Equity and P2P Lending) fall under financial return crowd funding. P2P lending takes place online and its legal implications in India aren’t questioned. However, it’s not regulated properly. The RBI (Reserve Bank of India) is still in process of formulating proper regulations for the P2P lending market but has categorized all P2P lending platforms under NBFCs (Non-Financial Banking Companies) which currently puts them under the purview of SEBI and the RBI. As per SEBI rules, digital selling of shares is prohibited due to the high risk involved and thus equity crowd funding is banned or not allowed under SEBI regulations in India.

The idea of crowd funding has already become popular around the world which empowers a business idea or venture by raising a small amount of money from a large number of people. Such an initiative might be very supportive to help entrepreneurs to bring innovative ideas and business ventures to life by gathering the initial funding needed. The development of the crowd funding market would complement the banking industry that almost single handedly is meeting the financing need of the country as an institutional source. Practically, the crowd funding possibilities left unexplored and undiscovered in the country; probably it is time for formulating a policy and regulatory framework in Bangladesh.

[1] Professor and Director (Training), BIBM ([email protected])

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