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Regulating Crowdfunding – Key Considerations

These slides and the associated text were used as part of my Keynote address to the first ever National Crowdfunding Conference in Hyderabad India in March 2015. My subject was – The Regulation of Crowdfunding, Key Considerations – and concluded that thus far no regulator has got it right!


Abbreviated commentary to accompany the slides

Great to be speaking at such a momentous event. The world’s largest democracy embracing the democratisation of capital is quite a thought.

Very difficult to cover such a broad, diverse and complex subject as the regulation of crowdfunding in such a relatively short period. So I intend to make a proposition that experience to date is that the regulators are not making a good job of regulating crowdfunding in any location and that this is a risk and a challenge as the old world old capital old regulation thinking hat is driving the regulators action is eroding the value of crowdfunding.

My proposition is then that crowdfunding is different finance, and it brings specific and unique values which make it better than other traditional finance.

If we regulate as if it were traditional finance re reduce those benefits, introduce risk and erode the opportunity presented by alternative finance.

If we are to nurture grow and secure crowdfunding and make maximum use of its unique and valuable features we need to think anew about how we regulate it.

Now I have been known to be critical of regulators – in particular in the UK, and some see me as being anti regulation. This is not the case. Regulation has an important role to play. But I am against BAD regulation or poorly framed regulation, ill informed regulation, or regulation which actually undermines what it sets out to achieve.

To begin with I suggest that crowdfunding is different and better finance.

Its nature, philosophical underpinnings, and dynamic bring so many additional benefits over and above simply funds. Let us highlight just a few of those benefits

For example this is new disintermediated money flowing directly into the marketplace. It is by its very nature more diverse because of the broad range of participants. This brings many different ideas, insights and attitudes. It often shows novel expectation of return because of this – that is to say the investors are not driven by the common single aggressive financial expectations of many traditional investors, the motivations are broader.

It is also closer to the market by virtue of the fact that the investors are often the consumers of the products and services they are backing and, as with crowdsourcing innovation, this has many benefits for fit, relevance insight etc.

It is lower cost over time because of the expectations, the terms, and the rapidity of solution. So yes it is often quick money, becoming available much quicker than any otehr methods of sourcing investment.

But at the same time it is often slow or patient money which may be an illiquid investment or not a fickle investment ready to jump ship at the first opportunity.

Finally it can be locally focused bringing and fixing the money into the local economy in a way which yields additional benefit when compared to the flight of capital to other locals. This is not unlike the effects and positive impacts of initiatives like local currencies.

Let us turn to the purpose of regulation. At a high level we can suggest that the purpose is to primarily reduce risk, build confidence and so grow the market. We can apply these across almost all circumstances so are not specific to any particular local. Regulation is often aimed at reducing the risk for all participants associated with the activity. Whilst not the specific action of the regulators they would hope that this should progressively build confidence and so grow the market place.

If we accept then that risk mitigation is a key function of regulation it is very important that we understand that crowdfunding has specific characteristics and philosophical principles of risk mitigation inherent to it.

Amongst these are the notion of atomisation – breaking funds into many small contributions – the “long tail” of finance if you will. As such each investment is sufficiently small to not present a risk to the portfolio.

Transparency. Access to information is much more open and transparent in a crowdfunding scenario. There is a much greater parity and ubiquity of access to data than in the typically asymmetric access investment model of old capital.

Scrutiny – the crowd provides a wide and very diverse scrutiny exercise bring a greater variety of exploratory and investigatory techniques than the older capital markets which tend to run on a limited range of established models and lenses.

In terms of nurturing growth the transaction costs must remain low for an atomised model to work and scrutiny is entirely dependant on very high levels of participation so no barriers to participants.

Any regulatory framework must both understand and respect these models. If they impede them in any way by perhaps driving up costs, erecting barriers, discouraging atomistation and encouraging the perception of Crowdfunding as being like any other investment model so distorting the breadth of expectation of return then the result is two fold

Firstly it will erode the unique inherent additional values that crowdfunding brings and, importantly, it increases risk.

Of the four models we think of the Loan/debt and Equity Model being the most heavily regulated but we should not forget that other models are subject to a raft of other regulatory requirement for example around TAX, IP protection, money transfer regulations, etc etc

If we accept that we can reasonably reduce the main purposes of regulation to some high level principles so too we can look at high level description of the approaches to regulating.

These are typically by:

  • Determining who is permitted to participate in the process through some form of gating.
  • Defining what is to be shared in what format, when and to whom
  • Setting a set of rules of behaviour and conduct to structure the process.

This is traditional financial regulation and immediately we can see that these default approaches present points of tension with h inherent risk mitigation processes in crowdfunding.

If we look at how regulation has developed and impacted on crowdfunding in the past few years we can actually see two distinctive approaches which spring from two distinctive legal and regulatory traditions which I shall describe as the “Common Law” and “Napoleonic Code” approaches.

These are you understand very broad brush strokes which allow us to deal with a complex environment but I think the model is a good sense making tool

In the Common Law tradition an approach is tolerated and accepted whereby participants satisfy existing applicable regulations and law which seem relevant to the activity in question. We might think of the UK as initially being a good example of this.

In the Napoleonic code there is a perception that a specific enabling law must exist to permit the activity to explicitly take place. This might be demonstrated in Italy for example.

In the Common Law tradition an approach is tolerated and accepted whereby participants satisfy existing applicable regulations and law which seem relevant to the activity in question. We might think of the UK as initially being a good example of this. They find ways to satisfy a series of regulatory barriers or requirements sufficiently to operate.

The mechanisms of this “satisfying” approach is novel and inherently innovative. Typical approaches have included techniques to outsource certain regulated functions or to progress through a regulatory approval framework were required. Similarly mechanisms where the structure of some type of investment vehicle is created in such a way to allow wider participation, so we might think of some of the holding models used by Symbid or similar. We can also find examples of where certain approaches use specific exemptions or operate below certain thresholds so we can think of the use of subordinated profit participating debt rules in Germany to avoid the prospectus requirements etc. we should not forget the sort of self denying gated approaches where only certain participants are permitted to access platforms – although I would question the validity of describing these operations as “crowdfunding” in any real sense. What is important though is that this environment encourages innovation and this, in my view, is much better than the permission mode.

In this Napoleonic or “permission” tradition, when a road block is encountered it cannot be circumvented or satisfied it requires the introduction of specific legislation to permit and so enable operations to take place. This is inherently less innovative and the issue in many ways is that this immediately defines the art of the possible. We can see this in Italy for example which trumpeted – rightly – the fact that it was first to specifically pass enabling legislation, but it has set very top down and defined parameters about what can and cannot be done.

The UK regulators like to trumpet the vibrant nature of crowdfunding in the UK as a tribute to its fabulous regulatory environment and draw favourable comparisons between, say, the UK and the USA. Apologists for them might also say this is an indication of good regulation. I would disagree. The UK’s pre-eminent crowdfunding culture is there despite the regulator and not because of it, and is a testament to the common law tradition not the regulator. The sector has always been regulated it is just that the mechanism of satisfying the regulations was innovative. Those specific regulations which have been subsequently added to deal specifically with crowdfunding have, in my view, been badly informed, unnecessary, and wholly detrimental to the long term future of crowdfunding as novel and better funding. In fact they introduce systemic risk into the sector by not understanding how crowdfunding mitigates risk as distinct from other money markets. They have, for example, reduced participation and reduced transparency, and they have done nothing to support the atomisation of investments.

I do not wish to single the UK regulators out though. It is hard to find examples of good, well informed, forward thinking, regulation. Italy will need to revisit its laws as they are clearly too restrictive. The USA still awaits Title III and individual states are simply going feral to accommodate need. Australia – long active in small raises – is increasingly recognising that it must embrace the retail investor in order to grow, and Germanys retrospective take on regulation is effectively strangling what had once been quite a vibrant market.

So no one gets a gold star!

The greatest danger with bad regulation is that it both increases risk but, probably even worse, is that by treating crowdfunding like old finance we erode the unique and specific value that crowdfunding brings. We have agreed that crowdfunding is much more than money and as such is a new paradigm in business development with better benefits and a more inclusive and equitable model.

The more we treat it like old finance through our regulatory approach the more institutional money flows on, the more old fashioned expectations predominate and the more we introduce risk.

This slide shows the volume of institutional money flowing onto one of the major P2P lending platforms in the UK. It is worth nothing growth of institutional money began when FCA took P2P under its regulatory wing. It is reasonable to ask if the sector is abandoning its roots in a dash fro growth and in so doing reducing the value of its offer and introducing risk?

If we look at the numbers for Crowdcube for example – and I am in no way criticizing the platform, it is a good a successful one and they do share their numbers – but the numbers seem to suggest a gradual climb of average investment size. This is a number to watch as I believe that if it continues to grow, and I fear it will on all platforms, then the principle of atomisation is declining and so risk is increasing for investors.

I want to leave you with an analogy and an inspiring quote from someone who I think knows a great deal about alternative finance. Muhammad Yunus speak about a similar challenge when establishing microfinance. He points out that it is not the same as old finance and so you cannot structure a new institution in the image of a different one. I would argue the same principle applies to crowdfunding. To make crowdfunding just an extension of old existing, and some might argue discredited finance, is inappropriate. It both loads it with risk and decreases its value.

I say the jury is till out on regulation but my call is for different, better informed and better regulation for better finance. The disintermediated world of crowd finance perhaps requires a disintermediated regulatory model.

Thank you


Equity Crowdfunding in Italy – Six months on

It’s been 6 months since the CONSOB Regulation enabling equity based crowdfunding was introduced in Italy. This was a significant event as it made Italy the  first country in Europe to formally introduce equity-based crowdfunding into the national legislation.

It seems that there has been a great deal of debate and apparent activity without a great deal actually being disclosed or indeed to show – “tanto fumo e niente arrosto” as Italians would say (“all talk and no action”). We can leave the issues of an apparent lack of transparency for another day but it is right and proper to ask – after six months exactly where are we with equity crowdfunding in Italy?

The regulation officially went into action at the end of July and inevitably, before we could expect to see offers popping up on the web and investors investing millions in them, there needed to be platforms in place to handle the offers. According to the Regulation, embryonic platforms need formal approval to operate via an application to Consob, the national financial authority, in order to be authorised and included in the portal owners registry. Who can open a platform? Individuals and institutions who meet the integrity and professionalism requirements set by Consob, who can be divided into two groups – those seeking registration for the first time, who are required to undergo a registration process, and those that already have certain financial approvals in place – like Banks and financial intermediaries – who can be placed on a special section of the registry. This later group must simply inform the CONSOB of their interest in becoming crowdfunding platforms. Such bodies are in effect pre-approved but they must wait to be officially included in the special section.

Perhaps surprisingly, the first equity platform to be included in the registry was one that had to complete the full approval process and is called StarsUp, listed in  October 2013. This was followed by Unicaseed, a platform operated by Unicasim, a financial intermediary firm, who curiously enough had to wait a bit more to see its portal first in the special section of the registry.

So far so good, two platforms registered, question is how are they doing? Unicaseed, as we announced, launched their first offer on the 31st of December with Diaman Tech Srl, a spin-off of the Diaman Holding group. The innovative startup is developing a financial analysis software and it’s seeking €147,000 (18.92% equity). The offer is currently under due diligence from an institutional investor until the end of this month. Starsup launched this week, with Cantiere Savona Srl, a young startup developing an innovative and sustainable concept for yacht. The three young founders are seeking €380.000. The offers will close after a period of (respectively) 3 and 4 months, therefore between end of March and end of May we will know the fate of these two pioneer experiences.

We also need to acknowledge the pioneering platforms, who are to be applauded for their innovation. Whilst they may not perhaps be blazing a trail, they are certainly breaking new ground and setting the tone for those that follow. And they are doing so with the help of the crowd. Leonardo Frigiolini, CEO of Unicaseed, told us that they are learning a lot from the people who have started using their portals and who are sending lots of suggestions for improvements, that Unicaseed team are carefully taking into account. For a traditional brokerage company such as Unicasim, this is a totally new way to operate, and whilst crowdsourcing may seem familiar to many of us, for firms in the established and conservative world of financial service we should applaud their courage and vision to adopt such novelty into their operations. Are we perhaps witnessing the beginnings of wider innovation in the traditional financial marketplace through these little things?

What is puzzling is the lack of other platforms. In the latest Analysis of Italian Crowdfunding Market (carried out with Ivana Pais) 9 equity platforms were identified as being in their launching phase, but so far only two have launched.

To try to understand what was happening and why there seemed to be such a delay we had a chat with some of the aspiring equity portal managers. What we found that key issues are – perhaps predictably – compliance issues and satisfying these requirements and translating the articles of the regulation into a real portal. It’s also worth remembering that these embryonic platforms are, in many cases, startups, and funding the costs associated with compliance can certainly take time. Many commentators in the media translate this delay into a message of “the regulation is too rigid” but the protagonists don’t always share this view, even those that are finding the approval process quite a protracted and painful one. On the question whether it’s easy to become an equity-based crowdfunding platform or not, the general answer was ‘no’ and it was generally answered with another question: Should it be? The entrance in the sector of a good number of operators (at least 10) would be positive and it would contribute to make the tool credible. However opening the process to anyone without regulations would mean to put the growth of the sector and the protection of investors at risk”, says Carlo Piras, co-founder of Starsup.

An interesting development emerged when we had the pleasure to participate at a round table organised by LUISS, the eminent University and Business School in Rome and  co-organisers of the most recent edition of crowdfuture. The meeting was to publicise a project entitled DREAM which may well have a significant impact on the emergence of equity crowdfunding in Italy. The Luiss DREAM (Diritto e Regole per Europa Amministrazione e Mercati – Law and Regulations for Europe, Administration and Markets), is the new research centre of the Law Department of the University, directed by prof. Gian Domenico Mosco. The acronym which forms the name can be interpreted in English as it is in Italian and encapsulates the aim of simplifying the legal and regulations, and one of its objectives would be to create accessible legal resources for startups wishing to collect risk capital through online portals. An interesting and ambitious project adhering very much as it does to principles of democratising capital.

As a final point to conclude this overview of the state of equity crowdfunding in Italy six months on from its enabling, we must acknowledge an example of Italian equity based crowdfunding project that decided to go abroad. It’s the case of GlassUp, an Italian startup who already completed a reward based crowdfunding campaign on IndieGoGo in June 2013. Now they are seeking to raise £100,000 (7.69% equity) on the UK-based equity crowdfunding platform Seedrs. We asked then why did they go abroad? According to Francesco Giartosio, CEO and founder of GlassUp, they felt they wanted to try an equity round where there was already a track record of successful funds. But this does not mean it’s the easiest and most convenient solution (for example, if they are successful they will have to create a UK legal entity because Seedrs only admit British startups). Whilst this could be viewed as a loss to Italy it should be remembered that such a move doesn’t exclude the possibility of another round on an Italian platform at some point in the future.

So, a lot of irons in the fire in a relatively short period of time. But, as it’s true for the Eternal City, democratisation of capital shall not be build in a day.

Equity-based crowdfunding is now legal in Italy

Equity-based crowdfunding is now legal in Italy

Yesterday, the Italian Financial Authority has formally announced the legislation on equity based crowdfunding and tomorrow the Regulation will be published on the Gazzetta Ufficiale. After the 15-day vacatio legis (period between the promulgation of a law and the time the law takes legal effect), equity-based crowdfunding will be legal in Italy, which becomes the first country in Europe to implement equity-crowdfunding laws.

The imminent publication of the regulation on crowdfunding by CONSOB, the Italian Financial Authority, introduced by the Legislative Decree n. 179 (Growth Decree) in December last year – was officially announced by Dr. D’Agostino, vice-director of CONSOB, at an event organized by Mission Community held in Milan yesterday.

Dr. D’Agostino began his presentation with a review of the circumstances  that have led to the development of equity crowdfunding as a means of alternative finance in Italy. He explained that the Bank of Italy says that the country is in a time of contraction of bank financing, especially for small enterprises, which have enormous difficulty in accessing capital markets; furthermore, that private equity has never taken off in Italy.

This represented a challenge when Consob was tasked to regulate a very new phenomenon, in a non-harmonized European regulatory framework, where there is no benchmark to refer to. He pointed out that in other countries, equity crowdfunding is “regulated” through exemptions from traditional legislation, and there are no established and consolidated regulations dealing specifically with crowdfunding. Consob, therefore, adopted a very open approach, as the most appropriate means of developing highly participatory and “crowdsourced” legislation with clarity in a new and complex matter. D’Agostino believes that the transparent nature of the regulatory instrument is also apparent from the fact that an “ad hoc” regulation was preferred to regulations scattered all over the legislation. This means that a single document is available for consultation, greatly facilitating the understanding of regulatory constraints.

Consob opened the collection of ideas and analysis to all stakeholders through a survey that  received “a huge number of contributions”, and which was followed – in February – by an open hearing that was intended to capture the essential aspects of the regulation in order to get to a first draft. This was then  placed once again in public consultation during March/April from which it received further contributions from the public.

Last Wednesday, the first part of this process has come to an end and tomorrow the Regulation will be published on the Gazzetta Ufficiale. After the 15-day vacatio legis period, the Regulation will take legal effect, but new portal operators can already  apply to be included in the register.

Dr. D’Agostino revealed some of the details contained in the regulation, notably the constraints under which it will permit this type of crowdfunding. Equity crowdfunding will only be for risk capital and not debt capital, this includes equities and shares issues from Limited Companies. Perhaps the most significant constraint is that equity crowdfunding is only permitted for “innovative startups”, as defined in the decree (you can read more on this in our previous post about equity crowdfunding in Italy

The purposes of the regulation is to facilitate the financing of companies with a very high risk profile and high-tech orientation. It is also intended to regulate the online platforms operators with the aim to reduce operational and legal risk, as well as the risk of litigation and fraud.

The legislators who introduced the initial decree that has led to the development of the regulation wanted specific provisions to bring a level of discipline to the running of the platforms. In addressing this the CONSOB has included a mechanism for the creation of an “ad hoc” register of operators to provide traceability and transparency.

Consequently wanna-be portal managers have to apply to be included in the register, whereas banks and financial intermediaries will “by right” be permitted manage their crowdfunding portal without prior registration. However they have an obligation to inform Consob when they start and they will then be included in a special section of the above mentioned register.

In terms of the professional requirements for operators, considerable flexibility has been introduced permitting non-executive directors of the platform to come from backgrounds other than financial ones. The  CEO, however, must have experience in the financial sector. Consob has also introduced the so-called “interlocking” ban, so as to avoid situations in which certain personalities who meet the right professional criteria are in the Board of more than one portal, simply to fulfill legal requirements.

Dr. D’Agostino emphasised that the regulations try to reduce the administrative burden in the process in order to encourage growth in the sector. That said a number of “information obligations” on operators are included in particular with regard to requirements to inform investors. The information obligation specifically addresses share offers and reaffirms the need to carry out suitability tests on investors, and that before making any investment the investors must complete a questionnaire that verifies that they are aware of the high risk involved in their investments. The obligation to provide information to the customer on the amount of money invested has also been introduced.

There are also efforts to simplify the investment process for smaller investors through the elimination of some requirements for investments of less than 500 Euro/offer (1000/year) (exemption from MiFID).

One important point to note is that it is absolutely forbidden for crowdfunding portal operators to give any investment advice but portals must make an effort to make information about offers as clear and complete as possible.

One of the most debated points of the proposed Regulation during the consultation process was the requirement for professional investors to subscribe  to at least a 5% of the shares in any offer. This was hotly debated and the compromise seems to be that this requirement now must be met in order to complete the process but is not necessary as a pre condition and prior to an offer being made. As it happens incubators of innovative start-ups are included in the professional investors category, so this offers a mechanism to those entrepreneurial champions to easily participate as equity based investors.

Italy can be proud of the fact that it is the only country in the EU with a legislation on equity crowdfunding even if it is limited to innovative startups. This places a responsibility not only on Consob, which will have the important task to supervise and monitor the market so that everything can develop in a fair and transparent way, but also on the entire sector.

Dr D’Agostino, emphasised the emerging nature of this sector  and the innovation at the heart of this regulation. He made the point that, in such circumstances, it is impossible to be certain that this type of regulation is robust, and that failures are in the nature of these initiatives. Consequently it is the  responsibility of all to challenge opportunistic and questionable behaviours. But, above all, he believes, that it is right to explore this form of alternative financing, and that open debate in such a young and emerging sector is a good thing. All Italian crowdfunding lacks at present is a critical mass and it is hoped that the regulation can act as a catalyst for growth and make this development a reality and not just an ambition.


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