This paper is a submission made in response to the discussion paper released by Treasury in December 2014 about the regulatory future of Crowd-Sourced Equity Funding ('CSEF') in Australia , The discussion paper seeks stakeholder feedback on characteristics of potential CSEF models, including a model put forward by the Corporations and Markets Advisory Committee ('CAMAC') in a report released in June 2014, as well as a model similar to that recently implemented in New Zealand. These are benchmarked against the status quo.
1.1 Regulatory Framework – The Status Quo
The regulatory status quo on equity crowd-funding is best summarized by ASIC Commissioner, Greg Tanzer stating in August 2012 that:
Crowd funding, as a discrete activity, is not prohibited in Australia nor is it generally regulated by ASIC. However, depending on the particular crowd funding arrangement, ASIC's view is that some types of crowd funding could involve offering or advertising a financial product, providing a financial service or fundraising through securities requiring a complying disclosure document. These activities are regulated by ASIC under the Corporations Act and ASIC Act and may impose legal obligations on operators of crowd funding sites and on people using those sites to raise funds. We want to make sure anyone involved in crowd funding is aware of these obligations to ensure they operate within the law and don’t potentially expose themselves to penalties under the Corporations Act or ASIC Act
1.2 Industry Growth
Over the past few years, crowdfunding has significantly increased across the globe with the US, China and EU making up nearly 90% of the market. Since the introduction of the JOBS act, year-on-year industry growth has neared 90% with the growth in CSEF being a key contributor to the additional growth.
1.3 Macroeconomic Factors
The current inquiry into CSEF occurs against the backdrop of the following macroeconomic developments:
- As resource prices reach record lows, Australia seeks to diversify into value-adding industries.
- There is growing investor interest in technology projects, some of which are at a nascent stage in their development.
- The start-up sector in Australia does not receive the same access to funding as in other markets and is lagging behind OECD markets. This attracts projects away from Australia.
- Globally, CSEF has sought to target the growing pool of retail investors with risk appetite.
- Regulators throughout the world are struggling to keep up with developments in technology that allow for efficient decentralised systems to offer an alternative distribution channel for financial and other services.
The discussion paper highlights the tension between government intervention through regulation and free market theory which dictates that the best efficiencies are created in a competitive market structure.
1.3.1 The Role of Technology
Crowdfunding platforms are the latest web application to take advantage of the internet’s ability to connect users and facilitate disintermediation through a decentralized exchange of resources. In other words, we no longer need the middle man to facilitate transactions as we can connect demand and supply directly through cheap and effective means. It is this theme that binds Uber (transport), AirBnb (accommodation), Freelancer (contract work), eBay (goods), Bitcoin (currency) and Kickstarter (crowdfunding).
The future is likely to see further evolution in this field, with the emergence of smart contracts alongside decentralized financial exchanges (e.g. Counterparty, Medici Stock Exchange, Ethereum, Omni). Technology will evolve in an efficient market to achieve overall efficiency and satisfy needs not currently met by the status quo.
1.3.2 The Role of Government
A 2013 World Bank report into crowdfunding discovered that:
…highly regulated economies and those with overly burdensome barriers to market entry are less likely to benefit from crowdfund investing…Data seem to suggest that crowdfunding platforms are more likely to emerge in economies with low market entry costs and adequate investor protection.
Thus, the role of government regulations in this area should be restricted to two areas. First, government, through its regulatory agents, must ensure that markets operate efficiently without being hindered by monopolistic behaviour and self-interest. Second, government should ensure that the investor is not defrauded of their funds through misrepresentations.
When it comes to investor protection and the regulation of risk, the intervention of the law 'is not merely to relieve someone from the consequence of his own foolishness. It is to prevent victimization’ (Justice Deane).
1.3.3 The Role of the Market
Markets function to match capital demand with capital supply in the most efficient manner possible. As technology increases, the role of the intermediary decreases to a relatively trust-less position. The role of intermediary will be limited to facilitating an efficient market transaction rather than anything else (e.g. relationships with project owners or investors).
1.4 Microeconomic Factors
The capital demands of business follows a similar pattern across industries, increasing as the business expands until it achieves maturity and is capable of self-funding. However, the options available for sourcing capital for startups and small businesses are clearly distinguished.
The following diagram represents the typical financing life-cycle of a company (Figure 2).
The financing life cycle for technology start-ups follows:
- The R&D phase is funded by family capital is used in combination with the R&D grant.
- The market for the start-up phase is largely undeveloped in Australia.
- The take-off phase is funded through personal debt and venture capital (itself an under-developed industry)
- The development phase is financed through corporate debt and private equity (leveraged buy outs (LBO) and expansion capital),
- Maturity & Sale leads to trade sales, Initial Public Offerings ('IPOs') and backdoor listings.
1.5 Cost-Benefit Analysis
The International Organization of Securities Commissions (IOSCO) in its 2014 report cited the following key benefits and risks in financial-return crowdfunding:
Key Benefits:
- Helps economic growth through new and increasing flows of credit to SMEs and other users in the real economy
- Fills a gap left by banks
- Lower cost of capital/high returns - Leverages off a lower cost basis
- Provides a new product for portfolio diversification
- Cost efficient
- Convenient
- Increases competition in a space traditionally dominated by a few providers
Key Risks:
- Project risk
- Platform risk
- Fraud risk
- Information asymmetry and quality
- Risk of investor inexperience
- Liquidity risk
- Cyberattack
1.6 Key Recommendations
- In the short term, the New Zealand model should be adopted as soon as possible to address the immediate need for a CSEF market.
- Relevant acts be amended to relax capital raising restrictions for proprietary companies.
- In the medium term, features from CAMAC model should be jointly adopted by Australia and NZ.
- The exempt public company form should be considered in a broader capital markets context.
- In the long term, the market should evolve to establish three distinct groupings:
Group 1: privately funded proprietary company; no disclosure requirements
Group 2: a publicly funded proprietary company (NZ model) or a public exempt company (CAMAC model); basic disclosure requirements
Group 3: Public companies and listed entities; comprehensive disclosure requirements
Group 2: a publicly funded proprietary company (NZ model) or a public exempt company (CAMAC model); basic disclosure requirements
Group 3: Public companies and listed entities; comprehensive disclosure requirements
6. The aim should be to allow the market to evolve most efficiently through minimal regulatory intervention. Where applied:
a. Regulations must both accommodate and differentiate small businesses and startups.
b. Regulators must allow for enough flexibility to deal with that which is yet to be invented.
b. Regulators must allow for enough flexibility to deal with that which is yet to be invented.
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