Financial Return Crowdfunding (Peer-to-Peer Lending, Securities-based Crowdfunding)
Crowdfunding is an alternative funding source that may allow companies to raise funds with lower costs due to lower fees. However, in Hong Kong there is currently no regulatory regime for crowdfunding, and it could constitute an illegal securities offering unless an exemption under s. 103(3)(k) of the Securities and Futures Ordinance (‘SFO’) is applicable. Crowdfunding has become more and more popular in the recent years and the industry is growing in America, Europe and Asia, with reports in the UK of it exceeding £1.6 billion in 2014.
Two relevant categories of raising funds for businesses are:
- Securities-based Crowdfunding: The crowd invests in an issuer in exchange for securities, either equity or debt.
- Peer-to-Peer Lending: An online intermediary platform facilitates lending between individuals, often in the form of unsecured personal loans.
As noted above, Hong Kong has yet to introduce specific regulations on crowdfunding, and each of these methods could run afoul of existing regulatory provisions.
Peer-to-peer lending is essentially a mutualized, cooperative arrangement, similar to a building society, with the significant distinction that the group of lenders is not fixed or grouped into a company. As mentioned above, peer-to-peer lenders use an online platform to match borrowers directly with lenders. Typically, the loan involves a number of lenders providing money for small parts of the overall loan to the borrower. The intermediary platform compiles these small parts of the loans and aggregates them into a whole paid to the borrower. The borrower will then repay the loan with interest through the platform. The interest rate depends on the borrower’s risk of default and should in most cases be lower than a traditional bank loan, although it could be high, depending on the risk profile of the borrower.
In Hong Kong, peer-to-peer lending may constitute carrying out money lending business, which requires a money lender license under section 7 of the Money Lenders Ordinance (MLO) (Cap. 163).
“Money Lender” is defined as “every person whose business (whether or not he carries on any other business) is that of making loans or who advertises or announces himself or holds himself out in any way as carrying on that business.”
It is an offence for a person to carry on business as a money lender without a license, and this offense is punishable by a fine of up to $100,000 and imprisonment of up to 2 years. Loan agreements entered into by a money lender without such license will not be enforceable.
Currently, there are various sites and platforms in Hong Kong that facilitate online lending but they are not peer-to-peer lending platforms. For example, Welend describes itself as an online lender rather than a pure P2P Lending platform as it only accepts loans from lenders in the company’s private network. Welend is a licensed money lender so any loans made to borrowers are regulated by the MLO.
Securities-based crowdfunding facilitates investment in a business through purchase of shares or debt issued by the company. This form of crowdfunding allows the securities to be allocated cheaply to many investors over an online platform. It is normally used for small start-up companies with limited access to other funding sources. These types of investments involve various risks, such as a relatively high risk of failure, dilution of initial shareholding and absence of a secondary market, making the securities illiquid.
Normally, offers of securities to the public require a full prospectus or long disclosure documents which are expensive for small startup companies. Crowdfunding processes are less formal and regulators in some countries have lifted the barriers to allow startups to engage in crowdfunding at relatively low cost. As explained above, Hong Kong has yet to introduce specific rules on crowdfunding. Thus the offer of securities in Hong Kong is governed by the Companies (Winding Up and Miscellaneous Provisions) Ordinance (“CWUMPO”), which requires a prospectus to be issued. A company which issues a prospectus that does not comply with the requirements of law commits an offence under the CWUMPO.
Existing crowdfunding platforms may take advantage of small and private offering exemptions set out in the 17th Schedule to CWUMPO. They include:
- Offers to not more than 50 persons,
- Offers only to professional investors,
- Offers for which the total consideration payable does not exceed HK$5 million, and
- Offers where the minimum consideration payable (for shares) or the minimum principal amount to be subscribed (for debentures) does not exceed HK$500,000, although this high denomination would almost never suit the needs of a small startup seeking initial funding.
In addition, securities-based crowdfunding may also infringe upon:
- The prohibition on the issue of unauthorised invitations to the public under section 103(1) Securities and Futures Ordinance; and
- The licensing requirements for crowdfunding platform operations in conducting “regulated activities” defined under the Securities and Futures Ordinance.
There is an exception to the 103(1) prohibition. For instance, 103(3)(k) states that the prohibition will not apply to investments that “… are or are intended to be disposed of only to professional investors.” It was not clear if broadly inviting the public to crowdfund would fall under this exception. The Court of Final Appeal in SFC v Pacific Sun Advisors Ltd  18 HKCFAR 138 clarified that a public invitation would be lawful if it can be proven that there was a genuine intention that the invitation only extended to professional investors. Hence, public invitations to seek professional investors are legal.
Because there is no specific regulatory framework for crowdfunding in Hong Kong, crowdfunding activities are currently fairly restricted. There have been calls for Hong Kong to consider amending its regulations to facilitate crowdfunding. However, until that time arrives, professional legal advice should be sought before engaging in any crowdfunding activities to avoid committing offences under the existing regulatory regime.
HK Lawyer Regulatory Insight
SFC Notice on Potential Regulations Applicable to, and Risks of, Crowd-funding Activities
Charltons’ Regulation of crowd funding in Hong Kong
|Checklist – You should know that: Crowfunding is an emerging alternative to IPO or bank-based fundraising for companies around the world; andThe different types of crowdfunding and their operations are subject to existing regulatory frameworks unless they are placed under a specific regime of crowdfunding rules.|