Views on improving the integrity of global capital markets
21 January 2016

Crowdfunding: IOSCO Report Highlights Global Rules on Alternative Finance

Cube Letters show crowdfunding in front of unsharp ludo figures. Background is light gray

Crowdfunding has created probably as many waves of excitement as dismissal in the 19 years that it’s been around. Small start-up companies and adventurous investors alike have praised the concept of small-scale capital raising to help the creation of various inventions, from a coding smart toy for toddlers to a live-streaming community for DJs. Others have dismissed crowdfunding as a ruleless “Wild West” of investing.

However you see it, crowdfunding has become a big business globally. According to a World Bank study, the crowdfund investing market could reach up to US$300 billion in the coming years. Due to the increased volume of crowdfunding transactions, some have suggested that it be more strictly regulated to ensure investor protection. So is there a need to create global laws on crowdfunding, and what has been done so far?

IOSCO’s Global Approach

The International Organization of Securities Commissions (IOSCO) has been keeping an eye on the regulatory developments on crowdfunding. In December 2015, the organisation published a statement and a report on the topic.

In the statement, IOSCO notes that there is a need to ensure investor protection in crowdfunding activities. Nonetheless, as many global jurisdictions have developed their own rules on crowdfunding at different paces and with differing restrictions, IOSCO does not propose a global legal framework at this stage. It does, however, note several issues that crowdfunding platforms and investors alike should take into consideration.

For example, IOSCO notes that possible risks for investors include:

  • High failures of start-up businesses
  • Fraud and money laundering/terrorist financing
  • Lack of liquidity (i.e., the absence of secondary market/exit strategy)
  • Investor inexperience and lack of due diligence

The IOSCO report covers responses to a crowdfunding survey it conducted among 23 of its members across the globe. The report notes that 12 out of the 23 jurisdictions do not have specific crowdfunding legislation, nor plans to introduce new laws in the area.

Our Take on Crowdfunding

CFA Institute has been monitoring developments on crowdfunding for several years. In our March 2014 issue brief, we analysed regulatory structures in key jurisdictions across the globe, and noted six points necessary for a comprehensive regulatory framework. These included transparency by issuers and platforms; investor access and appropriateness; and corporate governance protections.

We have also detailed our views on the topic in several public documents: a comment letter to the Financial Industry Regulatory Authority (FINRA) on Jumpstart Our Business Startups Act (JOBS Act) – Proposed Funding Portals; a comment letter to the US Securities and Exchange Commission (SEC) on the implementation of the requirements of Title III of the JOBS Act, which allows unregistered offerings through crowdfunding transactions; and a blog post.

In our 2015 member survey on the Capital Markets Union initiative, approximately half of the respondents noted that crowdfunding is important in the provision of capital to small and medium-sized enterprises (SMEs). In the European context, we are also a member of the European Commission’s Crowdfunding Stakeholders Forum.

CFA Institute supports the basic requirements of honest and fair dealing, whether in “ordinary,” regulated markets, or in a crowdfunding platform. A crowdfunding investor must be able to trust that the communications provided on a crowdfunding website are true and not misleading, and that statements posted by issuers are accurate. Otherwise, the crowdfunding process will fail; a system lacking integrity will lose the confidence of investors, and increasing capital will become more challenging for honest entrepreneurs.

Our views on some of the topics mentioned in the IOSCO report follow.

Advice and Recommendations

In France, the recently adopted crowdfunding framework requires crowdfunding platforms to provide investment advice to investors and allow only a restricted, gradual access of potential investors to the funding portal. Under the SEC rules, funding portals would be prohibited from providing investment advice and recommendations to investors. In the US, funding portals could advertise the existence of the funding portal and identify one or more issuers or offerings available on the portal; however, the funding portal would not be allowed to receive special or additional compensation for identifying the issuer or offering in this manner.

CFA Institute believes that crowdfunding platform owners and operators should be explicitly prohibited from offering investment advice or recommendations on the securities being offered through their portals. Investors new to these types of transactions could easily assign undue importance to such advice or believe it to be sanctioned by regulators.

Offering Document Disclosure

In Italy, a special regime applied to online crowdfunding offers requires publication on the funding portal of information that is clear and concise (no more than five pages), expressed in nontechnical language, and that allows for comparison across the offers in the portal. The form must contain a list of information concerning the risks and the terms and conditions of the offer, and a warning on the highly risky nature of the investment. In France, the national regulator (AMF) has published a template document for crowdfunding offerings. The information drawn up by the issuer and supplemented by the platform must be provided to investors by email prior to any subscription.

A number of jurisdictions (France, Germany, Korea, Singapore, US) also require (or propose to require) financial statements in crowdfunding offering documents. Japan, Québec, and the United Kingdom do not require financial statements in crowdfunding offering documents.

CFA Institute encourages issuers to provide additional disclosures about, among other things, business backlogs, material contracts, and the number of shares being sold by existing shareowners. We would also find particularly useful a discussion of material factors that would make an investment in issuers speculative or risky. In addition, we recommend that issuers without any operating history be required to specifically state this so that investors are aware of the potential inexperience of those issuers. It would also help investors if issuers were to provide a brief statement regarding prior capital-raising transactions and particularly of those where the target amounts were not reached.

Investing Limits and Cancellation Rules

Most of the participating jurisdictions place or propose to place limits on the investment amount. Under the proposed rules in Australia, for example, there would be a limitation on investment of A$25,000 per annum with no more than A$10,000 in a single issuer. In Japan, the limit is ¥500,000 in a single issuer per year by an investor per year.

A number of jurisdictions (Australia, Canada, Italy, Japan, Korea, US) provide (or propose to provide) certain cancellation or rescission rights to investors. In Italy, retail investors have a cooling-off period of seven days after order execution; in Japan a cancellation is accepted for up to eight days.

CFA Institute supports the requirements that investors be notified about their rights to cancel their investment commitments once the target amounts are met. We also believe that investors would have to reconfirm their investment commitments should a material change to the offering occur.

Risk Acknowledgement Form and Education Requirements

Some jurisdictions (Australia, Canada, France, Italy, US, and the UK) require (or propose to require) investors to sign the equivalent of a risk acknowledgement form that provides certain warnings to investors related to crowdfunding investments. In addition, a number of jurisdictions (Canada, Italy, France, Japan, US) have specific disclosure requirements relating to the risks of crowdfunding offerings. Under the US SEC rules, for example, potential investors are required to consent to electronic delivery of materials and complete a written questionnaire that acknowledges certain risks, and provides a representation that the investor has reviewed educational materials.

CFA Institute supports these types of educational materials that intermediaries must provide upon an account opening which highlight for investors the risks of investing in the particular securities offered.

The IOSCO report on crowdfunding has been published at an exciting time, with several regulatory developments taking place simultaneously across the globe. We will continue to actively follow the developments, and when useful, engage with national regulators on behalf of our members.

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About the Author(s)
Maiju Hamunen

Maiju Hamunen was an analyst for the Europe, Middle East, and Africa (EMEA) region in the Capital Markets Policy Group at CFA Institute. She was responsible for developing research projects, policy papers, articles, and regulatory consultations that advanced the policy positions of CFA Institute.

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