What is crowd-funding?

“Crowd-funding” is an umbrella term describing the use of small amounts of money, obtained from a large number of individuals or organisations, to fund a project, a business or personal loan, and other needs through an online web-based platform.[1]

What is Fintech?

“Financial Technologies (Fintech)” refers to the application of information and communication technology (“ICT”) in the field of financial services, including such areas as digital payment and remittance, financial product investment, distribution platforms, peer-to-peer financing platforms, cybersecurity and data security technology, big data and data analytics, and distributed leger application to new asset classes and processes.[2]                                                                                   

In view of the global emerging use of networking platform and the maturation of Fintech ecology, the concept of crowd-funding is appealing to the general public as an option for start-ups to raise funds on web or mobile based platforms. The two areas of financial innovation that have seen strong growth in recent years are:

Although the return rate is claimed to be higher than through traditional investments, these types of fund raising exercises may be subject to the provisions of the Securities and Futures Ordinance (Cap.571) (“SFO”) and/or the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap.32) (“C(WUMP)O”) depending on the structure and features of the arrangement.

Securities and Futures Commission (“SFC”), one of the regulators in Hong Kong, has reminded parties engaging in crowd-funding activities of the potential application of relevant securities laws and regulations and issued notice to raise the investors’ awareness of certain significant risks involved in participating in crowd-funding activities, including the following: 

• Default or failure of the investment project or business, especially start-ups and peer-to-peer lending platforms which may become insolvent or be folded for some reasons in the first few years of existence. 
• Illiquidity and dilution of stock value whereby it may be difficult for the investors to seek an exit as there may be little or no secondary market for such shares or debentures in start-ups or the value of the investment could be substantially diluted by further issuance.
• Platform failure may lead to a total loss of investment and loss of information as there is a possibility that a crowd-funding platform is forced to permanently shut down or may be hacked or where the platform is operating outside Hong Kong, investors may not enjoy the same protection as conferred by applicable laws and regulations in Hong Kong.
• Fraud due to the anonymity created by the online aspect of crowd-funding platforms and investments in crowd-funding activities could be subject to higher risks of fraud. 
• Information asymmetry and lack of transparency whereby full and accurate information on the investment or loan may not be readily available on or fully verified by the crowd-funding platforms and risks may not be fully disclosed before or after the investment or becoming a member of the crowd-funding platform.
• Cyber security is remote as crowd-funding is vulnerable to the risk of cyber-attacks in different forms in view of its online nature.
• Illegal activities may be engaged through the platforms, such as money laundering or illegal commerce that may lead to regulatory action taken by relevant law enforcement agencies.

Funding Sources

Policy makers and regulators have been seeking ways to encourage investment in small and medium-sized enterprises and start-ups so as to enhance their productivity and competitiveness in the rapidly changing business environment. In Hong Kong, funding sources for Fintech ventures varied across economies from private sector to incubation programs offered by innovation organisations (such as Cyberport and Hong Kong Science and Technology Parks Corporation) and the Hong Kong Government’s Innovation and Technology Fund.

According to a survey conducted by InvestHK on Hong Kong’s startup ecosystem in August 2015, there was a leap of 46% in the number of startups registered in their premises in less than a year, of which Fintech deployment increased by 16%. Given the rapid growth of Fintech and technology deployment, the financial institutions have been looking for collaboration with startups to enhance their services. For example, DBS Bank and NEST introduced the DBS Accelerator in April 2015; Standard Chartered Bank, in partnership with Baidu and Tuspark Global Network, is sponsoring the SuperCharger Fintech Accelerator Program. Some studies predicted that the global investments in Fintech may surge from US$12 billion in 2014 to over US$46 billion in 2020[3].

In delivering the 2016 Policy Address on 13 January 2016, the Chief Executive CY Leung has indicated that:

• the Hong Kong Government will set aside HK$2 billion to set up an Innovation and Technology Venture Fund for co-investing in local technology start-ups with private venture capital funds on a matching basis

• the Cyberport will allocate $200 million to launch a Cyberport Macro Fund for investment in its ICT start-ups

The Hong Kong’s Financial Secretary, John Tsang, announced a range of measures in the 2016-17 Budget on 24 February 2016 to drive the development and application of Fintech in Hong Kong. The Steering Group on Fintech (established by the Hong Kong Government in April 2015) further indicated that the Hong Kong Government’s Innovation and Technology Fund, with an injection of HK$5 billion in 2015, has the capacity to support both Fintech startups’ innovation activities as well as existing financial institutions’ in-house research projects. However, there is no concrete proposal or recommendation in the 2016-17 Budget or in the Report of the Steering Group on Fintech on how the current legislation or rules be applied or modified to the application of Fintech in the provision of financial services (including, among others, equity crowd-funding and peer-to-peer lending).

Hong Kong Regulatory Regime

The Hong Kong Government and regulators are playing a critical role in the development of a healthy Fintech ecosystem. You should take all precautions in seeking out and taking advantage of financial services and products made available over the internet as any activities involving the provision of such services and products may fall within the SFC’s purview and hence trigger regulatory concerns, especially if such activities are targeting persons residing in Hong Kong. SFC’s utmost concern is whether such funding/investment is detrimental to the interests of the Hong Kong investing public or to the market integrity of Hong Kong.

While the fundamental principles of regulation for advertising, offering and dealing in securities or interest in collective investment scheme are not premised on the use of a particular medium of communication or delivery, marketing activities relating to securities, investment arrangements and investment advisory services are regulated in Hong Kong. If it involves an offer to purchase or subscribe for securities (which include interests in any collective investment scheme), the party(ies) engaging in such activity(ies) is/are required to consider: (i) whether the restrictions on the marketing of offers/invitations to the public under the C(WUMP)O shall apply, and (ii) whether the party marketing the securities is required to be licensed or registered under the SFO.

Offer of Investment

Unlike other jurisdiction(s), such as the United States and the United Kingdom, currently, there are no dedicated legislation and/or exemptions enacted/applied in Hong Kong to cater for crowd-funding activities. Equity crowd-funding may be found illegal if it involves an offer to the public to purchase or subscribe for securities, in particular such offer is given through the crowd-funding platform with no restriction on dissemination or acceptance. Under the SFO, the person commits an offence if such person issues any advertisement, invitation or document which to his knowledge is or contains an invitation to the public to acquire securities or participate in a collective investment scheme, unless the issue has been authorized by the SFC or an exemption applies. The company and every person who is knowingly a party to the issue will also commit an offence for non-compliance of the prospectus registration requirement under the C(WUMP)O. 

As a general principle, the SFC will not seek to regulate securities dealing and leveraged foreign exchange trading activities that are conducted from outside Hong Kong and over the internet, provided such activities are not detrimental to the interests of the investing public in Hong Kong. The SFC may, taking into account the activities of the business as a whole, regard activities conducted over the internet as not targeted at people residing in Hong Kong, if

• it includes a prominent disclaimer clearly indicating that the subject services or products are not available to people residing in Hong Kong and such disclaimer is viewed with or before the advertisement or description of the services or products

• reasonable precautions are taken to guard against the acceptance of purchases from or provision of services to people residing in Hong Kong

However, a blanket statement to the effect that the service or product is not being made available in any jurisdiction in which the same would or could be illegal would not be acceptable to the SFC. Further, a request from the investor to simply identify whether he/she is a Hong Kong resident would not alone be regarded as sufficient to guard against such activities taking place in Hong Kong. 

SFC Licensing Requirements

Notwithstanding an exemption may apply to an offer of investment (for example, where the offer is related to shares or debentures of a private company[4]or made to certain categories of professional investors[5]), crowd-funding platform operators may still be subject to licensing obligations if any such activity and/or business constitutes “regulated activity”[6] and may require the following license(s) to conduct one or more of the following types of regulated activities:

• Type 1 (dealing in securities)
• Type 4 (advising on securities)
• Type 6 (advising on corporate finance)
• Type 7 (providing automated trading services)
• Type 9 (asset management)

The SFC is of the view that regulated activities should be uniformly regulated irrespective of whether such activities are conducted via paper-based media or electronic media.

Other Regulatory Requirements

Fintech can be applied to a range of financial services. In addition to the securities laws and regulations, there may be other Hong Kong laws and regulations relating to deposit-taking, money-lending, payment systems and stored value facilities, privacy, anti-money laundering and know-your client that are applicable to the crowd-funding activities. For instance, operators who carry on money-lending business or remittance and/or money changing service must be licensed by the competent authority(ies).

While the Hong Kong Government and regulatory authorities should keep an open mind when introducing new rules to support financial innovation that is favourable to consumers and the business sector, parties who wish to participate in crowd-funding activities must understand the risks involved and all the relevant responsibilities. To support the sustainable development of the Fintech industry in Hong Kong, the following Fintech dedicated platforms have been established: 

• The Hong Kong Monetary Authority has established a Fintech Facilitation Office to facilitate the healthy development of the Fintech ecosystem in Hong Kong and to promote Hong Kong as a Fintech hub in Asia

• The SFC has established (i) a Fintech Contact Point to enhance communication with businesses involved in the development and application of Fintech in Hong Kong and (ii) a Fintech Advisory Group to focus on the opportunities, risks and regulatory implications of developments relating to Fintech 

The Financial Services Development Council has proposed to modify the regulatory framework to facilitate the development of equity crowd-funding in Hong Kong and released a report entitled “Introducing a Regulatory Framework for Equity Crowdfunding in Hong Kong” on 18 March 2016. It proposes to create dedicated exemptions on offering restriction/prospectus requirement and licensing requirement for crowd-funding platforms to address crowd-funding activities. While the release of the report is a promising move, whether the proposal is acceptable should be matters of concern in later discussion, which will be subject to scrutiny through certain consultation procedures and is likely to be time consuming.

Nevertheless, unless an exemption applies, all crowd-funding activities are subject to a number of existing requirements and/or restrictions under the SFO and the C(WUMP)O. Non-compliance may lead to serious consequences, including civil and criminal liabilities.      

[1]   according to a staff working paper entitled “Crowd-funding: An Infant Industry Growing Fast” published by International Organisation of Securities Commissions in 2014

[2]   according to a Report of the Steering Group on Financial Technologies released on 26 February 2016

[3]   according to The 2016-17 Budget Speech

[4]   a private company within the meaning of section 11 of the Companies Ordinance (Cap.622)

[5]   the “professional investor” as defined in Schedule 1 to the SFO

[6]   the “regulated activities” as set out in Schedule 5 to the SFO

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