REGULATING ALTERNATIVE FINANCE: RESULTS FROM A GLOBAL REGULATOR SURVEY with the support of This report is jointly produced by the World Bank and the Cambridge Centre for Alternative Finance at the University of Cambridge Judge Business School. This study is kindly supported by the World Bank Group Knowledge & Research Hub in Malaysia and Suruhanjaya Sekuriti – the Securities Commission Malaysia. Please cite this report as World Bank and CCAF (2019) Regulating Alternative Finance: Results from a Global Regulator Survey. The World Bank Group Global Knowledge and Research Hub in Malaysia focuses on sharing Malaysia’s people-centered development expertise and creating new innovative policy research on local, regional and global issues. It is centered on support for Malaysia’s vision to join the ranks of high-income economies by 2020 through inclusive and sustainable growth, and to share its lessons with developing countries. The Hub also carries out cuttingedge development policy research in partnership with local and international research institutions www.worldbank.org/en/country/malaysia/brief/ global-knowledge-and-research-hub © 2019 The World Bank Group Global Knowledge and Research Hub in Malaysia 1818 H Street NW Washington DC 20433 Telephone: +1-202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with researchers from the Cambridge Centre of Alternative Finance at the University of Cambridge Judge Business School. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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JEL Classification Codes: F33; G00; G01; G15; G21; G23; G31 Keywords: Alternative Finance, FinTech, Financial Regulation, Regulatory Innovation, Crowdfunding, Peer-to-Peer Lending, Initial Coin Offerings, Sandbox, RegTech. TABLE OF CONTENTS Foreword...................................................................... 5 Research Team.............................................................. 7 Executive Summary ..................................................... 8 Introduction and research motivation .................... 13 1.  2. Survey methodology and sample .......................... 21 2.1 Survey administration and fieldwork.............................................. 21 2.2 Survey Data Sample......................................................................... 22  egulatory approaches to alternative finance ....... 28 3. R 3.1 Current regulatory approaches to alternative finance................. 28 3.2 Patterns in regulatory change........................................................ 33 4. Regulatory frameworks in detail............................. 43 4.1 Alternative finance - the permitted activities and requirements.43 4.2 Sector-by-sector analysis of alternative finance regulation......... 43 4.2.1 P2P/marketplace lending ...................................................... 43 4.2.2 Equity Crowdfunding (ECF)................................................... 48 4.2.3 Initial Coin Offerings (ICOs).................................................. 50 4.3 Implications of regulatory choices: two discussions.................... 54 The supervision of alternative finance ................... 58 5.  5.1 The perceived risks of alternative finance..................................... 58 5.2 The supervisory resources dedicated to alternative finance...... 60 5.2.1 Human Resources................................................................... 60 5.2.2 Trends in supervisory resource investment......................... 61 5.3 The impediments to effective supervision and regulation of alternative finance.................................................................................. 63 6. Regulatory Innovation............................................ 66 6.1 Regulatory innovation initiatives - their activity ........................... 66 6.2 RegTech and SupTech in focus ...................................................... 68 6.3 Regulatory innovation initiatives - their perceived impact.......... 70 7. The future of the regulation of alternative finance. 74 Annexes...................................................................... 80 Foreword Foreword Access to finance for small and medium size enterprises (SMEs) is at the top of the policy agenda in most countries noting their significant contribution to employment creation, innovation and inclusive economic growth. The current gap is enormous between the demand for finance by SMEs and existing matching supply; with IFC estimates at approximately $5 trillion worldwide. Consumers, especially in emerging markets, have also traditionally lacked the financial services they need. Whether firms or individuals, both share some common challenges including high transaction costs, information inconsistencies and distance between financial providers and clients; making it hard to serve many markets. Fortunately, over the past few years, we have seen incredible progress in providing expanded access to formal financial services. According to Global Findex data, approximately 1.2 billion new consumers gained access to formal financial services between 2011 and 2017. Fintech solutions, such as those introduced by mobile money providers, have been behind these gains. Not only have they increased financial inclusion, they have also increased competition, driving prices lower and improving the quality of services offered. This momentum -driving access to transaction accounts and electronic payments- is crucial for financial inclusion, but firms and individuals also need access to credit, insurance, long-term savings and pension products and investment capital. This report, Regulating Alternative Finance: Results from a global regulator survey focuses on peer-to-peer lending, equity crowdfunding and initial coin offerings, which constitute a rapidly growing segment of fintech for meeting credit, savings and investment needs. Technology platforms increase the efficiency of transactions, frequently making use of alternative data for customers who lack formal credit histories. They also provide new investment opportunities for consumers and investors, expand access to credit, and promote competition in many developed and developing markets. At the same time, there is justifiable concern about risks, including those related to integrity, sustainability of operations and consumer protections. Survey findings informing this report are based on responses from regulators in more than one hundred and ten jurisdictions across the world. The survey identified expanded access to finance for firms and individuals and strengthened competition as primary triggers for advancing the development of alternative finance. When asked about obstacles they faced in regulating alternative finance, regulators emphasized limited technical expertise, limited funding and resources, difficulties in coordinating multiple supervisory bodies, and often a lack of reliable empirical data. Data on global trends as well as on the specific policy approach taken by authorities in other jurisdictions, is a critical input to the alternative finance agenda. When reviewing alternative finance regulation, 90% of regulators included in the survey mentioned benchmarking and lessons learned from other jurisdictions as key triggers prompting changes in regulation more frequently than any other trigger. Malaysia is recognized among the top jurisdictions for benchmarking regulations for alternative finance at a global level. Malaysia issued the first regulations for equity crowdfunding in the ASEAN region and its alternative finance industry has steadily grown, providing opportunity for small businesses who might, otherwise, have lacked funding. Malaysia’s leadership in alternative finance is best expressed in its support of the research backing this report, which was co-funded by the World Bank Global Research and Knowledge Hub. The World Bank and Securities Commission Malaysia partnership also included the Cambridge Centre for 5 Regulating Alternative Finance – Results from a Global Regulator Survey Alternative Finance which implemented the survey and jointly produced the report. Last, but not least, we relied on the support from the International Organization of Securities Commissions (IOSCO) to share the survey amongst its members. We hope that the valuable insights contained in this report will encourage further knowledge sharing and peer learning amongst the global community of financial sector regulators. Alfonso Garcia Mora Chin Wei Min Global Director Executive Director Finance, Competitiveness and Innovation Global Practice Digital Strategy and Innovation The World Bank Group Securities Commission Malaysia 6 Research Team Research Team The joint World Bank and Cambridge Centre for Alternative Finance research team consists of the following individuals: Philip Rowan, Margaret Miller, Emmanuel Schizas, Bryan Zheng Zhang, Ana Carvajal, Apolline Blandin, Kieran Garvey, Tania Ziegler, Raghu Rau, Douglas Randall, Alicia Hu, Zain Umer, Katherine Cloud, Leyla Mammadova, Jaesik Kim and Nikos Yerolemou. Acknowledgements The Research Team would like to thank the International Organization of Securities Commissions (IOSCO) for distributing the survey to their members and engaging in follow-up activities with them. We also offer our most sincere thanks to the regulators who responded to the survey. A full list of the countries surveyed and the regulatory bodies which responded to the questionnaire is presented in Annex 1. For their generous support, we would like to thank the World Bank’s Global Knowledge and Research Hub in Malaysia for financial support. We are also grateful to the Securities Commission Malaysia for being a valuable technical partner led by Mr. Chin Wei Min, Executive Director, Digital Strategy and Innovation and technical support from Ms. Azrina Azmel, Deputy General Manager, Digital Strategy and Innovation of SC Malaysia for this work. From the World Bank side, we are thankful to the internal reviewers Mahesh Uttamchandani, Matthew Saal, Erik Feyen, Richard Mark Davis, Nagavalli Annamalai, Irina Astrakhan, Sharmista Appaya, Mara K. Warwick, Souleymane Coulibaly and Richard Record for their insightful comments and feedback. We also would like to thank Dina Elnaggar, Wei Zhang and Joshua Chee Yan Foong for their kind support for the report launch and publication. From the Cambridge Centre for Alternative Finance side, we are grateful to Robert Wardrop for his guidance and support for this study, Louise Smith for designing the report, Nicola Adams for proofreading, Charles Goldsmith for press support and Philippa Coney for her help with the online distribution. 7 Regulating Alternative Finance – Results from a Global Regulator Survey Executive Summary Regulating Alternative Finance – Results from a Global Regulator Survey is a report that details the key findings from a global regulatory survey that was jointly conducted by the World Bank and the Cambridge Centre for Alternative Finance (CCAF) at the University of Cambridge Judge Business School. This study intends to understand the global regulatory landscape for alternative finance through the collation of empirical data from regulators, including securities regulators, capital markets authorities and central banks. Focusing on peer-to- peer/marketplace lending (P2P), equity crowdfunding (ECF) and initial coin offerings (ICOs),1 the survey aims to comprehensively and comparatively analyze how regulators from both developing and developed economies are regulating and supervising these online alternative finance activities. Regulators from 111 jurisdictions around the world participated in the survey with 40% of the respondents from high-income jurisdictions and 30% of the respondents from lower middle or low income jurisdictions. The key findings from the global regulator survey are as follows: The potential of alternative finance speaks to a new set of regulatory objectives Policymakers globally are keen to explore the promise of alternative finance. A clear majority are optimistic about its potential to improve MSMEs’ and consumers’ access to finance (79% and 65% respectively) and stimulate competition in financial services (68%). Such expectations chime with regulators’ emerging priorities, as many now have statutory objectives to support financial inclusion, economic policies or competition. Alternative finance is still typically unregulated – but bespoke regulation is catching on Despite a boom in alternative finance regulation since 2015, the relevant activities are still not formally regulated in most jurisdictions – only 22% of jurisdictions formally regulate P2P lending, as opposed to 39% for ECF and 22% in the case of ICOs. Where these activities are regulated, some jurisdictions apply to them pre-existing regulatory frameworks (e.g for securities). More often, they are subject to bespoke regulatory frameworks, particularly in the case of P2P lending (12% of jurisdictions) and ECF (22% of jurisdictions). These might be brand new or adapted from those of other jurisdictions. While regulation is not the norm today, by mid-2021 most jurisdictions will be regulating ECF and more than a third intend to regulate P2P lending and ICOs; bespoke frameworks will likely become even more common. Regulatory change, however, is not limited to unregulated sectors becoming regulated; it also includes revisions of pre-existing frameworks, often in favour of bespoke ones. In the case of ECF, taking all of these types of change into account means that half of all jurisdictions are likely to see changes to their legal or regulatory frameworks over the next two years. Benchmarking drives global regulatory change Regulatory benchmarking is used by more than 90% of regulators when reviewing alternative finance regulation, and lessons learned from other jurisdictions have prompted changes in regulation more frequently than any other trigger (56% to 66% of regulators, across the three activities). Historical ties, legal traditions and language certainly influence who learns from 1 With regards to ICOs, applicable regulations depend on the legal nature of the underlying token. To date, several jurisdictions have adopted a token classification dividing cryptoassets into three broad categories, i.e. payment tokens, utility tokens, and security tokens. The study did not incorporate a classification, and therefore encompasses all types of ICOs, unless explicitly stated otherwise. For the inaugural CCAF review of the regulation of cryptoassets, see Blandin et al (2019) Global Cryptoasset Regulatory Landscape Study, April 2019: https://www.jbs.cam.ac.uk/faculty-research/centres/alternative-finance/publications/ cryptoasset-regulation/ 8 Executive Summary whom, but there are also global and regional leaders that others tend to look to. The most benchmarked-against jurisdiction is the UK, followed by the USA and Singapore, but emerging markets such as Malaysia, the UAE and Mexico also rank among the top 10. Alternative finance regulation is about making the sector safe at scale. Alternative finance regulation seeks to make the sector fit for the mass market, including both individual investors and MSMEs. Ensuring liquidity or minimizing the potential for capital losses do not appear to be prioritized over those goals. This may be an indication of how regulators interpret their consumer protection mandates in relation to alternative finance. Alongside AML/KYC requirements, regulators’ top priorities are protections against misleading promotions or the misuse of client money. Depending on the activity in question, between 93% and 100% of regulatory frameworks impose requirements in relation to the clarity and fairness of promotions; between 100% and 88% impose sector-specific AML/KYC requirements, and over 80% impose the segregation of client assets, where applicable.2 ICO regulation, where it applies, appear to be less prescriptive than regulation of P2P lending or ECF. There seems to be a greater acceptance among supervisors that investors in this sector should take responsibility for losses and conducting their own due diligence, and regulation is largely built on the assumption that such offerings are largely disintermediated. Alternative finance regulation isn’t ‘light touch’ There is little evidence yet of regulators purposefully creating light-touch regulatory frameworks for alternative finance. If anything, purpose-built regulatory frameworks tend to have more obligations in place than pre-existing ones – out of 20 potential obligations examined in the survey, the average bespoke frameworks for P2P lending or ECF featured 9, against 5 for pre-existing ones. For ICOs, the balance was 5 vs 3. Bespoke frameworks tend to prioritize checks on investor exposure, rigorous due diligence on fundraisers, client money protection and appropriate online marketing standards. That said, regulators clearly respond to feedback from the alternative finance sector, which have often proactively called for formal regulation of their activities. Those regulators that treat promoting competition as a statutory or strategic objective are particularly likely to report that they have taken such calls into consideration when developing their approach. As supervision stretches their resources, regulators are turning to innovation Alternative finance supervisors see fraud, capital loss and money laundering as significant risks. Enforcement cases are also common, particularly in unregulated ECF and ICO sectors. Thus, the supervisory resource dedicated to these activities globally has grown fast since 2017: by over a third in the case of ICOs and unregulated ECF sectors, about one sixth in the case of P2P lending, and nearly one tenth. Despite this, it is often more difficult for regulators to supervise alternative finance than traditional sectors. Reasons for this include limited technical expertise, limited funding and resources, difficulties in coordinating multiple supervisory bodies, and often a lack of reliable and empirical data. Regulators are thus looking to more innovative solutions to overcome these limitations in regulation and supervision. Among respondent regulators, 22% have created regulatory sandboxes, 26% have innovation offices and 14% have active RegTech/SupTech programs. Based on regulators’ responses, the number of sandbox and RegTech/SupTech programs could double and triple respectively in the coming years. In terms of sheer numbers, it seems that innovation offices that have the most quantifiable impact to date, having assisted 2 This does not include the equivalent figures for ICOs; although some regulators indicated that they have client money rules in place for ICOs, in most cases participation in an ICO is not intermediated, and therefore such protections could not apply. 9 Regulating Alternative Finance – Results from a Global Regulator Survey twelve times as many firms as sandboxes – over 2,100 in total, against just 180 for sandboxes. However, proponents of the sandbox might argue that for particular ‘policy-testing’ orientated sandboxes, the purpose is not to increase the number of innovative firms supported but to facilitate policy learning, design and review. Alternative finance regulation needs better support and a stronger global evidence base To design regulations for alternative finance, regulators have thus received support from a wide range of sources. Most common is for regulators to be supported by multilateral institutions such as various development banks (23%), followed by their peers, for instance, through associations of financial regulators (17%). Nevertheless, 77% of regulators would like more support. Comparing how often sources of support are currently available and desired, there are sizeable gaps. The gap appears larger in the case of support from academics: 13% have received this, but 61% would like to. A common concern shared by regulators is the lack of a rigorous evidence base on the impact of alternative finance on key policy outcomes such as female empowerment, financial literacy or job creation. Between one third and one half of all regulators claim that they lack high quality evidence on these matters; over one third claim that knowledge gaps make it harder to supervise the sector. All of this points to an evidence gap that could have a negative impact on the ability to regulate and supervise these activities. The challenge for regulators in lower-income jurisdictions The high level of response to the global regulator survey makes it possible to compare the experiences of regulators in high-income jurisdictions with those of regulators in medium- and low-income (here referred to collectively as ‘lower-income’) jurisdictions. Here are some key findings in this particular regard: Emerging-market regulators highlighting new regulatory objectives in regional clusters Most regulators in Sub-Saharan Africa, Latin America and the Caribbean now have statutory inclusion objectives, while regulators in Latin America are more likely than their peers elsewhere to have competition objectives. Regulators in lower- income jurisdictions are twice as likely as those in high-income jurisdictions to be tasked with supporting governments’ economic policies (42% vs 20%), and those in Sub-Saharan Africa are about three times as likely (64%). After a slow start, most regulatory changes in alternative finance are now taking place in lower-income jurisdictions and emerging markets. Lower-income jurisdictions are between three and four times less likely than high income ones to already regulate alternative finance activities (13% vs 36% for P2P; 19% vs 67% for ECF; 10% vs 42% for ICOs). However, lower-income jurisdictions are catching up in some areas: they are almost three times as likely as high-income ones to review their regulatory frameworks for P2P lending (43% vs 16%). Most jurisdictions in Latin America and the Caribbean are planning changes to their ECF or ICO regulations, and most jurisdictions in Sub-Saharan Africa are reviewing their ECF or P2P regulatory frameworks. Aligning multiple regulators might be challenging for regulators in lower-income jurisdictions The regulators that we surveyed in lower-income jurisdictions normally do not have explicit statutory mandates for regulating online alternative finance activities (35% vs 64% for regulators in high-income jurisdictions). Therefore, their views of the sectors’ risk profiles and supervisory challenges are still evolving. They also reported a particular challenge in coordinating regulatory and supervisory work in ‘multi-peak’ jurisdictions with multiple regulators responsible for same activities. This may prove particularly relevant to P2P lending activities in lower-income jurisdictions and in emerging markets, which tends to involve multiple regulatory and supervisory bodies. 10 Executive Summary Higher and lower income jurisdictions tap into different expert networks There are significant differences in how regulators in higher- and lower-income markets access external support. Regulators in lower-income markets are slightly less likely to benefit from advice and input from their peers than those in higher jurisdictions (19% vs 26%). The similar pattern can be seen in relation to support from academics (12% v 23%). Regulators from lower- income markets are, however, more likely to obtain support from multilateral organizations (34% vs 16%). Lower-income jurisdictions need more appropriate regulatory innovation options Lower-income jurisdictions are generally less likely to have active regulatory innovation initiatives in place than high-income ones. At the global level, the difference is substantial (14% v 53% for innovation offices, 28% vs 35% for Sandboxes and 9% v 28% for RegTech/ SupTech programs). At the regional level, however, the competing influences of legal institutions and policy trends have produced a more mixed picture. For example, regulatory innovation initiatives are rare in Latin America and the Caribbean, while, in Sub-Saharan Africa, a regulatory sandbox is in place or in development in nearly one in three jurisdictions (32%). In some of the resource-constraint jurisdictions, regulatory innovation initiatives such as the establishment of an innovation offices could prove to be a cost-effective option. 11 Regulating Alternative Finance – Results from a Global Regulator Survey 1.  Introduction and research motivation 12 1. Introduction and research motivation Introduction and research 1.  motivation The term “alternative finance” refers to MSME Access to Finance financial products and services that are developing outside the traditional, regulated According to estimates from the International banking and capital market sectors via Finance Corporation (IFC),3 there are more innovative and predominately online channels, than 160 million micro, small and medium size instruments and systems. In the context of enterprises (MSMEs) in emerging markets. this report, three types of online alternative Most of these are located in middle-income finance activities are studied: peer-to-peer jurisdictions such as Brazil, China and lending; equity crowdfunding; and initial Nigeria. East Asia and the Pacific (EAP) has coin offerings (ICOs). Alternative finance may the largest number of MSMEs (64 million), help to address some of the most important followed by Sub-Saharan Africa (44) and Latin priorities for financial sector development - America (28), as shown in Figure 1.1 below. As reducing barriers to micro, small and medium discussed in more detail in Chapter 3, these size enterprises’ (MSMEs) access to finance, regions are not only major drivers of demand expanding opportunities for consumer for MSME finance; perhaps relatedly, they are finance and increasing competition in financial also hotspots for regulatory change in relation services. This is because alternative finance to alternative finance. providers have some advantages over MSMEs are critically important to economic traditional financial institutions, including development. MSMEs at the larger end of streamlined, fully online procedures for loan the size distribution (small and medium sizes) approvals or equity decisions which should are important generators of employment, result in a lower cost of funds (risk being contributing to growth and dynamism, equal). Depending on the business model, including entrepreneurial activities as they they also include incorporating insights from reach scale. Micro and small enterprises non-traditional sources such as social media, help to alleviate poverty, providing a way payment histories (such as from e-commerce to generate income for people who might platforms), and insights from existing otherwise face unemployment or rely customers who are familiar with the borrowing solely on subsistence agriculture. There is a firms – reducing information asymmetries and persistent financing gap, however, for MSMEs promoting access. which is not easily solved. Here we briefly explore the existing gaps in access to finance for both MSMEs and consumers in developing economies to understand the magnitude of the financing opportunity which is motivating interest in technology enabled solutions, as well as how alternative finance may impact the competitive environment for finance. 3 Bruhn et al (2017) MSME Finance Gap: assessment of the shortfalls and opportunities in financing micro, small, and medium enterprises in emerging markets (English). Washington, D.C : World Bank Group., https://www.ifc. org/wps/wcm/connect/03522e90-a13d-4a02-87cd-9ee9a297b311/121264-WP-PUBLIC-MSMEReportFINAL. pdf?MOD=AJPERES&CVID=m5SwAQA 13 Regulating Alternative Finance – Results from a Global Regulator Survey Figure 1.1 Number of Micro, Small and Medium Enterprises and Finance Gaps by Region 70 2500 60 15.5 2000 No. of enterprises (millions) Finance gap (USD billion) 50 1.5 1500 40 30 1.3 1000 48.6 20 42.7 1.1 26.2 500 10 1.5 1.1 11.3 5.4 7.3 0 0 EAP ECA LAC MENA SA SSA No. of enterprises Micro     No. of enterprises SME Finance Gap SME        Finance Gap Micro Source: Bruhn et al (2017), op. cit The IFC’s 2017 report, “The MSME Finance support their business, especially when Gap,” estimates that the shortfall is $US the enterprise is new and lacks a track 5.2 trillion, indicating that nearly 60% of the record. Access to savings and investment needed finance is missing for micro, small products are also important for potential and medium size firms in emerging markets. entrepreneurs. According to Global Findex, Again, looking at Figure 1.1, it is possible twice as many consumers reported saving for to see the estimated finance gap for both a business as reported having borrowed. microenterprises and MSMEs, represented by lines superimposed on the bar chart (legend Figure 1.2 - Access to and sources of on the right-hand side). Nearly half the emergency funds estimated finance gap is in East Asia and the People in high-incomeeconomies are more likely to be able to raise emergency funds—and to do so through savings Pacific ($2.4 trillion) followed by Latin America Adults able to raise emergency funds (%), 2017 with a gap of approximately $1.2 trillion. Noticeably, the finance gap in Sub-Saharan High-income 44% 11% 5% 11% 3% Africa is relatively low but this is due to a lack economies of capital intensity in firms, more than half of which remain financially constrained. Developing 13% 16% 2% 18% 2% economies Financial inclusion for consumers Between 2011 and 2017, an estimated 1.2 0% 10% 20% 30% 40% 50% 60% 70% 80% billion consumers globally opened their Main source of funds first formal financial account. This incredible Savings progress was made possible through a Money from working Borrowing from a bank, an employer, or a private lender combination of technology, private sector Family or friends Other investments and public policy. In spite of Source: Global Findex Database these advances, an estimated 1.7 billion adults remained outside the formal financial system Limited financial inclusion impacts consumers in 2017, with low-income consumers, rural beyond possible MSME linkages. When populations and women most likely to be consumers lack access to formal finance there excluded. are a range of consequences which affect welfare and economic opportunities. For Lack of access to formal finance for consumers example, consumers in developing economies has implications for MSMEs since owners are less likely to be able to raise necessary will often leverage their personal credit to funds in an emergency and more likely to have 14 1. Introduction and research motivation to borrow from family or friends. They are also Competition in the financial system more likely to have to increase their work – which could be especially problematic if the Literature on competition and financial emergency involves their health or that of a inclusion in financial markets suggests that it family member requiring care. is important to look at contestability, together with measures of bank concentration. For Research indicates that when individuals are example, Owen and Pereira (2018) use panel financially included – such as having access data from 83 jurisdictions over a span of to mobile money - financial resilience is ten years and find that more competitive improved. In one study in Kenya, users of the systems result in higher levels of financial mobile money product M-PESA were able to inclusion. However, competitive systems don’t weather adverse shocks with no disruption in necessarily mean less concentrated – rather consumption due to their ability to activate the critical issue is the extent of market power their social network and receive remittances and thus contestability6. This insight aligns during their time of need. In contrast, with earlier work on bank concentration and consumers who did not have M-PESA contestability by Claessens (2009). Further, experienced a 7% decline in consumption4. Gropp and Kok (2017) use data from Europe to study the impact of internet banking on The ability to effectively reach out to one’s competition and find it has been positive due social network (essentially a kind of informal to the contestability of markets. The effect crowdfunding) is even more important due they find is stronger for retail deposits but to the lack of formal credit options. In most also present for consumer loans, which they developing economies, less than 10% of attribute to FinTechs / alternative finance. consumers report borrowing from formal financial institutions. A global agenda in support of Barriers to financial inclusion cited by innovation in finance consumers in developing countries include The World Bank and IMF are committed to lack of sufficient funds to justify opening supporting the responsible development of an account, the cost of formal finance and FinTech in a way that benefits jurisdictions, distance to providers. balancing the opportunities offered by the Traditional financial institutions have industry with stability and integrity concerns. struggled to find cost-effective, profitable These opportunities include, in particular, approaches to serving both the MSME market the potential for increased competition and and low-income consumers. Small transaction lower cost for financial services, in addition to sizes make it difficult to cover costs and its potential to provide access to finance to asymmetric information results in moral previously excluded customers and MSMEs. hazard and adverse selection, increasing risk In the fall of 2018, the World Bank and IMF and the cost of credit (Cortina and Schmukler, jointly committed to the Bali Fintech Agenda 2018). Further exacerbating this situation in (BFA), which has twelve principles that guide many emerging markets is a lack of robust the development of responsible products competition in financial services, due to and services in FinTech – including alternative relatively high levels of bank concentration finance. This report, and the survey data it is which may also result in higher cost of credit.5 based upon, directly contribute to several of the BFA goals (see Box 1 below). 4 Jack, W. & Suri, T. (2014) ‘Risk Sharing and Transactions Costs: Evidence from Kenya’s Mobile Money Revolution.’ American Economic Review, 2014, 104(1); 183-223. 5 Calice, P. & Leonida, L. (2018) ‘Concentration in the Banking Sector and Financial Stability : New Evidence’ (English). Policy Research working paper no. WPS 8615. Washington, D.C. : World Bank Group. http://documents.worldbank.org/curated/ en/953311539698216215/Concentration-in-the-Banking-Sector-and-Financial-Stability-New-Evidence 6 Owen, A. & Pereira, J. (2018) ‘Bank Concentration, Competition and Financial Inclusion.’ Review of Development Finance 8(2018); pp. 1-17. 15 Regulating Alternative Finance – Results from a Global Regulator Survey Box 1 This report and the global survey data from national financial regulators that it is based upon, directly contribute to the following goals of the World Bank – IMF Bali Fintech Agenda: Embrace the Promise of FinTech with its far-reaching social and economic impact, particularly in low-income jurisdictions, small states, and for the underserved. Monitor Developments Closely to Deepen Understanding of Evolving Financial Systems, maintain an ongoing dialogue with industry players (new and incumbents) to support the formulation of policies that foster the benefits of FinTech and mitigate potential risks. Adapt Regulatory Framework and Supervisory Practices for Orderly Development and Stability of the Financial System and facilitate the safe entry of new products, activities, and intermediaries; sustain trust and confidence; and respond to risks. Regulation should remain proportionate to the risks. Encourage International Cooperation and Information-Sharing across the global regulatory community to share knowledge, experience, and best practices to support an effective regulatory framework. The Financial Stability Board has also recognized the potential for FinTech, including alternative finance, and the need to balance the opportunities it presents with attention to new risks, writing: “Relative to traditional banks, FinTech credit platforms’ heavy digitalisation of processes and specialised focus may lower transaction costs and entail convenience for end users. It may also increase access to credit and investments for underserved segments of the population or the business sector. Notwithstanding these benefits, there are a number of potential vulnerabilities that might impede the future growth of the industry. The financial performance of platforms could be substantially buffeted by swings in investor confidence, given their agency lending models. Moreover, financial risk in platforms may be higher than that at banks due to greater credit risk appetite, untested risk processes and relatively greater exposure to cyber-risks.” The potential for alternative finance to positively impact competition in financial markets, as well as introduce risk, especially if these markets grow, is also highlighted by the FSB: “Among potential benefits are access to alternative funding sources in the economy. A lower concentration of credit in the traditional banking system could be helpful in the event there are idiosyncratic problems at banks. FinTech platforms may also pressure incumbent banks to be more efficient in their credit provision. At the same time, if FinTech credit achieves a significant share of credit markets, it may give rise to systemic risk concerns.” This report, based upon survey responses from regulators in 111 jurisdictions, shows that there is alignment between the perspectives of global bodies and jurisdiction-level authorities, regarding the potential benefits of alternative finance. 16 1. Introduction and research motivation Figure 1.3 outlines respondents’ views on the potential impact of alternative finance. Figure 1.3 - Potential impact of Alternative Finance SME access to finance 79% 1% 20% Consumer access to finance 65% 9% 2% 23% Competition in financial services 68% 6% 1% 25% Financial inclusion 56% 11% 4% 30% Job creation 43% 21% 1% 35% Financial literacy 37% 17% 2% 43% Female empowerment 20% 30% 1% 49% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Positive Impact     Neutral Impact     Negative Impact     Insufficient Evidence Source: the Global Alternative Finance Regulation Survey (see Chapter 2 of this report) The survey data show that access to finance In lower income jurisdictions, regulators for small firms, followed by competition in are more likely to cite positive impacts on financial services and access to consumer financial literacy and female empowerment finance, are believed to benefit from than colleagues in high-income jurisdictions alternative finance; in the case of MSME - importantly in the case of female finance by just under 80% of respondents. The empowerment the difference is almost broader measure of access – financial inclusion entirely due to positive perceptions among – is also seen by more than half of the sample African regulators. Reported benefits to as benefiting from alternative finance. competition and job creation are also skewed in the same direction, with lower income It is particularly interesting to note how such jurisdictions reporting greater benefits. But evaluations vary among regulators. Regulators when it comes to consumer access to finance who actively supervise at least one of the and financial inclusion, expected benefits alternative finance activities are more likely are just as frequently cited in high-income than others to stress their importance to jurisdictions as in lower-income ones. job creation, financial literacy, and access to finance for MSMEs (though not for consumers). Figure 1.4a: Regulators with positive views of the impact of alternative finance, by remit, jurisdiction’s income level and region (access to finance). 100% 84% 86% 85% 83% 90%  83%     78% 75% 75% 75% 75%  80%  72%  71%    70%  67%  70% 63% 63%  63% 60%   59%    60% 52% 51% 53%    50% 42%  40% 33%  30% 20% 10% 0% No Remit over Remit over High Medium or Low Europe and Latin America Sub-Saharan Other alternative at least one Central Asia and the Africa finance activity Caribbean JURISDICTION JURISDICTION INCOME SELECTED REGIONS GROUP SME access to finance     Consumer access to finance     Financial inclusion Source: the Global Alternative Finance Regulation Survey (see Chapter 2 of this report) 17 Regulating Alternative Finance – Results from a Global Regulator Survey Figure 1.4b: Regulators with positive views of the impact of alternative finance, by remit, jurisdiction’s income level and region (citizen empowerment). 100% 90% 79%  80% 67% 68% 64% 64% 66%  64% 70%      55% 60% 50% 50% 52%  50%   44%   50%  42%  40% 32% 31% 30%  28%   30%  20% 22% 19%    20% 10% 3% 5% 4%    0% No Remit over Remit over High Medium or Low Europe and Latin America Sub-Saharan Other alternative at least one Central Asia and the Africa finance activity Caribbean JURISDICTION JURISDICTION INCOME SELECTED REGIONS GROUP Competition in financial services     Job creation     Female empowerment Source: the Global Alternative Finance Regulation Survey (see Chapter 2 of this report) Looking at perceived impacts overall, it is Africa. Indicatively, the core of this group of striking that nearly one in five regulators see a ‘high potential’ jurisdictions are medium- positive impact from alternative finance across sized emerging economies such as Malaysia, all or all but one of the dimensions suggested Colombia and South Africa; financial inclusion by the survey. As might be expected, those success stories such as Kenya and Tanzania; tend to be concentrated among lower-income and small island nations such as the Comoros, jurisdictions, and particularly in Sub-Saharan Fiji, Nauru, or the Marshall Islands. Figure 1.4c: Number of dimensions (out of seven)7 in which alternative finance is reported as having a positive impact, by jurisdiction’s income level and region. 100% 6% 10% 8% 20% 33% 32% 80% 40% 30% 47% 30% 58% 60% 15% 5% 28% 35% 40% 28% 29% 40% 12% 31% 17% 20% 25% 25% 28% 21% 17% 17% 15% 0% High Medium Europe and Latin America Sub-Saharan Other or Low Central Asia and the Africa Caribbean ALL JURISDICTION INCOME GROUP SELECTED REGIONS None     One to Three     Four to Five     Six to Seven Source: the Global Alternative Finance Regulation Survey (see Chapter 2 of this report) 7 Regulators were also asked to describe the expected impact of Alternative Finance on financial literacy; while this is not charted in Figures 1.4a and 1.4b, it was taken into account in calculating the overall scores reported in Figure 1.4c. 18 1. Introduction and research motivation Meeting the need for more data 2 presents the survey methodology and and analysis on alternative finance information about the sample of 111 jurisdictions which responded to the survey. A lack of available data and analytics on the Section 3 focuses on regulatory approaches development of alternative finance activities, to alternative finance and Section 4 goes including policy approaches and how they into depth on specifics of the legal and relate to industry outcomes, makes it difficult regulatory framework for the three types of to learn from what is working and share finance which are the focus of this report: insights effectively across jurisdictions. peer-to-peer lending, equity crowdfunding and initial coin offerings. Section 5 looks at This report is one contribution to this task. the supervision of alternative finance, Section It presents the results of the first Global 6 addresses innovation in regulation of the Alternative Finance Regulation Survey, sector and Section 7 concludes with issues providing valuable insights on the status for future consideration including how the of regulations facing alternative finance global community can support responsible providers and trends in regulatory reforms. development of alternative finance, balancing The report is organized as follows. Section the opportunities and risks. 19 1. Introduction and research motivation  urvey methodology 2. S and sample 20 2. Survey methodology and sample 2. Survey methodology and sample 2.1 Survey administration and fieldwork The Global Alternative Finance Regulation Survey responses were ultimately received Survey was administered between April from 99 participants, representing 111 and June 2019 via a secure web-based jurisdictions across six continents. This questionnaire. The primary target were those corresponds to a response rate of 47% among regulators who were thought most likely to individual invitees and 50% among target have jurisdiction over three main alternative jurisdictions. This includes a small number finance activities - peer-to-peer/marketplace (seven) of jurisdictions which completed lending (P2P), equity crowdfunding (ECF), and a shortened version of the survey due to initial coin offerings (ICOs) - in their geographic capacity constraints. This version captured market.8 Unless otherwise stated, all estimates only the current and planned regulatory mentioned in this report, whether in tables, approach to alternative finance, together with in figures or in narrative, are sourced from the the factors that motivated its development. Global Alternative Finance Regulation Survey. Because of this, and because many questions were non-compulsory, the results reported A number of channels were utilized to here reflect varying levels of question non- disseminate the survey in order to achieve a response across the survey instrument. Annex geographically representative sample, and 2 records the actual unweighted case sizes for intensive follow-up activities were conducted the Figures utilized throughout the report. over a two-month period to encourage a high response rate. Overall, CCAF and World Alternative finance activities are not yet Bank researchers targeted 209 regulators regulated in many jurisdictions, and only representing a total of 221 jurisdictions.9 a minority have given additional powers The International Organization of Securities to regulators in respect to these activities. Commissions (IOSCO) distributed the survey Nevertheless, almost half of the regulators among its members and conducted follow-up surveyed (48%) are directly responsible for activities, reaching out to 144 jurisdictions in supervising at least one of the alternative total, with World Bank researchers following finance activities in focus. In all cases, CCAF up with contacts in 89 of those and CCAF researchers sought out the most relevant researchers following up with contacts in contacts within target organizations and the remaining 55 jurisdictions via email or additionally asked that the survey invite be telephone. forwarded to more appropriate contacts where necessary. On completion of survey This first stage of outreach was fieldwork, the research team accommodated complemented by contacting individual several requests to revise responses that regulators through the World Bank and respondents, on reflection, felt were not CCAF’s network, in particular where a market technically correct. However, all other did not have a regulator which is a member of complete responses have been treated IOSCO. Seventy-two regulators were directly as definitive and were not independently invited to participate by CCAF via mass emails corroborated or updated between the end of or ad-hoc invites, and another five were fieldwork and the date of publication. approached by the World Bank. 8 P2P / Marketplace Lending includes a) P2P Business Lending, ie debt–based transactions between individuals and existing businesses which are mostly SMEs with many individual lenders contributing to any one loan or b) P2P Consumer Lending, ie individuals using an online platform to borrow from a number of individual lenders each lending a small amount; most P2P consumer loans are unsecured personal loans. Equity Crowdfunding includes the sale of stakes in a business via an online platform to a number of investors in return for investment, predominantly used by early–stage firms. An Initial Coin Offering, Token Sale or Coin Sale is a digital way of raising funds from the public using a virtual token, also known as a cryptocurrency. ICOs vary widely in design. The digital token issued may represent a share in a firm, a prepayment voucher for future services or in some cases offer no discernible value at all. Often ICO projects are in a very early stage of development. 9 Two respondents - the Eastern Caribbean Securities Regulatory Commission, and the Central African Financial Market Supervisory Commission - cover multiple markets under their jurisdiction. 21 Regulating Alternative Finance – Results from a Global Regulator Survey 2.2 Survey Data Sample Sample by geography The final sample is geographically diverse. based in Latin America and the Caribbean Figure 2.1 provides a map of participating (26%) or Europe and Central Asia (27%). jurisdictions, with the full list available in Figure 2.2 provides a breakdown of regulator Annex 1. One quarter of the jurisdictions participation by world regions, based on the represented were in Sub-Saharan Africa; and World Bank’s geographic groupings.10 marginally higher shares of the sample were Figure 2.1: Geographic map of survey respondents Responded Responded Figure 2.2: Geographic distribution of respondents REGIONS NUMBER OF % OF REGION'S % OF REGION’S GDP % OF REGION’S JURISDICTIONS JURISDICTIONS ACCOUNTED FOR POPULATION BY REGION ACCOUNTED FOR ACCOUNTED FOR Powered by Bing East Asia and Pacific 14 37 69 Extract, Wikipedia 70 Microsoft, NavInfo, Thinkware © GeoNames, HERE, MSFT, Europe and Central Asia 27 45 65 66 Latin America and the Caribbean 26 57 85 84 Middle East and North Africa 13 57 51 26 North America 2 67 100 100 South Asia 4 50 80 77 Sub-Saharan Africa 25 52 80 68 Sample by income group Figure 2.3 shows the distribution of survey developed capital markets. While high- responses according to the World Bank’s income jurisdictions are over-represented classification of jurisdictions by income.11 By (40%) in the sample, most respondents were the nature of its focus, the study was primarily from emerging and developing markets. relevant to jurisdictions with sufficiently 10 For further information about the World Bank’s classification, see: World Bank Country and Lending Groups https://datahelpdesk. worldbank.org/knowledgebase/articles/906519-world-bank-country-and-lending-groups. [Accessed: 31 May 2019]. 11 Ibid. 22 2. Survey methodology and sample Figure 2.3: Breakdown of respondents by This report acknowledges that regulators World Bank income groups in % may have very different perspectives on the risks and prospects of alternative finance depending on how close they are 17% to regulating the sector. Therefore, where possible, the views of active supervisors and non-supervisors of alternative finance 40% are contrasted. This should not be read as implying that one set of views are mistaken; 16% jurisdictions without a named supervisor for these sectors are very likely to be ones where both the risks and opportunities presented by the sector are less pronounced. Figure 2.4 sets out the statutory and non- 27% statutory objectives of regulators in the 104 jurisdiction for which details were High        Upper Middle provided.12 Unsurprisingly, consumer Lower Middle   Low protection (81% of respondents), market integrity (81%), and financial stability (75%) feature most prominently among regulators’ Sample by remit and objectives statutory objectives. Promoting the growth/ Almost half of respondents (48%) are directly development of financial markets also ranks responsible for supervising at least one particularly high (67%), with 40% of regulators alternative finance activity. This partly reflects indicating that fostering financial inclusion is the fact that supervisory powers over many one of their statutory objectives. Figure 2.5, alternative finance activities have yet to further below, highlights that the prominence be assigned in many jurisdictions, and this of financial inclusion as a regulatory objective is particularly common in emerging and is due to government support for this in Sub- frontier markets In medium- and low- income Saharan Africa and Latin America - 60% of jurisdictions, only 35% of regulators had an regulators have a financial inclusion mandate explicit mandate to regulate at least one of set out in legislation. In other regions, fewer the three activities examined. This contrasts than a quarter of regulators report having with 64% of regulators in high-income such a mandate, even though nearly all jurisdictions. consider it a significant goal. Figure 2.4: Statutory and non-statutory objectives of respondents STATUTORY OBJECTIVE NON-STATUTORY OBJECTIVE Consumer Protection 81% 12% Market Integrity 81% 13% Financial Stability 75% 16% Growth / development of financial markets 67% 20% Financial Inclusion 40% 51% Supporting government initiatives (ie economic or industrial policies) 34% 40% Promoting Competiton 25% 51% Other 17% 0% 12 The 7 missing respondents include regulators who took a shortened version of the survey as well as some who provided paper copy responses. The latter had the option of not responding to this question, whereas online respondents could not proceed without doing so. 23 Regulating Alternative Finance – Results from a Global Regulator Survey The promotion of competition is less discusses the implications of such incentives commonly listed as a statutory objective (25%) for policy design in more detail. among respondents. However just over 50% of respondents consider this to be a non- There is no clear pattern at the geographic or statutory objective, and this has implications income level for the promotion of competition for their work in relation to alternative finance. among regulators. It is most common among As one regulator in the Americas pointed out: regulators in the Latin America and the “The main challenge when elaborating the Caribbean in the sample, with 36% having a [domestic alternative finance legislation] was statutory objective to promote competition. to set legal and regulatory frameworks that Finally, the incidence of regulatory objectives will not create barriers to the entry of new to support government initiatives, i.e. institutions but, at the same time, protects the industrial or economic policies, varies widely interests of consumers.” across jurisdictions based on their income This is important in the context of alternative group. As Figure 2.5 demonstrates, it is more finance, since those regulators with even common for regulators from lower-income a non-statutory objective to promote jurisdictions to be tasked with supporting competition may be more inclined to support government economic policy. This is or put in place a regulatory framework for particularly notable in Sub-Saharan Africa, alternative finance activities. Section 3.2 where 64% of respondents report such a statutory objective. Figure 2.5: Differences in regulators’ statutory objectives, by jurisdiction’s income level group, region and resource management mode 70% 64% 60%  60%   60% 50% 45%  42%  38% 38% 40%  36%   28% 27% 30%  23% 23%  22% 20%   20%  19%  18%  20%   12%  10% 0% High Medium Europe and Latin America Sub-Saharan Other or Low Central Asia and the Africa Caribbean JURISDICTION INCOME GROUP SELECTED REGIONS Supporting government initiatives/policy     Financial Inclusion     Promoting Competiton 2.3 Understanding the remit of alternative finance regulators A number of respondents have shared markets where it is regulated. This may be regulatory jurisdiction of alternative finance because a securities regulator is more likely activities in their market, as illustrated by to have clear jurisdiction for an activity such Figure 2.6. For example, for P2P lending, as equity crowdfunding, while the natural shared jurisdiction was reported by 10% of ‘home’ for P2P lending may be more open to regulators, rising to 29% in markets where debate. Regulators shared responsibility for P2P lending is regulated. However, for equity ICOs in 17% of the markets where the activity crowdfunding, just 4% of regulators share is regulated. jurisdiction for this activity, rising to 9% in 24 2. Survey methodology and sample Figure 2.6: Regulators who share supervisory responsibilities, as % of those with remit over any alternative finance activity 67% 70%  57% 60%  50% 50% 50%  45%   50%  41% 38% 39%    40% 33% 33%   27% 30% 25%   18% 20%  13% 17%  17%  11%  12% 9% 8%   10%   6%  0% 0%   0% Total High Medium Europe and Latin America Sub-Saharan Not resource Resource or Low Central Asia and the Africa rationing rationing Caribbean JURISDICTIONS INCOME RESOURCE MANAGEMENT SELECTED REGIONS MODE GROUP P2P     ECF     ICO As Figure 2.6 demonstrates, the incidence activities because they interact with their of shared remits varies by income group, pre-existing regulatory perimeter. But in many and even more so by region. Overall, less cases, policymakers actively choose which developed markets are more likely to have regulator is the better fit for what they see as multiple authorities overseeing P2P lending, the core activities and risks in each sector. but less likely to do so in relation to ICOs. Shared regulatory jurisdiction for alternative To explore these two patterns, simple “sector finance activities is less common in Europe bias” scores were calculated for 24 pairs of and Central Asia, but more common in the (alternative finance activity) x (traditional case of P2P lending in Latin America and the finance activity). For example, the score for Caribbean. the ‘P2P lending x consumer credit’ pair is the difference between the percentage of P2P For ICOs, regulators that are rationing supervisory bodies that have responsibility for their resources are more likely to share consumer credit and the percentage of non- responsibility. However this appears to be P2P-supervisors that have responsibility for driven by the fact that ICOs are unregulated consumer credit. In this example, a positive in much of the world. As discussed further score could, if large enough, suggest a in Chapter 3, more resource constrained degree of overlap between credit supervision regulators may be choosing to allow small and P2P lending supervision – for example and/or nascent alternative finance sectors in terms of the skills required of supervisors, to operate without regulation. The number the underlying activities and risks, or the of regulatory bodies involved in regulating applicable legal and regulatory framework. this activity decreases as it becomes more formally regulated. This analysis, summarized in Figure 2.7, suggests that regulators with responsibility for supervising P2P lenders are substantially From traditional to alternative finance: more likely to also have responsibility for transferability of supervisory expertise deposit taking, consumer and commercial Different alternative finance sectors are credit, and payments. In other words, these typically supervised by different types of regulators are more likely to be central banks regulators. Often supervisors have no choice or supervise retail banking. One implication but to assume responsibility for new financing of this might be that P2P lending regulation is 25 Regulating Alternative Finance – Results from a Global Regulator Survey more likely, on balance, to focus on borrower client categorizations, prospectus and other protections and responsible lending than disclosure requirements from the world of on investor protection. Where this is the collective investment to this sector. case, a pre-existing regulatory framework for consumer credit or microfinance might be The allocation of regulatory responsibility seen as the point of departure for regulating is far less clear when it comes to ICOs. No the sector; individual borrowing caps, clear distinction can be drawn between creditworthiness and affordability standards those with and without direct supervisory and other protections might be adapted from powers over ICOs. That it is not possible to that framework for use in regulating P2P. identify a ‘typical ICO supervisor’ profile in this sample should not be surprising. First, This pattern contrasts sharply with the while ICOs subject to bespoke regulation profile of equity crowdfunding supervisors. might be supervised by a well-defined Supervisors of this sector are much more group of regulators, those subject to pre- likely to oversee capital markets and funds existing regulations might find themselves regulation, and to supervise the distribution within the perimeter of different regulatory of financial instruments. Almost all (95%) are bodies depending on the details of the responsible for regulating securities issuance. offering. Second, as discussed earlier in this Where pre-existing regulatory frameworks section, regulators are more likely to share are used to regulate the sector, they might responsibility for supervising ICOs than for be those related to collective investment or ECF or P2P lending. Alternatively, it is possible alternative fund management, or adaptations that a ‘typical ICO supervisor’ profile does of existing rules on the distribution of exist, but is close to the average profile of securities. This might mean, for example, that regulators that responded to this survey. regulators adapt marketing restrictions and Figure. 2.7 Sectoral ‘bias’ in the remit of regulators responsible for alternative finance Operation of securities markets and infrastructure 30% 25% Consumer and commercial credit 20% Securities Issuance 15% 10% 5% 0% -5% Deposit taking and savings -10% Fund management Payments or Payments Infrastructure Marketing and advising on financial products Wholesale banking and capital markets infrastructure P2P regulators vs non-P2P regulators     ECF regulators vs non-ECF regulators     ICO regulators vs non-ICO regulators Bias scores explained: A positive score means that a regulator responsible for alternative finance activity X is more likely to regulate the traditional activity Y than a regulator that is not responsible for alternative finance activity X 26 1. Introduction and research motivation  egulatory approaches 3. R to alternative finance 27 3. Regulatory approaches to alternative finance Regulatory approaches to 3.  alternative finance 3.1 Current regulatory approaches to alternative finance Survey respondents were asked whether, describe their regulatory stance towards the and how, the three online alternative finance sector as ‘Other’ or ‘Not regulated but not activities were regulated in their jurisdictions prohibited.’ If the application of pre-existing as of early 2019. Innovative sectors may often regulatory frameworks is assessed in this be allowed to evolve without regulation, or way, then the 62% of jurisdictions where the under a self-regulatory regime, while their size activity is not explicitly prohibited or was and potential to cause consumer detriment not explicitly described as unregulated by remains small. Where such an approach is respondents could be said to regulate parts not considered sufficient to balance the of the sector. While regional and cross-section opportunities and risks presented by the comparisons in this Chapter are based on sector, the sector might instead become the strict definition of a regulated sector (as regulated, or be banned outright. in Figure 3.1), the implications of a broader definition are also examined at the end of the Figure 3.1 summarizes the high-level Chapter. (see Figure 3.5). approach among the jurisdictions participating in the survey. For each of Figure 3.1 - Summary of regulatory the three activities, about one third of approach by activity jurisdictions surveyed allow the sectors to grow without regulation, although P2P 100% 90% lending is marginally more likely to be treated 22% 22% 80% 39% in this way and ICOs marginally less likely. Share of jurisdictions 70% Outright prohibition is rare, however, with only 31% 60% 35% 8% of jurisdictions banning ICOs – the highest 50% rate among the three activities. 33% 40% A significant share of regulators could not 30% 40% 38% identify their approach as non-regulation, 20% 23% regulation or prohibition. This is typically 10% 5% 5% 8% the case for respondents in jurisdictions 0% P2P ECF ICO where the sector is absent or not developed. Such responses are also common among Prohibited         Non-applicable or other Un-or self-regulated    Regulated jurisdictions where the relevant activities have not yet been not officially defined, and local Regulators’ resource allocation decisions are regulators do not have formal responsibility likely to have an important influence over for them. the decision on whether, when, and how to In the case of ICOs in particular, a pre-existing regulate an emerging sector. Across all three regulatory framework is more likely to be activities studied in this report, resource- employed given that in several instances the rationing regulators are significantly more underlying token would qualify as a security. likely to leave firms unregulated compared to In fact this is the likeliest regulatory treatment their peers who do not ration their resources even in jurisdictions where regulators as strictly (see Figure 3.3).13 Furthermore, 13 Respondents were asked to indicate whether resource constraints made it comparatively more difficult for them to supervise alternative finance activities than more traditional financial services (see Figure 5.5). Because of the comparative element of the question, a positive response does not necessarily indicate that a regulator has very limited resources in absolute terms. A better interpretation might be that the regulator finds it necessary to ration the amount of supervisory resource allocated to these activities, e.g. because higher-impact traditional sectors are making more urgent demands on their resources. 28 Regulating Alternative Finance – Results from a Global Regulator Survey authorities in more developed and higher seen in Figures 3.2 and 3.3. This is particularly income economies were more likely to true of equity crowdfunding, where some regulate alternative finance (in one way or aspects of securities regulation will likely another) and less likely to leave the regulatory apply in high income jurisdictions. remit of the sector as undefined. This can be Figure 3.2 Share of jurisdictions that actively regulate alternative finance activities 67% 70%  59%  60% 52%  50% 42%  38% 40% 36%  37% 40%   35%   29%  26% 27% 27% 30% 25%   24%    19% 19%   16% 20% 13%  10% 12% 12%   8%   10%  0% High Medium Not resource Resource Europe and Latin America Sub- Other or Low rationing rationing Central Asia and the Saharan Caribbean Africa JURISDICTION INCOME RESOURCE MANAGEMENT SELECTED REGIONS GROUP MODE P2P     ECF     ICO Figure 3.3 Share of jurisdictions that allow alternative finance sectors to operate without statutory regulation 70% 65%  58% 60%  52%  46% 50%  42% 44% 40% 41% 40%     40% 36% 35%    33% 32%  31%   27% 27% 26% 26% 30%   22% 24% 22%   21%     20% 15%  12%  10% 0% High Medium Not resource Resource Europe and Latin America Sub-Saharan Other or Low rationing rationing Central Asia and the Africa Caribbean JURISDICTION INCOME RESOURCE MANAGEMENT SELECTED REGIONS GROUP MODE P2P     ECF     ICO Regulators in Sub-Saharan Africa are However, this low percentage is likely particularly unlikely to regulate alternative explained by the absence of activity in the finance activities. Equity crowdfunding, region. Regulators willing to tolerate an the most likely of the three activities to unregulated but active sector are in fact more be regulated in the region, is reported common in Latin America and the Caribbean. as regulated in only 12% of jurisdictions. 29 3. Regulatory approaches to alternative finance Finally, benchmarking against peers may Figures 3.4a and 3.4b provide a more also be a factor in deciding who regulates comprehensive visualization of the regulatory alternative finance. OECD jurisdictions in frameworks for alternative finance around the the sample were considerably more likely to world. Taken together they point to a handful regulate across all three activities, beyond of jurisdictions with a strong preference for what is implied by their higher income levels providing legal certainty. This first group, and market size. This suggests a possible including Canada, Australia and Finland, have peer group effect, whereby jurisdictions largely sought to regulate alternative finance accustomed to coordinated policy efforts activities. A second group, which includes may benchmark against one another and Bolivia, Colombia, China and Morocco, has thereafter converge on some elements of implemented an outright ban on one or good practice. The impact of benchmarking more alternative finance activities. A third on regulatory change is discussed in more group, which includes Russia and a number of detail in Section 3.2 of this Chapter. African markets such as Uganda, South Africa, Mauritania and Mozambique, have largely left Un- or self-regu alternative finance unregulated. Regulated Figure 3.4a: Map of Regulatory Approaches to P2P / Marketplace lending Prohibited Other Un-or self-regulated    Regulated    Prohibited    Other The classification of jurisdictions is based on the response provided by the participating regulator(s) Mapping approaches to the regulation of Only a small minority of survey participants ICOs is more complex, since this typically have adopted a categorization of tokens, with depends on the legal definition of the token the most common distinction drawn being being offered. One jurisdiction may, for between tokens that were securities and those Powered by Bing example, regulate ICOs under securities that were © GeoNames, not. HERE, Microsoft, jurisdictions MSFT, Some explicitly NavInfo, Thinkware Extract, Wikipedia law when the respective tokens qualify as allow for a category of ‘security tokens’, securities. However, this will not be the case which provide rights and obligations akin to for all ICOs. Therefore Figure 3.4c, which traditional financial instruments. For example, summarizes the approaches taken by different they may indicate an ownership position in an jurisdictions to ICOs, differs from Figures entity, a creditor relationship with an entity, or 3.4a and 3.4b in that it distinguishes between other rights to ownership or profit. ‘Security different models of regulation. tokens’ may be similar in this regard to shares, debentures or units in a collective investment scheme. 30 Regulating Alternative Finance – Results from a Global Regulator Survey Un- or self-reg Figure 3.4b: Map of Regulatory Approaches to Equity Crowdfunding Regulated Prohibited Other Un-or self-regulated    Regulated    Prohibited    Other The classification of jurisdictions is based on the response provided by the participating regulator(s) Distinctions between transferable and of transactions. Respondents were not non-transferable tokens, or tokens that are asked whether they treat pre-token sales or commodities versus those that are not, were sales of pre-mined tokens14 differently from Powered by Bing much less common. No jurisdiction classified other © GeoNames, issuances HERE, (e.g. MSFT, Microsoft, via an NavInfo, ICO), Thinkware or whether Extract, Wikipedia tokens depending on their function in a pre-mined tokens are themselves treated DLT-based ecosystem - for instance, whether differently from other tokens. Un-or sel they had a role in incentivizing the validation Figure 3.4c: Map of Regulatory Approaches to Initial Coin Offerings Bespoke Pre-exist Prohibite Other Un-or self-regulated            Bespoke or adjusted regulatory framework Pre-existing regulatory framework     Prohibited Other The classification of jurisdictions is based on the response provided by the participating regulator(s) 14 Pre-token sales are defined in CCAF’s Global Cryptoasset Regulation Regulatory Landscape Study (Blandin et al, 2019) as private round offerings of token units, often at prices presented as discounted, and typically while the relevant network or application is not yet operational. These tokens, referred to as ‘pre-mined’ tokens, are often limited to accredited investors and subject to lock- up periods, and may not be fully or at all transferable. Powered by Bing © GeoNames, HERE, MSFT, Microsoft, NavInfo, Thinkware Extract, Wikipedia 31 3. Regulatory approaches to alternative finance Focusing on regulated markets, a number of is much more common than the creation of different models of regulation are employed bespoke or exemption-based frameworks. in the oversight of alternative finance activity, The latter would, in almost all cases, require as set out in Figure 3.5. legislative change. In the case of P2P lending and equity- Not all jurisdictions that opt for a sector- based crowdfunding, these activities are specific regulatory framework create bespoke predominantly, and increasingly, subject ones from the ground up. A minority of to newly created, bespoke regulatory regulators reported that their jurisdictions rely frameworks. A bespoke regulatory framework on pre-existing regulation with sector-specific might be a radical departure from past amendments and exemptions. The boundary regulatory practice domestically, however between these two approaches can be it need not be new from an international difficult to draw. However, as a general rule, perspective. As discussed in Section 3.2, exemption-based and adjusted frameworks bespoke regulatory frameworks are often the are narrower in scope, with most aspects result of the domestic application of lessons of the activity in question governed by pre- learned when benchmarking against other existing regulation. For example, a particular markets. class of alternative investments might be exempt from particular aspects of the pre- As discussed earlier in the Chapter, most existing financial promotions regime or jurisdictions that regulate ICOs do so under a required to provide tailored disclosures and pre-existing legal and regulatory framework. risk warnings to investors. For example, all of the jurisdictions surveyed have securities laws in place. Thus, if an Figure 3.5: Regulated jurisdictions by type ICO issuer should opt into, or stray into, the of regulation regulatory perimeter for securities issuance, the relevant regulatory framework will apply 70% by default and local regulators will enforce the 60% 2% law and their own rules. 4% Share of jurisdictions 50% To reflect this, Figure 3.5 recombines regulators’ responses in a slightly different 40% 9% 38% way than the one employed for Figure 3.4. 30% Where respondents indicated that ICOs are ‘unregulated or self-regulated’ in their 20% 5% 22% jurisdictions, or stated they are subject to an 10% 12% 16% ‘other’ legal or regulatory framework, it was 5% 8% 0% assumed for the purposes of Figure 3.5 that P2P ECF ICO they might, under certain circumstances, be Regulated under pre-existing regulatory framework subject to pre-existing regulation. This helps Regulated under framework created for this activity to better illustrate the impact of pre-existing  egulated under pre-existing framework, with adjustments/ R exemptions for this specific activity legislation and rules. Potentially regulated under pre-existing regulatory framework As Figure 3.5 shows, such regulation-by- default accounts for most of the jurisdictions Sector-specific regulatory frameworks for in which ICOs might be subject to pre-existing alternative finance activities, including regulatory frameworks. Even ignoring those both bespoke and adjusted ones, are still cases, however, the reliance on a pre-existing fairly new.15 While the earliest example of regulatory framework for regulating ICOs substantive alternative finance regulation 15 CCAF researchers undertook a manual data collection exercise in order to build a library of relevant regulations in the respondents’ jurisdictions. Dates were recorded for the introduction of bespoke regulatory frameworks, sector-specific exemptions, bans, or highly significant guidance. Therefore, any jurisdictions that did not regulate or explicitly ban the sectors in question, or relied on pre-existing regulatory frameworks without extensive guidance, were omitted from this analysis. 32 Regulating Alternative Finance – Results from a Global Regulator Survey in the sample dated back to 2008,16 83% of regimes existed prior to 2017. As Figure 3.6 jurisdictions with bespoke or exemption- shows, 2015 was the busiest year for new based rules created their original P2P lending alternative finance regulation frameworks and equity crowdfunding regulations in 2015 to date. However, 2018 saw a boom in the or later. No jurisdictions are still operating regulation of ICOs, which has continued into regulatory frameworks that are unchanged 2019. since before 2014, and, as expected, no ICO Figure 3.6: Timing of the first sector-specific regulations or guidance for alternative finance activities. 60% 56%  guidance or prohibitions for the sector, % of total with bespoke regulations, 50% that first regulated in each year 40% 33%  30% 26%  23% 22%  20%  17% 17%  20%   14% 13%  11%  9% 9%  9% 9% 10%     0% 2014 2015 2016 2017 2018 2019 P2P    ECF    ICO NB x axis is truncated 3.2 Patterns in regulatory change As the industry matures, many policymakers the same timeframe. This is illustrated in are considering changes to their regulatory Figure 3.7. Importantly, regulators do not frameworks for alternative finance sectors. always have clarity on whether their regulatory frameworks would need to adapt to the Half of the regulators surveyed are planning development of alternative finance activities. to review their regulatory frameworks for Around one third of those surveyed are equity crowdfunding within the next two years unsure of how the regimes for P2P lending (i.e. by early 2021), while about three in ten and ICOs might change even in the near-term. are considering changes to their regulatory Almost one quarter said the same about their frameworks for ICOs and P2P lending within approach to equity crowdfunding. Figure 3.7: Regulatory change trajectory in the next two years, by alternative finance activity P2P/Marketplace Lending 30% 34% 13% 24% Equity Crowdfunding 50% 24% 17% 9% Initial Coin Offerings 28% 31% 17% 24% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Share of jurisdictions Framework will change     Unsure     Framework will not change     Not Applicable 16 AMF (2008), ‘Avis relatif à l’exploitation des plates-formes de prêts de personnes-à-personnes (peer-to-peer lending)’ December https://lautorite.qc.ca/fileadmin/lautorite/reglementation/valeurs-mobilieres/0-avis-amf/2008/2008dec19-avis-peer-to-peer-fr. pdf Although this publication, from the financial markets authority of Quebec (AMF), is strictly speaking guidance, it stands out for setting out the AMF approach in detail and inviting firms to submit their business models for review. 33 3. Regulatory approaches to alternative finance The expectation of regulatory change is However, the overall differences between greatest in Latin America and the Caribbean, the trajectory of regulation in high, medium and in Sub-Saharan Africa. Most regulators in and low income jurisdictions, or between these two regions expect to make changes to resource-rationing and non-rationing their equity crowdfunding frameworks, with regulators, are not statistically significant nearly half expecting to review the regulation given the small base sizes. The exception is of ICOs (see Figure 3.8). The appetite for the future regulation of P2P lending, where regulatory change in these regions is perhaps regulatory change is substantially more likely related to the level of untapped demand for in medium and low income markets than in finance. As discussed in Chapter 1, these high income ones. are host to some of the biggest markets for MSME finance, in which substantial finance gaps still persist. Figure 3.8: Expectations of future regulatory change by region and income groups. 90% 81%  80% 70% 64%  60% 53% 54% 52%   50%  48% 48%  50%  43%   40% 34% 35%  40%  31%  32%  28% 29%   26%  24% 30%  23% 23%    16% 20%  10% 0% High Medium Not resource Resource Europe and Latin America Sub-Saharan or Low rationing rationing Central Asia and the Africa Caribbean JURISDICTION INCOME GROUP RESOURCE MANAGEMENT MODE SELECTED REGIONS P2P    ECF    ICO While it is important to understand the Additionally, those regulators preparing pattern and timing of regulatory change, it is changes to their regulatory frameworks were even more important to understand how this asked about the steps taken to both review comes about and why. Survey respondents the existing framework and develop the were asked which factors had helped emerging, new one. Figure 3.9 summarizes shape their existing regulatory frameworks. the regulators’ responses to these questions. 34 Regulating Alternative Finance – Results from a Global Regulator Survey Figure 3.9: Triggers and elements of the regulatory change process P2P ECF ICO Reviewing another jurisdiction's approach to regulating 56% 66% 65% alternative finance activities Industry-driven requests for regulation or guidance 54% 67% 54% Alternative finance activity becoming larger 46% 49% 43% Triggers of regulatory change - past two years Government policy or strategy 41% 51% 35% New emerging evidence from supervisory work 22% 28% 35% New powers or objectives given to organization by lawmakers 22% 25% 16% Other 20% 7% 8% Analyzed the regulatory frameworks of other jurisdiction(s) 94% 91% 94% Carried out informal consultation with firms, industry bodies, 60% 51% 44% consumers or other stakeholders Used supervisory powers and external evidence to carry out a 34% 30% 15% diagnostic or thematic review Elements of the regulatory Observed new business models through temporary licensing, change process 34% 26% 6% including in a ‘test-and learn’ or regulatory sandbox environment Published a call for evidence or consultation paper 20% 21% 15% Firm failure exposing fraud and/or leading to damages to 6% 6% 32% consumers Other 11% 11% 3% The survey findings provide empirical markets where activities are less developed. evidence for the importance of benchmarking Regulators must instead look for information in driving regulatory change. Of those where it is most readily available. This dearth regulators who expect to make changes to of data might also explain the substantial their regulatory frameworks over the next two percentage of regulators who used informal years in at least one activity, more than 90% consultations (between 44% and 60% across have benchmarked their existing regulatory the three activities) in developing their framework against their regulatory peers frameworks. This is in contrast with the much in other jurisdictions. More than half of all smaller share of regulators who carried out regulators suggest that the development of thematic reviews and diagnostics (15-34%) or their existing frameworks has been prompted consulted formally (15-21%). As per Figure 3.9, in part by a benchmarking exercise. where these more formal exercises do occur, they are likely to have been preceded by This was reflected in commentary provided by much more extensive, if informal, engagement one Central American regulator: “[We have] with stakeholders (44 – 60%). been researching and analyzing information about the experience in other jurisdictions Relatively little alternative finance regulation regarding alternative finance services and appears to be purely reactive. Even the products…”. Between half and two thirds of regulation of ICOs, of which around 20% the sample reported that benchmarking had have characteristics suggesting a high risk of been an influence in the development of their fraud,17 has been triggered by high-profile existing regulatory frameworks. failures in only about one in three cases. P2P and ECF regulation, on the other hand, has The dominance of benchmarking as a source only been influenced by high profile firm of knowledge is partly related to the relative failures in 6% of cases. scarcity of market and supervisory data in 17 The share of ICOs that fail, or never deliver a product to the market, is much higher; however systematic reviews of fraud indicators in ICO activity converge on roughly this figure. See Shifflett & Jones (2018) ‘Buyer Beware: Hundreds of Bitcoin Wannabes Show Hallmarks of Fraud’ The Wall Street Journal, 17 May 2018. https://www.wsj.com/articles/buyer-beware- hundreds-of-bitcoin-wannabes-show-hallmarks-of-fraud-1526573115 and Florysiak & Schandlbauer (2018) https://papers.ssrn. com/sol3/papers.cfm?abstract_id=3265007 35 3. Regulatory approaches to alternative finance Regulation is often proactively welcomed Moreover, those regulators with an by industry, with between 54% and 67% of operational regulatory innovation initiative, regulators reporting such requests as an such as an Innovation Office or Regulatory influence in their policymaking. Firms might Sandbox (see Chapter 5), are particularly likely seek legal certainty through guidance or to receive and consider industry requests for new rules. However, regulation might also be regulation. used by incumbent firms to create barriers to entry. One way of testing which of the These findings are based on small base sizes two motivations is more prevalent is to and should be treated with caution. Further check whether having a mandate to promote research into this point might consider, for competition makes regulators more or less example, whether having more touchpoints likely to respond to calls for regulation from with innovative firms makes regulators more industry. aware of competitive dynamics in the sector and whether industry calls for regulation As Figure 3.10a shows, regulators with a might under certain conditions be anti- competition mandate are more likely to competitive. respond to industry calls for regulation. Figure 3.10a: Competition mandates and the effectiveness of industry calls for regulation 90% 78% influenced or caused regulatory change % of regulators reporting that industry 80%  70% calls for guidance or regulation 67% 65%  70%   56% 60% 50%   50% 43% 40%   36% 40%  30% 20% 10% 0% P2P ECF ICO Statutory competition objective     Non-statutory competition objective     No competition objective Figure 3.10b: Regulatory innovation and Chapter 2 discussed the possibility that, given the effectiveness of industry calls for limited information, policymakers make high- regulation level strategic decisions as to the desirability of new business models or technologies, 90% from which all actual interventions proceed. influenced or caused regulatory change % of regulators reporting that industry 80% 68% An analysis of the regulatory change process calls for guidance or regulation 64% 66%  70%   60% as described by respondents to the survey  60% further supports this view. Across all three 50% 47%  alternative finance activities, between 35% 42%  and 51% of regulators report that their 40% regulatory approach has been influenced by 30% the need to align with government policy or 20% strategy. This is more pronounced among 10% regulators with a statutory obligation to 0% grow their domestic financial markets, P2P ECF ICO and particularly so in the case of ICOs. Any operational regulatory innovation initiative Almost half (46%) of all regulators with a No operational regulatory innovation initiatives 36 Regulating Alternative Finance – Results from a Global Regulator Survey statutory objective to grow the domestic compared with just 9% of all regulators financial market cited government policy without market growth objectives. as an influence on their approach to ICOs, Box 2 - In depth: Who is learning from whom? Given the extent to which regulatory benchmarking drives and informs regulatory change, it is useful to examine which jurisdictions have tended to influence others and who the net exporters of inspiration are. 42 respondents who reported that benchmarking was an influence on their policymaking were willing to name the jurisdictions they had studied, resulting in 205 benchmarking pairs. These have provided deep insights into the benchmarking process. Across the sample, only 38% of the average regulator’s benchmarking partners are intra-regional, while 62% were inter-regional. In other words, regulators are willing to cast their nets wide in the search for new ideas. European regulators are an exception to this rule, and strongly prefer to learn from other European jurisdictions. This may be due to significant areas of financial regulatory harmonization within the European Union. Historical and linguistic ties undoubtedly influence many of the benchmarking pairs, as benchmarking can be frustrated by incompatible legal systems or language barriers. Thus, for example, Tunisia has looked to France in reviewing alternative finance regulation, Angola to Portugal, Colombia and Costa Rica to Spain, and Bahrain and Brunei to the UK. Finally, the rise of alternative Islamic finance solutions might explain some cross-regional benchmarking pairs, such as regulators in Saudi Arabia and Brunei benchmarking against the regulatory framework in Malaysia. Overall, the UK is the most frequently benchmarked-against market by a significant margin - cited by 76% of all regulators who have benchmarked against at least one market. The USA was cited by 62%, followed by Singapore with 38%. Spain, France, Malaysia, Australia, the UAE, New Zealand, Mexico, Hong Kong, Kenya, Italy and Switzerland (in descending order of frequency) are all cited by at least 10% of respondents. It is also possible to highlight each region’s top exporters of regulatory thinking in the area of alternative finance, as set out in Figure 3.11. Further details of the history of regulatory innovation in Malaysia are available in Box 3. Figure 3.11: Regulatory benchmarking by region REGION % OF BENCHMARKING % OF BENCHMARKING MOST BENCHMARKED THAT IS INTRA- THAT IS CROSS- JURISDICTIONS REGIONAL REGIONAL WITHIN REGION Europe and Central Asia 68 33 United Kingdom, Spain East Asia and Pacific 35 65 Singapore, Malaysia Latin America and the Caribbean 34 66 Mexico Middle East and North Africa 26 74 UAE North America 25 75 USA South Asia 60 40 India Sub-saharan Africa 24 76 Kenya 37 3. Regulatory approaches to alternative finance It is possible that benchmarking has marginally favored the adoption of bespoke regulatory frameworks. 67% of regulators working with a bespoke framework cited benchmarking as an input into the development of existing P2P regulations, 74% in relation to ECF and 100% in relation to ICOs. In all cases, these percentages are higher than the comparable percentages for jurisdictions without bespoke frameworks. Among the top ten most-benchmarked against jurisdictions, only eight regulators provided complete responses regarding their regulatory approach to key sectors. Of those eight, four said P2P lending is subject to a bespoke framework in their jurisdictions, and six said the same regarding ECF. It is therefore possible, that benchmarking is one of the factors driving the gradual shift towards the adoption of bespoke regulatory frameworks for alternative finance activities. 38 Regulating Alternative Finance – Results from a Global Regulator Survey Box 3: Alternative Finance Regulation: the experience of Malaysia Closing the MSME Financing Gap with Alternative Finance As Malaysia continues its transition into a high-income country, policymakers have identified small to medium enterprises (MSMEs) as a key driver of economic growth. In 2017, MSMEs produced 37.1% of the country’s GDP and employed around two thirds of its labor force.18 However poor access to capital hinders their growth; the financing gap for Malaysian MSMEs is estimated at around USD21.5bn., or 7% of GDP.19 Therefore, a primary motivation for expanding Malaysia’s alternative finance market is the potential to introduce innovative financing options for MSMEs. The CCAF estimates that, in the past several years, the alternative finance market in Malaysia has experienced strong growth - an average of 127% per annum between 2013 and 2017.20 This growth has been facilitated by a regulatory environment that has sought to encourage innovation while protecting consumers and investors. Equity Crowdfunding (ECF) Regulation in Malaysia Malaysia was the first ASEAN country to create a regulatory framework for equity crowdfunding. SC Malaysia released the Guidelines on Recognized Markets in December 2015, outlining regulations for ECF platforms.21 Parties interested in becoming recognized market operators were invited to submit applications to SC Malaysia, and six platforms were approved in 2015. As of May 2019, a total of ten ECF platforms have been registered with the regulator. ECF investments present a high risk of capital loss to investors, and are highly illiquid. ECF platforms also present a target for fraudulent operators. In light of these risks, SC Malaysia's guidelines were designed to protect investors without placing insurmountable burdens on fund seekers. First, ECF platforms must be registered as recognized market operators (RMOs), a designation that imposes responsibilities on the operator to maintain a fair and transparent market, manage risks, and comply with all other relevant regulations. ECF platforms must also conduct due diligence on issuers, conduct investor education programs, require acknowledgements of risk from investors, and ensure that issuers and investors are following their respective regulations.22 For issuers, eligibility is restricted to locally incorporated, private limited companies and limited liability partnerships. They must provide information on business plans, the intended purpose for the raised capital, and financial 18 Mahidin (2018) “Small and Medium Enterprises (MSMEs) Performance 2017” Department of Statistics Malaysia. Accessed April 22, 2019. https://www.dosm.gov.my/v1/index. php?r=column/cthemeByCat&cat=159&bul_id=cEI0bklpZHJaTlhRNDB3d2ozbnFIUT09&menu_ id=TE5CRUZCblh4ZTZMODZIbmk2aWRRQT09 19 MSME Finance Forum, ‘MSME Funding Gap Database Updated Oct 2018’ https://www.smefinanceforum. org/sites/default/files/MSME%20Finance%20Gap%202018-19%20Update%20(public)%20.xlsx Accessed 25 September 2019 20 Ziegler et al. (2018) 3rd Asia Pacific Region Alternative Finance Industry Report. CCAF https://www.jbs.cam. ac.uk/faculty-research/centres/alternative-finance/publications/3rd-asia-pacific-region-alternative-finance- industry-report/. 21 Securities Commission Malaysia (2019a) ‘Guidelines on Recognized Markets.’ Accessed April 22, 2019. https://www.sc.com.my/api/documentms/download.ashx?id=eb8f1b04-d744-4f9a-a6b6-ff8f6fee8701 22 Ibid. 39 3. Regulatory approaches to alternative finance statements where available. Once approved by the platform, issuers may raise up to RM 3 million in any 12-month period, and up to RM 5 million in total. Finally, investors are divided into three types and face different restrictions based on their classification: retail, angel, and sophisticated. Retail investors are limited to investing RM 5,000 per issuer and RM 50,000 in a 12-month period. Angel investors can invest up to RM 500,000 in a 12-month period, whereas sophisticated investors face no restrictions on investment amounts. Since the regulatory framework was introduced, capital raised on ECF platforms has steadily grown. By June 2019, RM 54.91 million had been raised by 63 issuers.23 CCAF findings suggest that ECF has demonstrated a positive effect on financial inclusion, given that 70% of beneficiaries are businesses led by women or people under the age of 35.24 Peer-to-Peer Financing (P2P) Regulation in Malaysia In May 2016, the SC added P2P regulation to its alternative finance regulatory framework. As of May 2019, 11 platforms have been registered as P2P operators. P2P platform operators must be registered by the SC as recognized market operators (RMOs); they are required to be locally incorporated and have at least RM 5 million in paid-up capital. P2P operators must conduct due diligence on potential issuers, assess their creditworthiness, and communicate such information about issuers to investors. The maximum interest rate that may be charged over a year is 18%. They must also have processes in place to recover what is owed to investors in the event of borrower default. There is no limit on the amount of capital borrowers can raise. However, they may only access the amount raised if it exceeds 80% of the funding goal and may not receive any amount above that goal. Retail investors are encouraged to keep investments below RM 50,000, but unlike in ECF, there are no strict limits on investments.25 Malaysia’s regulatory framework for P2P stands out in two respects. First, unlike other jurisdictions, in Malaysia the regulator only allows businesses to seek funding through such platforms, in line with the overall goal of increasing financing for MSMEs and start-ups. Moreover, unlike other jurisdictions that have largely relied on platforms to self-regulate, the SC mandates that platform operators conduct risk assessments on potential issuers. Each operator may design its own risk rating system, but the processes used must be available to investors to increase transparency.26 By December 2018, 643 MSMEs had raised capital through P2P platforms, with funds totaling RM 212.65 million and transaction volume rising fourfold since 2017.27 Investors are generally younger members of the population, with a majority under the age of 35, and most invest in multiple issuers.28 23 Securities Commission Malaysia (2019b) ‘Crowdfunding Statistics as at June 2019’ https://www.sc.com.my/ api/documentms/download.ashx?id=7a5f8b07-bfe4-4e34-8ac9-e013ea2c217c 24 Ziegler et al (2018) op. cit. 25 Securities Commission Malaysia (2019a) op. cit. 26 ibid. 27 Securities Commission Malaysia (2018) Annual Report 2018 https://www.sc.com.my/api/documentms/ download.ashx?id=69b9ad2a-13c7-40bf-b0d3-341951a62278 28 Kourabas & Ramsay (2018) “Equity Crowdfunding in Malaysia.” Company Lawyer, Vol. 39, No. 6, pp. 187-196, 2018 op. cit. 40 Regulating Alternative Finance – Results from a Global Regulator Survey Insights from the Survey The data collected from this survey gives further insight into the Malaysian framework and allows for comparisons to be drawn between Malaysia and other jurisdictions. First, the range of permitted activities within Malaysia’s P2P and ECF regulation is broader than that of any other respondent market in the region except New Zealand. For example, only Malaysia and New Zealand permit access to relevant credit/transaction data on P2P borrowers from a public registry or as mandated open data. Malaysia is also the only market besides New Zealand that explicitly permits the operation of secondary markets for equity crowdfunding and peer-to-peer financing. When considering requirements concerning communication, advertising, and promotion, Malaysia’s regulation is broadly similar to that of other countries in the region, with a general requirement that communications with customers are accurate and complete, and that platforms provide standardized information to investors (e.g. risk warnings, costs, or incentive structures). With regard to requirements applicable to client on-boarding, it is useful to focus on those requirements of the Malaysian regulatory framework that are not universally applied by regulators throughout the region. In particular, the SC caps the absolute amount that individuals can invest both at the level of the individual bid and platform-wide over a 12-month period. Moreover, while platforms are allowed to establish their own eligibility criteria, there are high-level prohibitions on certain types of issuers. These include foreign issuers, publicly-listed or highly capitalized issuers, issuers with complex group or financial structures; those with an unclear (or no) business plan; and those aiming to fund acquisitions or investments in other companies. In terms of financial inclusion, Malaysia stands out as the only respondent in the East Asia and Pacific region that has required recognized market operators to report gender-based data on users or transactions for the purposes of supervision or to track impact for both P2P and ECF. Conclusion The Malaysian regulatory framework provides a valuable example of regulation that seeks to balance the development of alternative finance with attention to investor protections. As of 2018, 80% of alternative finance platforms in Malaysia reported satisfaction with the regulatory framework in CCAF’s annual survey of alternative finance platforms; this was the highest percentage of any Asia-Pacific jurisdiction,29 and, as discussed earlier in this Chapter, Malaysia is one of the most benchmarked-against jurisdictions globally. While it isn’t possible yet to prove a connection between the quality of regulation and the rapid growth of alternative finance in the country, it is worth noting that Malaysia stands out as a regional leader in equity crowdfunding in particular. In 2017, the latest year for which comparable CCAF data are available, CCAF estimated that the Malaysian ECF market arranged USD7.96 million of funding, a total larger than those of countries such as Indonesia (USD3.78 million) and Japan (USD3.55 million). 29 Ziegler et al. (2018), op cit. CCAF statistics are collected in local currency; for comparability, they are converted into USD using the annual average bid rate. In addition to activity covered in official statistics, CCAF estimates for Malaysia include funding of local issuers by platforms that are unregulated or registered and regulated outside Malaysia. 41 1. Introduction and research motivation  egulatory frameworks 4. R in detail 42 4. Regulatory frameworks in detail 4. Regulatory frameworks in detail 4.1 Alternative finance - the permitted activities and requirements This study distinguishes between two For all three activities, the most commonly dimensions of regulation. The first are the permitted functions in a regulated market are functions which firms are (and are not) allowed promotions to individual investors, fundraising to carry out. In regulated sectors this will for incorporated entities and holding client usually be conditional upon holding the assets to facilitate transactions. The breadth relevant license. of permissions varied across the three activities, with regulated P2P/Marketplace The second dimension is that of the lending firms allowed the broadest range of obligations which are imposed on firms by activities, and issuers of ICOs the narrowest. regulation. This includes requirements with respect to communications, advertising or promotions; operations, management 4.2 Sector-by-sector analysis of and systems and controls, and to client alternative finance regulation onboarding. 4.2.1 P2P/marketplace lending In relation to permitted activities, respondents The ability to promote to individual investors were asked to comment on a functional basis. (as opposed to professional and institutional In other words, whether a particular function investors) is the most common permission could be performed within each of the three to regulated P2P lending firms, as set activities, regardless of the type of entity or out in Figure 4.1. This is consistent with firm. In relation to requirements, respondents policymakers taking action in order to ensure were asked to comment on an entity basis. In that these activities become or remain a retail other words whether a particular requirement proposition. In the case of P2P/marketplace applied to a particular type of regulated lending, most of the lending that occurs entity, i.e. a peer-to-peer lending platform, on such platforms is still through individual equity crowdfunding platform or an ICO investors, though institutional investors’ share issuer. of total funding is on the rise. This differing approach was determined mainly by the need to isolate a specific aspect of the activity of issuing a token via an ICO. This allowed an exclusive focus on the token issuer as the object of regulation, rather than any other intermediated activities, such as the exchange or storage of tokens. To ensure consistency, the two other alternative finance activities - P2P lending and equity crowdfunding – were also presented on an entity basis. 43 Regulating Alternative Finance – Results from a Global Regulator Survey Figure 4.1: Permissible activities for regulated P2P/marketplace lending firms Promotions to individual investors 100% Fundraising for incorporated entities 79% Holding client assets to facilitate 68% transactions Fundraising for individuals or 58% unincorporated entities Access to relevant credit/transaction data on users from a public registry 42% or as mandated open data Operation of a secondary market 42% Operation of a fund or insurance product for the purpose of compensating 32% investors in the event of losses 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Within jurisdictions where P2P/Marketplace commonly permitted – in 42% and 32% of Lending activities are regulated, 79% of jurisdictions respectively. Secondary markets regulators indicate that firms are allowed to are fairly common in the P2P lending sector; raise funds for and on the behalf of limited however there are two ways of reconciling the companies, while only 58% provide such relatively small number of jurisdictions that permission for lending to individuals. While permit them with observed industry trends.30 these findings are in line with the sector’s First, it may be platforms in the largest P2P perceived role as an increasingly important lending markets (e.g. the UK, continental source of funding for MSMEs and even larger Europe and North America) which are corporate borrowers (see Box 1), it is perhaps responsible for the bulk of secondary market surprising that more jurisdictions do not allow activity. Survey responses are not weighted by regulated firms licensed as P2P lenders to market volume, so trends in market practice lend to individuals, sole-traders and other will not always match trends in regulatory unincorporated businesses. This may have activity. Second, some jurisdictions may treat ramifications for financial inclusion and loans (and constituent parts of loans) traded economic growth more generally. on P2P lending platforms as securities, which would in turn require an additional license to Holding client assets to facilitate transactions operate a secondary market. In a European is another common permitted activity, context, for example, some platforms cited by 68% of respondents. This involves might be licensed to operate Multilateral regulated firms temporarily holding Trading Facilities (MTFs) for this purpose. investors’ funds ahead of allocating them Consequently, an entity with a license to to investments, or holding income from operate as a P2P/marketplace lender might investments ahead of distributing it to not automatically be permitted to operate investors. As both institutional and individual secondary markets as a result, but may be lender activities become more prevalent, this able to obtain additional licenses for this permission becomes particularly important, purpose. but comes with obligations to keep funds segregated and retain custodianship of such funds. Finally, the operation of a secondary market and the operation of a fund or insurance product for the purpose of compensating investors in the event of losses are less 30 CCAF’s global alternative finance research (Ziegler et al. (2018), op. cit.). suggests that the introduction of secondary markets to P2P lending platforms has accelerated in recent years and secondary market activity is of substantial volume internationally. 44 4. Regulatory frameworks in detail Box 4: Innovative Finance and the Regulatory Perimeter: the case of Uganda In early 2019, CCAF researchers undertook a focused, desk-based review of Uganda’s regulatory framework for the capital markets and collective investment, with a view to uncovering regulatory barriers to the development of alternative finance. CCAF categorized potential barriers into: • Regulatory perimeter issues precluding innovative financing • Potentially disproportionate regulations • Technology biases in regulation • Ecosystem biases in regulation • Unclear application or objective of regulations The review found that the obstacles to building thriving regulated alternative finance sectors were rarely technological biases. In fact, Ugandan law contains good examples of technology-agnostic reporting and record-keeping requirements which could be used in other parts of the regulatory framework. Rather, the regulatory perimeter was identified as the most significant regulatory barrier to the development of the sector. P2P lending and securities crowdfunding were found to be challenging to regulate in Uganda without at least some legislative change. Both activities intersected with the definitions of collective investment schemes.31 Furthermore, P2P lending intersected with the definitions of deposit-taking and corporate bonds, while equity crowdfunding platforms might overlap with the definition of a stock market. Less problematic, though noteworthy, was the interaction between equity crowdfunding and securities brokerage and dealing. There are at least three options available to addressing these types of regulatory perimeter issue: 1. Regulate platform operators as intermediaries (e.g. equities brokers), while using exemptions to sidestep the definition of a public offering of securities or of deposit-taking. For example, Uganda’s CMA has wide discretion to switch off parts of the Prospectus Regime for eligible equity listings as a class. Practically this might subject platforms to rules about the promotion of investments, the protection of client money, disclosure and management of conflicts of interest and incentives, and potentially mandatory qualification and training requirements for operators. Because of the use of an exemption, strict eligibility conditions for issuers would also be a de facto part of the sector’s conduct regime, meaning that the types of eligible business would be tightly defined. 31 The relevant legislation defines collective investment schemes as arrangements “with respect to property of any description […] the purpose or effect of which is to enable [participants], whether by becoming owners of the property or any part of it or otherwise, to participate in or receive profits or income arising from the acquisition, holding, management, or disposal of the property or sums paid out of such profits of income. […] such that [participants] do not have day to day control of the management of the property […] whether or not they have the right to be consulted or to give directions”; and have either or both of the following characteristics: a) “that the contributions of the participants and the profits or income out of which payments are to be made to them are pooled” and b) “that the property is managed as a whole by or on behalf of the operator of the scheme.” 45 Regulating Alternative Finance – Results from a Global Regulator Survey 2. Regulate platforms, particularly in the P2P sector, as collective investment schemes or other funds, but allow more explicitly through legislation for off-balance sheet investments. This might mean holding platforms to the same standards as fund managers on asset quality, standardization and diversification; on risk management; and on governance, particularly in regards to their relationships with investors. In such a scenario, platforms might be required to be linked to repositories, which would directly hold the clients’ investments. 3. Regulate platforms as markets or trading venues. Under one option considered by researchers, the Interim Trading Facility provisions in secondary legislation could be repurposed to allow ECF platforms to function as a flexibly regulated stock market for a pre-determined period of time before becoming licensed either as a full stock market or some other kind of entity; effectively, creating a sector-wide Sandbox. Bespoke venues analogous to the EU’s Multilateral Trading Facilities might also be defined in legislation. The Interim Trading Facility approach would have strong implications for platforms, as market participants would need to be represented in their governing bodies, they would need to establish a physical trading venue, and they would need to take responsibility for market infrastructure. Which of the three options are taken depends on the degree to which investors are expected to take responsibility for outcomes and the extent to which alternative financing is to be a viable proposition for retail investors. Regulation as a collective investment scheme provides a fairly rigid and costly framework for operation, limiting the platform’s freedom to adjust its offerings, but providing individual investors with greater transparency and continuity. Regulation as an intermediary emphasises responsible marketing of investments and can allow for additional protections for less sophisticated investors; but it also means regulators have less control of customer outcomes later in the process, such as the level and quality of diversification. Regulation as a market venue emphasises the integrity and execution of transactions but relies on highly-engaged intermediaries with a stake in the success of the market, and on regulatory requirements and protections elsewhere in legislation to enable transparent and fair valuations. None of the above are entirely possible without legislative change but adjustments to collective investment legislation might be less complex. Importantly, these are political decisions; they can be supported through empirical evidence but not decided outright by the evidence. 46 4. Regulatory frameworks in detail Regulatory requirements related to marketplace lending firms. Requirements to communications, advertising or promotions provide standardized information to potential The most significant emphasis was on the lenders, including on risks or costs, were requirement to ensure communications also prominent. Given that P2P/Marketplace with customers were accurate and did not Lending primarily targets retail investors, this omit important information, with 95% of is not altogether surprising, especially from respondents noting this as a requirement. regulators with a strong consumer protection Figure 4.2 below sets out some of the mandate. regulatory requirements for regulated P2P/ Figure 4.2: Selected regulatory obligations for regulated P2P/Marketplace lending firms Ensure communications with 95% customers are accurate and complete Comply with Anti Money Laundering (e.g. 90% KYC) rules specific to this type of firm Provide standardized information to investors (e.g. risk warnings, costs, 90% incentive structures, etc) Comply with complaints 85% handling requirements Separate client assets from firm assets 80% Comply with mandatory governance requirements (e.g. independent risk 75% management, internal audit) Ensure eligibility criteria are met before fundraising (e.g. minimum 75% company age, profitability) Conduct creditworthiness/ 75% affordability checks on borrowers Have a ‘wind-down’ plan to minimize impact of platform failure (e.g. 60% resolution packs or living wills) Verify the claims made by the 60% fundraiser (incl via third party) Provide fundraisers/investors 50% with cancellation rights Maintain a minimum amount of capital 45% Comply with restrictions of advertising using specific types 35% of media (e.g. social media) Cap the amount that may be 30% raised over eg 12 months Cap the amount that a single investor 30% may provide a single fundraiser Share relevant user data (e.g. with 30% a public or private credit registry) Cap the amount invested by an individual at a defined percentage 25% of their wealth or income Hold capital proportionate to total 15% amount invested on the platform Promote to investors differently 15% based on wealth and/or experience 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Because P2P investors are not expected to in which P2P is regulated impose client take as much risk as investors in the ECF and categorizations of this type. ICO sectors, regulators typically allow them to take significant exposure at their own It is more common, however, for regulators discretion. It is relatively rare for regulators to cap the share of wealth or income that to restrict marketing to less sophisticated or an investor can allocate to this sector - just less wealthy investors, or insist on greater under a third of regulatory frameworks (30%) protections for them - only 15% of jurisdictions were doing so at the time of the survey. This 47 Regulating Alternative Finance – Results from a Global Regulator Survey percentage is reasonably high, but it still jurisdictions tend to impose the highest points to a less stringent treatment than in the minimum capital requirements (in USD), while case of equity-based crowdfunding. low income jurisdictions tend to impose the lowest. A similar share of regulators (30%) capped the amount a borrower might raise over a given period (typically 12 months). This restriction Regulatory requirements related to might share a two-fold purpose. It might operations, management, systems and protect lenders from exposure to failing controls businesses or prevent excess borrowing. It Requirements in relation to systems and might also help police those areas where controls were very common in regulatory marketplace lending risks overlapping with frameworks applying to P2P and marketplace deposit-taking activity, by limiting the extent lending. Rules related to complaint handling to which businesses fund their ongoing processes (85%), segregation of client assets operation by borrowing from the public. (80%), and governance (75%) ranked highest. This is consistent with the risks perceived to be highest by regulators. Regulatory requirements related to client- onboarding (Borrower and Lender) Anti-money Laundering (AML) requirements 4.2.2 Equity Crowdfunding (ECF) were a priority for regulators, ranking as the Where equity crowdfunding is regulated, second most common regulatory theme in funding for incorporated entities is permitted this sector (90%). Requirements to conduct by nearly all regulators, allowing the sector due diligence, especially as related to to act as a funding venue for startups and eligibility criteria of borrowers (75%) and early stage companies. It is possible that creditworthiness / affordability (75%) were certain equity-like funding models (e.g. profit obligations commonly imposed upon firms. or royalty sharing) are also allowed to cater to individuals and partnerships – which was Nearly half of the regulatory frameworks for reportedly allowed in 35% of jurisdictions P2P/Marketplace lending included capital with regulated equity crowdfunding sectors. requirements. However, the amount required Figure 4.3 below summarizes the most was rarely linked to the size of firms’ loan common permissible activities for regulated books. Only 15% of regulators had such a equity crowdfunding firms. requirement in place. Mid-to-high income Figure 4.3: Permissible activities for regulated equity crowdfunding firms Fundraising for incorporated entities 97% Promotions to individual investors 85% Holding client assets to 50% facilitate transactions Access to relevant credit/transaction data on users from a public registry 35% or as mandated open data Operation of a fund or insurance product for the purpose of compensating 35% investors in the event of losses Fundraising for individuals or 35% unincorporated entities Operation of a secondary market 26% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% At the heart of equity crowdfunding is the into incorporated entities. To enable this, ability to raise funds from individual retail equity crowdfunding platforms typically need investors via online platforms and invest them to promote offers to individual investors. 48 4. Regulatory frameworks in detail Among the surveyed regulators, close to permitted activity for equity crowdfunding 85% of respondents stated that promotions platforms in their jurisdictions. This low to investors are permitted. The remainder proportion may be due to the operation very likely restrict access to such platforms to of a secondary market for securities being professional investors. captured under different regulation and thereby requiring other licenses outside of the Just over a quarter of regulators state that scope of equity crowdfunding specifically32 . the operation of a secondary market is a Figure 4.4: Selected regulatory obligations for regulated equity crowdfunding firms Ensure communications with 100% customers are accurate and complete Provide standardized information to investors (e.g. risk warnings, costs, 91% incentive structures, etc) Comply with Anti Money Laundering (e.g. KYC) rules 88% specific to this type of firm Comply with mandatory governance requirements (e.g. independent risk 85% management, internal audit) Separate client assets from firm assets 82% Ensure eligibility criteria are met before fundraising (e.g. minimum 82% company age, profitability) Comply with complaints 76% handling requirements Verify the claims made by the 74% fundraiser (incl via third party) Provide fundraisers/investors 59% with cancellation rights Have a ‘wind-down’ plan to minimize impact of platform failure (e.g. 53% resolution packs or living wills) Cap the amount invested by an individual at a defined percentage 53% of their wealth or income Promote to investors differently 47% based on wealth and/or experience Maintain a minimum amount of capital 38% Cap the amount that may be 35% raised over eg 12 months Cap the amount that a single investor 35% may provide a single fundraiser Comply with restrictions of advertising using specific types 29% of media (e.g. social media) Hold capital proportionate to total 21% amount invested on the platform Share relevant user data (e.g. with 21% a public or private credit registry) 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Every jurisdiction within the sample that majority of jurisdictions (88%) also require actively regulates equity crowdfunding firms to adhere to Anti-Money Laundering requires platforms to ensure communications regulations including Know Your Customer are accurate and complete, as set out requirements. in Figure 4.4. Aligned with this is the requirement for firms to provide standardized A common operational requirement for information to investors, with over 90% of equity crowdfunding platforms (82% of jurisdictions mandating this as a part of surveyed regulators) is that the money that regulating this activity. Aside from marketing investors place on these platforms is held and promotions stipulations, the clear separately from the platform, to ensure funds 32 As observed regarding Multilateral Trading Facilities in Section 4.1.1. 49 Regulating Alternative Finance – Results from a Global Regulator Survey are not co-mingled. Another requirement income that can be invested in crowdfunded that is often applied to equity crowdfunding equity. Just over a third cap the amount that a platforms is to ensure fundraising entities single fundraiser can raise within a given time meet an eligibility requirement before they period (typically 12 months), and a significant can solicit funds from potential investors share also cap the amount a single investor via the platform, with over 82% of surveyed may provide to a single fundraiser. There is, regulators stipulating this requirement. therefore, an important divide between more and less prescriptive approaches to investor Less commonplace were requirements participation in the sector. relating to the type of media which can be used to promote investment offers via equity crowdfunding, whether via social media or 4.2.3 Initial Coin Offerings (ICOs)33 offline. Fewer than one third of respondents As shown by Figure 4.5, all of the surveyed stipulated such a requirement. regulatory authorities that regulate ICOs allow for the promotion to individual investors. One point of divergence amongst regulators Despite the significant incidence of fraud in in their requirements for equity crowdfunding the ICO market 34, this fundraising mechanism is that around half of all regulators require was initially designed with individuals and different approaches to marketing and retail investors in mind and conceived as a promotion based on the level of wealth and market where participants took complete experience of investors. For example, 47% responsibility for their decisions. Hence, of respondents impose added restrictions regulators may have sought to regulate ICOs or requirements to firms marketing to less to ensure their suitability for mass retail knowledgeable investors. Most respondents investment, while preserving their original (53%) cap the share of an investor’s wealth or value proposition. Figure 4.5: Permissible activities for regulated ICOs Promotions to individual investors 100% Fundraising for incorporated entities 86% Holding client assets to 43% facilitate transactions Fundraising for individuals or 43% unincorporated entities Operation of a secondary market 29% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% The vast majority of respondents allow permitted the operation of a fund or fundraising for incorporated entities (86%), insurance product for the purpose of whereas 43% also allow for fundraising by compensating investors in the event of losses. certain types of unincorporated entities. While this is true of the regulators’ approach While ICOs have primarily been a vehicle for to capital losses from ICOs themselves, startups from the crypto asset and blockchain CCAF’s 2nd Global Cryptoasst Benchmarking ecosystem to raise funds quickly to develop Study shows that mandatory refund their product, a number of ICOs were also procedures are becoming a norm amongst conducted through not-for-profit foundations. cryptoasset-related intermediated activities (e.g. exchange, or storage).35 None of the surveyed regulators have 33 The reader should be aware that permissible activities and requirements discussed in this section only apply to ICOs whose underlying token does not qualify as a security or is not otherwise subject to a pre-existing regulatory framework. Where an issued token has been deemed to be a security, the regulatory framework for issuance and distribution will tend to be much more restrictive and/or prescriptive than what is described in this section. 34 Shifflett & Jones (2018) and Florysiak & Schandlbauer (2018) , op cit. 35 Rauchs et al (2018) ‘2nd Global Cryptoasset Benchmarking Study.’ CCAF, December https://www.jbs.cam.ac.uk/fileadmin/user_ upload/research/centres/alternative-finance/downloads/2018-12-ccaf-2nd-global-cryptoasset-benchmarking.pdf 50 4. Regulatory frameworks in detail It is possible that some of the responses the local jurisdictions’ approach to custody provided by regulators in relation to of digital assets. Similarly, other regulators ICO issuers’ permissions in fact refer to reported that they permit the operation of permissions granted to intermediaries. For secondary markets, which ICO issuers do example, 43% of regulators in jurisdictions not typically seek to do on a centralized with a regulatory framework for ICOs referred basis. However, ICO issuers may envisage to firms being allowed to hold client assets participants in an issuer’s ecosystem in order to facilitate transactions, which ultimately being able to trade tokens on a an ICO issuer is highly unlikely to do. This secondary market. Regulators who do not finding should be approached with caution prohibit this may have chosen to indicate that and may reflect the presence of mandated this is permitted. intermediaries such as ICO platforms, or Figure 4.6: Selected regulatory obligations for regulated ICOs Comply with Anti Money Laundering (e.g. KYC) rules 100% specific to this type of firm Ensure communications with 93% customers are accurate and complete Comply with mandatory governance requirements (e.g. independent risk 86% management, internal audit) Provide standardized information to investors (e.g. risk warnings, costs, 79% incentive structures, etc) Separate client assets from firm assets 71% Promote to investors differently 71% based on wealth and/or experience Ensure eligibility criteria are met before fundraising (e.g. minimum 29% company age, profitability) Provide fundraisers/investors 21% with cancellation rights Comply with complaints 14% handling requirements Cap the amount invested by an individual at a defined percentage 14% of their wealth or income Maintain a minimum amount of capital 7% Cap the amount that a single investor 7% may provide a single fundraiser Verify the claims made by the 7% fundraiser (incl via third party) Cap the amount that may be 0% raised over eg 12 months Hold capital proportionate to total 0% amount invested on the platform Share relevant user data (e.g. with 0% a public or private credit registry) Have a ‘wind-down’ plan to minimize impact of platform failure (e.g. 0% resolution packs or living wills) Comply with restrictions of advertising using specific types 0% of media (e.g. social media) 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% The main applicable requirements contained All existing regulatory frameworks for in existing regulatory framework highlight ICOs require that issuers comply with AML regulators’ primary aim is to prevent provisions. As presented in CCAF’s inaugural fraudulent activities and address the risk of Global Cryptoasset Regulatory Landscape capital losses with respect to ICOs. This is Study,36 regulators’ first response to the illustrated in Figure 4.6. emergence of cryptoassets and related 36 Blandin et al. op cit. 51 Regulating Alternative Finance – Results from a Global Regulator Survey activities has been to ensure compliance investors demonstrate their knowledge and with AML obligations. This has been led by understanding of the asset class before being the Financial Action Task Force (FATF), which allowed to invest. published its first AML/CFT guidelines for cryptoassets as early as 2015 to prevent the Despite this, the regulatory frameworks circulation of laundered cryptocurrency;37 currently governing ICOs are markedly less more recently the FATF provided an updated prescriptive than those for the crowdfunding interpretation of FATF Recommendation 15 in sectors in many other ways. This is partly relation to New Technologies, which further due to the disintermediated nature of token clarifies the treatment of tokens and crypto- offerings but an expectation also exists asset service providers and will no doubt among many regulators that investors should accelerate the development of local policies take responsibility for what are clearly high- in this area.38 risk investments. For example, only one of the regulatory frameworks examined mandates Regulatory requirements are primarily independent due diligence over the issuer. concerned with communication and Few frameworks mandate cancellation rights information disclosure to potential investors or complaints handling arrangements for ICO and protecting them from abuse by better investors. Other types of restrictions typically informed ICO insiders. Nearly all applicable absent in the regulation of this activity include regulatory frameworks (93%) contain a general caps on the amount an issuer can raise, or requirement that communications with the amount a single investor may provide customers are accurate and complete, 86% to an issuer. Only one of the regulators that apply mandatory governance requirements regulate ICOs has imposed an investment (e.g. independent risk management, limit per round of offering. internal audit) on issuers, and 79% require the provision of standardized information Even these rare examples are likely to involve to investors (e.g. risk warnings, costs and jurisdictions that impose the presence of incentive structures). These figures could intermediaries in the ICO process – for be interpreted in particular as regulators example mandating the use of a regulator- addressing the irregularity and inconsistency approved platform for all ICO issuers. of whitepapers used by fundraisers to Importantly, none of the existing regulatory advertise their product online.39 frameworks restrict promotion via specific In the absence of regulation, whitepapers media. This recognizes the fact that much greatly differ in terms of quality, transparency, of the communication and advertising in the and the disclosure of risks, which may cryptoasset industry occurs on social media result in misleading communication, given (e.g. via Twitter and Reddit). the information asymmetries between issuers and investors. In fact most existing regulatory frameworks require that issuers treat investors differently based on their wealth and/or experience (71%) – this can range from banning promotions to most non-professionals to requiring that individual 37 FATF (2015) ‘Guidance for a risk-based approach to virtual currencies’, FATF, Paris https://www.fatf-gafi.org/media/fatf/ documents/reports/Guidance-RBA-Virtual-Currencies.pdf 38 FATF (2019a) ‘The FATF Recommendation: International standards on combating money laundering and the financing of terrorism & proliferation’ Paris: FATF https://www.fatf-gafi.org/media/fatf/documents/recommendations/pdfs/FATF%20 Recommendations%202012.pdf and FATF (2019b) ‘Guidance for a risk-based approach to virtual currencies and Virtual Asset Service Providers’ FATF, Paris http://www.fatf-gafi.org/media/fatf/documents/recommendations/RBA-VA-VASPs.pdf 39 ‘Whitepaper’ is the commonly used term for a key document accompanying an ICO, which among other things details the issuer’s business plan and application roadmap, as well as the function, origination and mode of distribution of their tokens. Where an ICO is treated as a public offering of securities, regulators will want to be assured that a Whitepaper meets their expectations of a Prospectus. 52 4. Regulatory frameworks in detail Box 5: Mexico’s FinTech Law and its approach to consumer protection In March 2018, Mexico adopted an umbrella law on FinTech (“FinTech Law” - Ley para Regular las Instituciones de Tecnología Financiera, in Spanish), aiming to enable a fair and transparent environment for innovation, as well as promote the development and adoption of new technologies and business models in the country. The Mexican FinTech Law positioned the country as a pioneer in establishing a comprehensive legal framework to foster the development of FinTech companies in a safe and sound way, based on the principles of (i) financial inclusion and innovation, (ii) financial consumer protection, (iii) financial stability, (iv) competition, and (v) anti-money laundering and combating the financing of terrorism. The Mexican Fintech Law aims to regulate activities of several types of “disruptive” financial service providers, focusing on non-bank e-money issuers and operators of peer-to-peer lending (i.e. crowdfunding) platforms. In particular, the Law introduces: i. a comprehensive legal framework for licensing and supervising FinTech companies ii. legal underpinnings for a regulatory sandbox environment for innovative companies; iii. concepts of open data, covering non-confidential/aggregate and transactional data, accessed through Application Programming Interfaces (APIs) iv. provisions for virtual assets and their operations in Mexico. The FinTech Law outlines at a high-level certain consumer protection requirements, and provides for further detail to be determined through secondary regulation. Thus in September 2018 and March 2019, secondary regulations were issued by the Mexican authorities, establishing provisions on the information to be disclosed on projects by crowdfunding platforms, as well as on cybersecurity and client’s authentication. Additionally, in July 2019, secondary regulation introduced further transparency and disclosure requirements for FinTech companies40, together with dispute resolution mechanisms. The FinTech Law contains consumer protection provisions mainly with regard to disclosure and transparency, and safeguard of consumers’ funds. For example, it establishes that transparency and disclosure provisions which apply to existing firms in Mexico also apply to FinTech companies. FinTech companies must disclose all the information needed to ensure consumers identify the relevant features and risks associated with the new products and services. In this context, crowdfunding platforms must provide adequate information to consumers, related to the selection criteria for fundraisers, according to rules established by the CNBV41 40 ‘Disposiciones de carácter general de la CONDUSEF en materia de transparencia y sanas prácticas aplicables a las instituciones de tecnología financiera’, of July 9, 2019. 41 The following authorities play a relevant role in regulating and supervising FinTech companies in Mexico: Secretaria de Hacienda y Credito Publico – SHCP (Ministry of Finance), Comision Nacional Bancaria y de Valores – CNBV (National Banking and Securities Supervisor), Banco de México (Central Bank of Mexico), and Comisión Nacional para la Protección y Defensa de los Usuarios de Servicios Financieros – Condusef (National Commission for the Protection and Defense of Users of Financial Services). 53 Regulating Alternative Finance – Results from a Global Regulator Survey At the same time, a number of potential asymmetries are yet to be addressed in the context of the Law. This includes defining deposit insurance schemes, and data protection requirements. While FinTech companies are subject to the general Personal Data Protection Law in Mexico, specific requirements on personal data protection for FinTech companies are yet be issued, and are due in 2020. 4.3 Implications of regulatory On average, bespoke regulatory frameworks choices: two discussions for alternative finance provide for a wider range of permitted activities than pre- It is difficult to quantify the impact of existing frameworks, but also create more regulation on industries and their users, or to explicit obligations. In the case of equity highlight through empirical methods the most crowdfunding and ICOs, bespoke frameworks important differences between two or more do not differ significantly from exemption- regulatory frameworks. based regulatory frameworks. However in the case of P2P lending, bespoke frameworks are For this purpose two simple metrics were indeed more demanding and provide for a constructed that consisted of a simple count greater range of permitted activities. of the number of permitted activities (out of the range cited in Chapter 4.1) and a To illustrate this at a high-level, it is possible simple count of the number of obligations to compare the number of obligations (including implied obligations such as a reported for bespoke and unmodified,43 pre- cap on exposures). While these measures existing frameworks. Out of a maximum of are crude, they provide a simple and 20 types of requirements that respondents useful quantification of the complexity and were prompted with, the average bespoke restrictiveness of regulation. framework for P2P lending or ECF featured 9, against 5 for pre-existing ones that had not Discussion 1: Are bespoke regulatory been adjusted in some way. For ICOs, the frameworks ‘light-touch’ regimes? balance was 5 to 3. While it is generally accepted that proportionate and flexible regulation can Compared to pre-existing regulation, support innovation, different regulators bespoke and exemption-based regimes may reach different conclusions as to how for P2P regulation tend to emphasize much technology-enabled financial services creditworthiness checks for borrowers and providers can be accommodated without exposure caps for investors (see Figure 4.7). compromising other objectives. Evidence to Bespoke and exemption-based regimes date on the performance of major technology also tend to emphasize online marketing companies (‘BigTechs’) in the digital lending requirements, client money protection market suggests that they are much quicker and wind-down planning, as well as data to take market share from incumbents in protection and cancellation rights. more lightly regulated markets.42 If regulators look to those jurisdictions with the largest or In the equity crowdfunding space, bespoke fastest-growing markets for good practices, and exemption-based regimes tend to and regulation is inversely related to growth emphasize investor exposure and fundraising in the medium-term, then overly light-touch caps, due diligence requirements and social regulation could come to be seen as good media advertising rules. Counterintuitively, practice for some time before its limitations bespoke ECF regimes are less likely become evident. than pre-existing frameworks to classify 42 Bank of International Settlements (2019) ‘Big Tech in Finance: Opportunities and Risks’ in BIS Annual Economic Report 2019 https://www.bis.org/publ/arpdf/ar2019e3.pdf 43 This does not include responses from regulators who claimed that a pre-existing framework applies in their jurisdiction, but ‘with exemptions or amendments’ specific to the sector. 54 4. Regulatory frameworks in detail investors into groups based on their relative Discussion 2: Does government policy bias sophistication or wealth. The effect of this the development of alternative finance is that less sophisticated investors are less regulation? likely, in bespoke regimes, to be prohibited A similar approach can be taken to analyzing from investing in ECF, to be restricted regulatory frameworks that are influenced in the amount they can invest relative to by broader government economic and professional investors, or to enjoy additional industrial policies. Where alternative finance protections (such as, for example, access to activities are regulated, regulators that an alternative dispute resolution mechanism) facilitate government policy either due to that are not available to professional or highly statutory requirements or due to strategic experienced investors. considerations tend to allow a broader range of activities to take place on ECF Figure 4.7: Differences between bespoke platforms, and allow ICO issuers to undertake and other regulatory frameworks: selected a broader range of activities than regulators obligation types for P2P lending and equity that operate completely independently of crowdfunding government policy (Figure 4.8a). Regulators aligned to government policies, however, also 100% 92%  tend to place more stringent obligations on 90% 81%  ECF platforms (Figure 4.8b). 80% 71%  70% 61% 58%  60%  50% 40% 33%  30% 20% 10% 0% ow ili t r a lai r a r i e a s e CF rr ab uc er t y is ms nc d nd c (o pe b E b o rd n d s s e ex t l y ot e fu he m er P fo co F y t f ir or en m P2 s/af to EC r i f t h e d / fe r ro on e s nt an dif o p by ve r k s in me e to fo lth s t t e c r t h ire a d y) n t ea to n w es me m rt e c h wo q u pa m r o n in uire i t Re i r e i rd u to q t h Re q v Re ed cr Bespoke framework Pre-existing or exemption-based/adjusted framework 55 Regulating Alternative Finance – Results from a Global Regulator Survey Figure 4.8a: Average number of permitted activities in regulated markets, by activity and presence of government policy mandates 5.0 4.0 4.0   4.0 3.6  3.5  3.3  3.0 2.4  2.0  2.0 1.0  1.0 0 No. of P2P permitted activities No. of ECF permitted activities No. of ICO permitted activities Promoting Gov’t Policy is a Statutory Objective Promoting Gov’t Policy is a Non-statutory Objective Promoting Gov’t Policy is not an Objective Figure 4.8b: Average number of regulatory requirements in regulated markets, by activity and presence of government policy mandates 12.0 11.0  10.4 10.4   10.0 8.4 8.7   8.0 6.8  6.0  6.0 5.0  4.0 2.0  2.0 0 No. of P2P obligations No. of ECF obligations No. of ICO obligations Promoting Gov’t Policy is a Statutory Objective Promoting Gov’t Policy is a Non-statutory Objective Promoting Gov’t Policy is not an Objective These findings are essentially qualitative and need to be interpreted with caution, as sample sizes are small and many potential confounding variables have not been controlled for. If they could be replicated, however, they would suggest that a mandate to promote government policy does not necessarily lead to a ‘light touch’ regulatory framework. 56 1. Introduction and research motivation  he supervision of 5. T alternative finance 57 5. The supervision of alternative finance The supervision of alternative 5.  finance 5.1 The perceived risks of alternative finance Survey respondents were asked to identify Typically, those regulators without direct up to five risks which they see as the most responsibility for supervising the activities important for their organization with respect in question devote greater attention to the to peer-to-peer/marketplace lending, equity risk of abuse for the purposes of fraud or crowdfunding, and initial coin offerings money laundering, as well as the risk of data (ICOs). This allowed the research team to loss. Their regulatory peers who do have gauge whether there are common risks, supervisory responsibilities are comparatively whether between activities or even between more concerned about the impact of jurisdictions. Figure 5.1 below demonstrates exposing retail investors to highly illiquid how regulators rank these risks, broken down assets. This contrast is particularly strong in by whether they have remit over the relevant the case of equity crowdfunding. alternative finance activity. Given the nascent status of these alternative Figure 5.1 shows that the same three risks are finance activities in many jurisdictions, it is identified as most important across all three perhaps surprising that the risk of regulatory alternative finance activities. For regulators arbitrage is ranked as quite low. This includes without an explicit remit over the three the case of ICOs, which, as documented in activities, these are fraud, capital losses and CCAF’s 2019 cryptoasset regulatory landscape money laundering. Among those regulators study, regulators tend to see as posing a risk with powers over the relevant activities, the of regulatory arbitrage.44 It may be that those third most common risk is instead exposure regulators most confident in determining the to poor value products. ICOs were generally level of this risk are also the most likely to have seen by respondents as having a much higher adequate measures in place against it. risk profile, with strong concentrations of fraud, money laundering and liquidity risks. 44 Blandin et al (2019) op cit 58 Regulating Alternative Finance – Results from a Global Regulator Survey Figure 5.1: Regulators’ ranking of alternative finance risks 83% P2P 81% FRAUD 66% ECF 85% 86% ICOs 95% 78% CAPITAL LOSSES FOR INVESTORS P2P 76% 82% ECF 66% 79% ICOs 81% PURPOSES (MONEY 52% P2P LAUNDERING) 67% MISUSE FOR CRIMINAL 37% ECF 70% 71% ICOs 73% VALUE PRODUCTS OVERINDEBTEDNESS 30% P2P 52% FUNDRAISER 18% ECF 42% 7% ICOs 22% EXPOSURE TO POOR 61% P2P 45% INVESTOR 55% ECF 51% 71% ICOs 63% 35% P2P 45% CUSTOMER MISUSE OF 18% DATA ECF 43% 7% ICOs 25% 35% P2P REGULATORY 31% ARBITRAGE 29% ECF 23% 29% ICOs 42% LIQUIDATE / REALISE 43% P2P INVESTMENTS INABILITY TO 17% 61% ECF 30% 64% ICOs 47% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Has remit     Has no remit/remit unclear 59 5. The supervision of alternative finance 5.2 The supervisory resources dedicated to alternative finance 5.2.1 Human Resources It was not possible, due to item non-response per supervisor (down from twelve in 2017), but in certain major markets, to provide a robust only about two ECF platforms and ICOs per global estimate of the supervisory workforce. supervisor. Figure 5.2 illustrates this in further Overall, and as of 2019, those regulators that detail. did respond reported a ratio of six P2P firms Figure 5.2: Evolution of firm-to-supervisor ratio by activity (all jurisdictions where data were available) 14 11.9  12 10 8 6.7  6.2  6 4 2.6 2.5 2.4  2.3 2.1     2 1.2  0 P2P ECF ICO 2017     2018     2019 Figure 5.3: Evolution of firm-to-supervisor ratio by activity (all jurisdictions where the activities were regulated, and data were available) 5.0 4.5 3.8 4.0 3.6   3.5 3.1 3.1  3.0   3.0 2.3 2.2 2.5   1.9 2.0 1.7   1.5 1.0 0.5 0.0 P2P ECF ICO 2017     2018     2019 60 Regulating Alternative Finance – Results from a Global Regulator Survey Jurisdictions that formally regulate each of number of ICO ‘supervisors’ in markets where the three activities account for most of this the latter are unregulated. human resource. The demand on supervisory resource is greater where activities are In markets where an activity is not regulated, regulated (see Figure 5.3), with each it is still possible for activities to be enforced supervisor typically covering just two to four against if they are considered to be firms.45 Where alternative finance activities fraudulent, or if they inadvertently cross into are unregulated or banned, regulators’ the perimeter for a very different regulated resources are likely to be primarily targeted at activity. For example, a P2P lending platform enforcement, resulting in a disproportionately might fall afoul of rules regulating collective low number of firms per supervisor. It is this investment schemes or deposit-taking, pattern that accounts for the relatively large depending on its structure. 5.2.2 Trends in supervisory resource investment Figure 5.4: Trends in supervisory staff dedicated to each activity type (in those jurisdictions that provided data) by the fact that some jurisdictions have only 38% 40%  just begun regulating these platforms and may begin with higher levels of supervisory 35% 32% 32% resource. % change between 2017 and 2019   30% The firm to supervisor ratio might not 25% necessarily rise quickly as a sector matures 20% due to consolidation. Underfunded or poorly 15% run firms can survive for years in unregulated  12% 15% sectors; most, however, will not persist if  9% they are required to be licensed and observe 10%  higher standards of conduct or increased 5% capital requirements. One example of this 0% is the UK FCA’s experience of licensing P2P ECF ICO firms operating in the marketplace lending sector. Between mid-2014 and mid-2018, the Regulated     Total regulator had licensed 63 firms,46 while 310 As Figure 5.4 shows, the absolute number had withdrawn their licensing applications.47 of supervisors of peer-to-peer/marketplace This was despite firms already in the market lending platforms has grown by around 15% in 2014 being allowed to operate for some in regulated markets and 12% overall between time under temporary licenses (“interim 2017 and 2019 – where data were available. permissions”). This is a slower pace of change than for the The rate of enforcement action (per 100 firms) other two alternative finance activities. The taken in the peer-to-peer/marketplace lending ratio of P2P platforms per supervisor is also sector differs based on regulatory approach. decreasing, as seen in Figure 5.2 and 5.3. Although more than 75% of all enforcement These findings may be explained partly by against P2P platforms appears to be taking the greater maturity of this sector and partly place in markets where the sector is not 45 The ratios reported here are averages of jurisdiction ratios, sourced from the subset of regulators who provided estimates of both firms and supervisors for each year. Large, non-reporting jurisdictions are likely to have much higher firm-to-supervisor ratios in 2019, but not necessarily in 2017. 46 FCA (2018a) ‘Loan-based (‘peer-to-peer’) and investment-based crowdfunding platforms: Feedback on our post-implementation review and proposed changes to the regulatory framework’ CP18/20 https://www.fca.org.uk/publication/consultation/cp18-20. pdf 47 FCA (2018b) ‘Freedom of Information / Right to Know Request FOI5783,’ 13 June https://www.fca.org.uk/publication/foi/ foi5783-response.pdf 61 5. The supervision of alternative finance explicitly regulated,48 this reflects the fact that Initial Coin Offerings most firms are concentrated in such markets. There has been a sharp increase in the When standardized against the size of the firm number of Initial Coin Offerings (ICOs) population, the rate of enforcement against taking place over the last three years. The this activity is around 50% higher where a total number of new ICOs in the jurisdictions regulatory framework is in place – regulators that provided data more than tripled from reported roughly one historical enforcement 2017 (103) to 2018 (360), and will likely case (since 2017) for every 10 currently active exceed the 2017 total in 2019 (83 as of June). firms. Although this estimate is based on a subset of comparatively smaller markets, it reflects the trends observed through CCAF’s direct Equity crowdfunding monitoring of ICO activity.49 Total human supervisory resources devoted to equity crowdfunding are rising fast, growing In those jurisdictions for which data were by about 38% between 2017 and 2019 in available, the total number of supervisory staff those jurisdictions that provided data. This dedicated to ICOs has increased significantly, was justified by the increasing attention growing by about a third between 2017 the sector received from policymakers over and 2019. This reflects the increasing the period and the greater likelihood of the attention regulators are paying to the sector, activity being regulated in the first place. The particularly given the complexity of the ratio of platforms to supervisors is also higher, underlying technology and the specificity of in this subset of jurisdictions, for equity each offering. However it might also reflect crowdfunding than for P2P lending, at over 3:1 a strong emphasis on enforcement over in regulated markets. supervision. The mean reported ratio of 2.1 ICOs per supervisor50 almost certainly takes In proportion to the total firm population, into account person-hours dedicated to ECF enforcement cases are common – across enforcement. both regulated and unregulated markets their number was equal to 18% of the population The number of enforcement cases related to of active firms. As with P2P lenders, however, ICOs is significant, but not disproportionately it is the number of enforcement cases in high. In the handful of regulated markets unregulated ECF markets that makes up covered by survey responses, the total number most of the global total, and enforcement in of historical enforcement cases reported is regulated markets was relatively rare, at 7% equal to around 8% of the total number of of the total ECF population. The very high ICOs since 2017. By contrast the equivalent incidence of ECF enforcement in unregulated ratios for P2P/marketplace lending and equity markets may in part be explained by the crowdfunding are approximately 10% and 7% fact that equity crowdfunding involves the respectively. In unregulated markets, the total marketing of securities; it is easy for at least number of ICO enforcement cases comes up some part of the ECF value chain to stray to 20% of the historical number of ICOs, but, into more traditional regulated activities, as an appropriate comparison, the equivalent and regulators have many more avenues for ratio for P2P lenders in unregulated markets is addressing misconduct than they might for around 15%.51 other sectors. 48 Even where a sector is unregulated, the authorities may still take action if a firm’s activity is considered to be fraudulent, or strays into the perimeter of another regulated activity (e.g. deposit-taking). Hence enforcement action is common in jurisdictions that do not formally regulate a sector. 49 Rauchs et al 2018, op cit. 50 Note that regulators representing the largest ICO markets typically did not provide supervisor numbers, so this ratio is very likely an underestimate. 51 These ratios must not be interpreted as percentages of current operators who have been subject to enforcement action. The total population of active firms is used in order to standardize enforcement figures only. If firms subject to enforcement action are more likely to exit the market, then the ratios quoted here should be overestimates of the share of operators who have ever been subject to enforcement action, and even higher overestimates of the share of existing firms who have been subject to enforcement. These distortions will be higher for P2P lending and equity crowdfunding, as the denominator of the ratio is net of all failed firms, whereas that for ICOs it is gross of failed issuers. 62 Regulating Alternative Finance – Results from a Global Regulator Survey 5.3 The impediments to effective supervision and regulation of alternative finance Regulators responding to the survey were Foremost among these is limited technical given a list of specific impediments to the expertise; over three quarters of regulators effective supervision and regulation of with responsibility for at least one alternative alternative finance activities, as set out in finance activity see this as an obstacle. As one Figure 5.5 below, and asked to select the regulator says: ones affecting their own work. “We realize the fact that technology is changing financial markets and there is urgent need for us as a financial market regulator to acquire tools and capabilities to match the trend of technological innovations.” Figure 5.5: Impediments to regulation or supervision specific to alternative finance, as compared to “traditional” financial services activities IMPEDIMENTS TO EFFECTIVE SUPERVISION Limited technical expertise within the regulator(s) 65% Need to co-ordinate the activities of multiple regulators 38% Limited funding / resources for the regulator(s) 48% Small size of firms/industry; can’t justify intense supervision 29% Regulators’ jurisdiction over this activity is unclear or limited 41% Not applicable – we are not actively supervising 25% Lack of usable / reliable data on firm activities 34% Other, please specify 7% Limited funding and resources were also ecosystems and are consequently dealing frequently cited as constraints and, notably, with more sophisticated alternative finance were more likely to be cited by regulators in models. Furthermore, these regulators are higher-income jurisdictions. One regulator more likely to be responsible for regionally or stated: globally significant financial institutions and “We have been facing limited human markets, which may render it more difficult to resource and capacity building issues prioritize the supervision of alternative finance activities. for a while. The pool of resources is very thin in this jurisdiction”. Comparing those regulators with remit over alternative finance with their peers that Regulators in high income jurisdictions are do not have direct responsibility for these also more likely to worry about the adequacy sectors also points to practical obstacles to of technical expertise (79%), or question effective regulation. For example, those with whether they have the resources to regulate a remit are more than twice as likely to point or supervise appropriately (66%). This could to coordination with fellow regulators as a be explained by the fact that these regulators challenge. preside over large and varied financial 63 5. The supervision of alternative finance Fig 5.6: Selected obstacles to alternative finance supervision, by jurisdiction’s income level, region and regulators’ remit. 100% 90% 79%  76% 80%  66% 68% 70%  64% 64% 63%  61%   60%   56% 55%  60%   50% 52% 50% 47%    50% 41%  41% 42% 38%    40% 34%  36%   26% 28% 30%  25%   20% 10% 0% High Medium No remit Has remit Europe and Latin America Sub-Saharan Other or Low Central Asia and the Africa Caribbean JURISDICTION INCOME REMIT OVER ALTERNATIVE SELECTED REGIONS GROUP FINANCE Limited technical expertise     Limited funding / resources     Inter-institutional coordination 64 1. Introduction and research motivation 6.  Regulatory Innovation 65 6. Regulatory Innovation 6. Regulatory Innovation Chapter 5 discussed in some detail the instead responded to the challenge constraints that regulators must operate of balancing the benefits and risks of under, and how these make supervision of technology-enabled financial innovation by alternative finance activities more challenging. innovating themselves. These regulatory Only a small part of this challenge can be innovation initiatives include innovation overcome by increasing regulators’ budget offices, regulatory sandboxes, and RegTech/ and headcount. SupTech programs, which make use of advanced technologies to improve financial Many regulators around the world have supervision.52 6.1 Regulatory innovation initiatives - their activity Regulatory innovation initiatives are still to be operational in the next 12 months or relatively rare. Among the sample of 111 were actively considering initiatives. Figure jurisdictions, 73 did not have any operational 6.1 below illustrates the prevalence of these regulatory innovation initiatives. However, a regulatory innovation initiatives among significant number expected such initiatives respondents. Figure 6.1: Prevalence of regulatory innovation initiatives among respondents INNOVATION OFFICE REGULATORY SANDBOX REGTECH/SUPTECH Yes - Currently Operational 26% 22% 14% Yes - Forthcoming (within the next 12 months) 3% 9% 2% Currently Under Consideration 13% 14% 27% Not in Place 48% 46% 42% Not applicable 11% 9% 14% An innovation office is a dedicated function survey sample). It is possible that there is a within a regulator which engages with perception that they are resource intensive, - and provides regulatory clarification to- and that this accounts for the lower incidence innovative financial services providers. This among medium and low-income jurisdictions, can help to reduce regulatory uncertainty however this is not necessarily the case when through providing a channel for innovators compared to other regulatory innovation to engage with regulators to better initiatives (see Box 6). Innovation offices understand regulatory frameworks and their also appear to be more common where requirements. Innovation offices might also be regulators have a specific remit for at least used by regulators to inform policymaking. one alternative finance activity, suggesting a deliberate skew towards assisting challengers Innovation offices are the most common and new market entrants. regulatory innovation initiatives, with just over a quarter of respondents highlighting that Regulatory sandboxes are formal regulatory such were in place. High-income jurisdictions programs that allow market participants to are the most likely to report having an test new financial services or models with innovation office (more than 40% of the live customers, subject to certain safeguards 52 See UNSGSA FinTech Working Group and CCAF. (2019). Early Lessons on Regulatory Innovations to Enable Inclusive FinTech: Innovation Offices, Regulatory Sandboxes, and RegTech. Office of the UNSGSA and CCAF: New York, NY and Cambridge, UK. Available at: https://www.jbs.cam.ac.uk/faculty-research/centres/alternative-finance/publications/early-lessons-on-regulatory- innovation-to-enable-inclusive-fintech/#.XPEhHYhKhPY 66 Regulating Alternative Finance – Results from a Global Regulator Survey and oversight. Regulatory sandboxes As a result, and despite capacity constraints, have become increasingly popular with regulators in lower-income jurisdictions, policymakers around the world, with just particularly in Sub-Saharan Africa, are more under a quarter of respondents highlighting likely to have a regulatory sandbox than an that they have one in place. Furthermore, innovation office. However, these sandboxes one in ten regulators are planning to launch a may be being used to develop regulatory sandbox in the next 12 months, with a further frameworks and/or understand alternative 14% currently considering whether to do the finance – a rebranding of ‘test-and-learn’ same. environments which already have a long history of successful operation in these This is likely to be driven by a degree of regions. herding; the survey findings demonstrate how regulatory benchmarking drives change and Similarly, regulators might be reluctant to convergence among jurisdictions in terms commit to a particular type of innovation until of the types of rules applied to alternative it has been tested by a peer regulator they finance. The same could be argued in relation benchmark against. The relative absence to regulatory innovation – regulators look to a of regulatory innovation programs in Latin small number of regional and global leaders America and the Caribbean might be one for good practices. example of this dynamic. Figure 6.2: Incidence of regulatory innovation by jurisdiction’s income level, resource management mode and region. 70% 59%  60% 53%  50% 45%  38% 38% 40% 35%    31% 33% 32% 32%   27% 29% 28% 28%   30%     21%  16% 16% 20% 14% 13%   12%  9%  8% 8%  10%    4%  0% High Medium Not resource Resource Europe and Latin America Sub-Saharan Other or Low rationing rationing Central Asia and the Africa Caribbean JURISDICTION INCOME RESOURCE MANAGEMENT SELECTED REGIONS GROUP MODE Innovation office operational or forthcoming Sandbox operational or forthcoming RegTech / Suptech programme operational or forthcoming As Figure 6.3 shows, innovation offices Since sandboxes are a more recent addition support a much higher number of firms to the regulatory toolkit than innovation than regulatory sandboxes. Respondents offices, this margin might become narrower had collectively supported over 2,000 firms with time. However, even the longest-running through innovation offices but less than a sandbox programs are highly selective and tenth of that (180) total through sandboxes. resource intensive compared to the typical This ratio holds even for those jurisdictions innovation office and cannot reach the that have both types of initiatives in place – the same number of firms. For example, the median regulator reported ten times as many UK Financial Conduct Authority’s “Direct Innovation office alumni as Sandbox tests. Support” function within the regulator’s 67 6. Regulatory Innovation innovation office has supported 686 firms, regulators surveyed had such a program in compared to a total of 110 regulatory sandbox operation, and a review of the key SupTech tests completed or ongoing to date.53 technologies suggests that between 8% and 18% of jurisdictions surveyed employed Figure 6.3 - Number of firms supported by each of them (see Figure 6.4). The lower innovation offices and regulatory uptake of SupTech by regulators, compared sandboxes to other types of regulatory innovation, does not appear to be driven by lower income 2,500 2,163 jurisdictions. Indeed, one European regulator  confessed that: 2,000 “Our main deficiency in the process have been the lack of capacity both in 1,500 the terms of staff available, but also the funds to develop our IT systems in 1,000 order to keep up with the markets.[…] we would require some form of support 500 in order to increase [capacity] both 180  in the sense of staff education and IT 0 infrastructure development.” Total number of firms assisted by Innovation Office Total number of firms assisted by Regulatory Sandbox Nevertheless, RegTech and SupTech programs are the most likely form of regulatory Clearly each type of initiative provides a innovation initiative to be considered by different function and benefits, but such a respondents for future development, with finding is instructive for those regulators regulators in more than a quarter of all considering how best to use their limited jurisdictions (27%) considering launching such resources to most efficiently achieve impact. a program. The securities regulator in one Proponents of the sandbox might reasonably African jurisdiction summarized their interest argue that ‘policy-testing’ orientated in a prospective RegTech / SupTech initiative sandboxes are not necessarily intended thus: to increase the number of innovative firms supported but to facilitate policy learning, “We are interested in developing design and review. RegTech solutions to enable us to monitor our regulated institutions, better 6.2 RegTech and SupTech in focus protect investors and foster financial inclusion.” SupTech is the use of innovative technologies by regulators to tackle regulatory or Such enthusiasm is reflected among supervisory challenges; it is a subset respondents who already have programs in of RegTech, which includes any use of place, of whom none expressed doubts about technology to match structured and the impact to date. This compares favorably unstructured data to information taxonomies with innovation offices and regulatory or decision rules that are meaningful to both sandboxes where 8% and 5% of respondents regulators and the firms they regulate, in with such an initiative in place cited only order to automate compliance or oversight limited impact to date. processes. What is clear is that those regulators which RegTech and SupTech programs were have established RegTech or SupTech the least common regulatory innovation programs are particularly enthusiastic about initiatives. About one in seven (14%) of the using particular technologies to help them do 53 FCA (2019): The Impact and Effectiveness of Innovate April https://www.fca.org.uk/publication/research/the-impact-and- effectiveness-of-innovate.pdf 68 Regulating Alternative Finance – Results from a Global Regulator Survey their job. Figure 6.4 shows that 60% of such with almost half exploring blockchain/ regulators are employing machine learning, Distributed Ledger Technology. Figure 6.4: Technologies employed by regulators with an operational RegTech/SupTech program TECHNOLOGY % OF JURISDICTIONS EMPLOYING (CONDITIONAL UPON % OF ALL HAVING OPERATIONAL REGTECH/SUPTECH PROGRAM) JURISDICTIONS Machine Learning (Supervised & 60% 18% Unsupervised) Blockchain/Distributed Ledger Technology 47% 14% Natural Language Processing 40% 8% Data transfer protocols (e.g. APIs) 40% 18% Direct data pull or push systems 33% 15% Machine-readable or executable regulation 33% 12% Cloud Computing 33% 12% Robotic Process Automation 20% 8% Bio-metrics (e.g. Digital ID) 13% 10% Other 13% 15% It is possible to compare these findings programs cited in particular the development with recent evidence on the prevalence of of automated and standardized data technologies in the offerings of RegTech collection systems, including web scraping vendors, as presented in CCAF’s inaugural for unstructured public data; document and Global RegTech Industry Benchmark Report.54 casework management systems; and risk- Applications of DLT are much more prevalent based supervision and surveillance systems, in the applications tested by supervisors than including some utilizing Big Data. in the overall product offering of the industry. Nearly half of those regulators which have The CCAF’s first benchmark report into the an operational RegTech/SupTech Program RegTech sector also discusses in more detail (47%) employ DLT, versus just 14% of RegTech how the 20% of RegTech firms that have an vendors in the CCAF Benchmark Report.55 offering aimed at supervisors’ use cases Regulators might additionally have a more differ from their peers that do not target the pronounced preference for on-premises SupTech market.57 SupTech solutions were deployment of RegTech / SupTech solutions, more likely than RegTech products aimed at as opposed to utilizing Cloud Computing, the private sector to employ deep learning, than the broader population of RegTech users graph analysis, NLP and data transfer do. One third of those regulators which have protocols. From a functional perspective, an operational RegTech/SupTech Program SupTech offerings were more likely to (33%) claimed to employ Cloud Computing, incorporate management information tools, in contrast to two thirds (66%) of RegTech automated control audits and documentation, vendors.56 Otherwise, the broad technology and to be aimed at building an end-to-end, mix in SupTech solutions seems to be fully automated compliance process. Finally, comparable to that for the broader RegTech from a thematic perspective, SupTech use industry. cases were particularly likely to be focused on regulatory reporting, governance and Those regulators who opted to provide more accountability. details in relation to their RegTech or SupTech 54 Schizas et al (2019) The Global RegTech Industry Benchmark Report, September https://www.jbs.cam. ac.uk/fileadmin/user_upload/research/centres/alternative-finance/downloads/2019-ccaf-global-regtech- benchmarking-report.pdf 55 Ibid. 56 ibid. 57 Ibid. 69 6. Regulatory Innovation 6.3 Regulatory innovation initiatives - their perceived impact Among those regulators who have developed type and magnitude of the impact perceived regulatory innovation initiatives, most have varies widely between the different initiatives, seen at least some benefits. However, the as illustrated by Figure 6.5 below. Figure 6.5: Perceived impact of regulatory innovation initiatives REGULATORY INNOVATION STATUS HAS HAS HAS HAS NO OPERATIONAL OPERATIONAL OPERATIONAL OPERATIONAL INNOVATION SANDBOX REGTECH/ REGULATORY OFFICE SUPTECH INNOVATION INITIATIVE INITIATIVES Improved our understanding of key technologies. 92% 76% 93% 0% Built stronger relationships / a stronger network with this sector. 77% 62% 71% 0% Issued industry guidance to clarify our expectations 77% 57% 64% 0% Improved regulatory requirements or framework 54% 57% 57% 0% Developed an improved risk diagnostic framework 27% 24% 29% 0% Too Early to tell 23% 38% 21% 0% Improved reporting framework 19% 24% 21% 0% Limited impact to date 8% 5% 0% 0% Other, please specify 4% 5% 7% 0% None 0% 0% 0% 0% The strongest impact across all three “Stringent regulatory and compliance initiatives is that they have strongly supported requirements have previously been regulators improving their understanding of more of an obstacle than a facilitator key technologies. However, this effect is felt for potential innovators […]. Many more strongly among regulators who operate institutions are now rethinking their innovation offices and RegTech/SupTech business models due to regulatory initiatives compared to those regulators who operate regulatory sandboxes. This is an pressures and this has also affected interesting finding given that many regulators’ their technology infrastructures. Faced professed desire for a regulatory sandbox is with tighter budgets, firms are now to help them understand the technologies more willing to turn to innovative which financial innovators are seeking to technology to improve efficiency employ. and reduce costs. The [regulatory] sandbox would offer a home to these The next most strongly felt impact is that of new innovations that will translate to building stronger relationships or a network ameliorated business.” with the sector. This was most keenly felt by those regulators with innovation offices, Among those regulators with sandboxes, it narrowly followed by those with a RegTech/ is notable that 38% feel that it is too early to SupTech initiative and a regulatory sandbox. assess the impact of their sandbox initiatives, The benefits of clarifying the regulator’s while another 5% report limited impact to expectations of industry are also most date. This is not a surprising result, with keenly felt by those with an innovation office. regulatory sandboxes requiring considerable Improved relationships and communications periods of design and implementation, with industry may not seem like very tangible combined with their relatively recent benefits, but as one African regulator emergence. explained, they are instrumental to driving change within firms, including incumbents: 70 Regulating Alternative Finance – Results from a Global Regulator Survey Box 6: Innovation offices and regulatory sandboxes in perspective This study has highlighted that policymakers in many jurisdictions are seeking to change their regulatory framework for alternative finance. As noted above, fully half of respondents were planning to do so in the next two years for equity crowdfunding alone, and this is just one area of alternative finance. The next step is then deciding what to do and how to do it. Limited technical expertise within a regulator was cited as the largest challenge or obstacle to regulatory innovation, with over 75% of regulators with a remit for FinTech citing this. Limited funding or resources is also a significant issue, with 50% of respondents citing this as a challenge or obstacle. Many regulators therefore face a conundrum. They understand that there is a need to take action, but have limited technical expertise and resources to do so – and cannot risk building a regulatory framework that they can’t subsequently adequately supervise. With this in mind, regulators have been turning to each other for input, guidance and inspiration. Figure 3.9 illustrates that the primary trigger of regulatory change is reviewing another jurisdiction’s approach to regulating alternative finance activities. The analysis of other jurisdictions is also the most common element of the regulatory change process. Regulators who undertook this process analyzed the regulatory frameworks of other jurisdictions in fully 90% of cases across all three types of alternative finance. It is therefore perhaps unsurprising that regulatory sandboxes have begun to proliferate around the world. Sandboxes have captured the imagination of regulators and have to some extent become the ‘default’ regulatory response to FinTech. There are now at least 50 regulatory sandboxes in operation or under development around the world.58 It is also notable that the most benchmarked jurisdictions within a region (as per Figure 3.11) all either have a regulatory sandbox or are planning to implement one. However, the results of this survey provide evidence for caution against this trend. Regulatory sandboxes are more likely to live up to their potential when they fit well with both their hosts' innovation support objectives and the resources available to them. For example, while 76% of jurisdictions with a regulatory sandbox highlighted that it had improved their understanding of key technologies, this was higher still for jurisdictions with an operational innovation office (92%) or RegTech/ SupTech initiative (93%). Innovation offices also appear to be more conducive to building stronger relationships or networks with the FinTech sector, with 77% of jurisdictions with an operational innovation office citing this, compared to 62% for those with a regulatory sandbox. 58 UNSGSA FinTech Working Group and CCAF. (2019). Early Lessons on Regulatory Innovations to Enable Inclusive FinTech: Innovation Offices, Regulatory Sandboxes, and RegTech. Office of the UNSGSA and CCAF: New York, NY and Cambridge, UK. https://www.jbs.cam.ac.uk/faculty-research/centres/alternative-finance/ publications/early-lessons-on-regulatory-innovation-to-enable-inclusive-fintech/#.XXDs3ChKj-g 71 6. Regulatory Innovation It is also clear that innovation offices high costs of operating a regulatory have assisted many more firms on sandbox. The largest regulatory average than regulatory sandboxes, sandboxes have been known to require even allowing for the latter being more as many as 25 full-time employees, recent additions to the regulators’ and the operational costs of running toolkit. Innovation offices have a regulatory sandbox can be over one supported over 10 times as many firms million US dollars. as regulatory sandboxes, as illustrated in Figure 6.3. Some of this gap is to be The financial, and opportunity, costs expected. Many sandboxes are very of regulatory sandboxes are real. new; other, ‘policy-testing’ orientated, If regulators wish to put in place sandboxes are not intended to regulatory innovation initiatives increase the number of innovative firms to improve their understanding supported but to of technologies, build stronger relationships with the alternative facilitate policy learning, design finance sector, and/or improve their and review. It is still, however, regulatory framework, they may wish to worth considering how efficient a consider a wider range of options. This proposed sandbox is given the host's is particularly important for regulators circumstances and objectives. in emerging markets and developing markets, where resources (financial, Recent research from the World Bank human and attention) are scarce. and CGAP59 highlights the potentially 59 CGAP Blog (2019): “Running a Sandbox May Cost Over $1M, Survey Shows”. https://www.cgap.org/blog/ running-sandbox-may-cost-over-1m-survey-shows 72 1. Introduction and research motivation he future of the 7. T regulation of alternative finance 73 7. The future of the regulation of alternative finance 7. The future of the regulation of alternative finance Chapter 3 highlighted that policymakers Examining each activity in further detail, 90% in a significant number of jurisdictions are of all markets where P2P is unregulated are planning to change their regulatory approach open to the possibility of regulatory change to alternative finance in the next two years. over the next two years, and 36% are clear that regulation will change during that period. As seen in Figure 3.7, half of regulators report More than half (52%) of those markets where plans to change their regulatory approach P2P is regulated are open to change and 35% for equity crowdfunding alone, with a further expect change to occur. quarter unsure. Taken together, at least 60% However, those jurisdictions which prohibit of respondents are definitely or possibly ECF are mostly planning (67% of respondents) planning for changes to their regulatory to change their approach, or are at least framework in any one area of alternative open to the possibility of doing so (83% finance in the next two years. Overall, the of respondents, including those who were direction of travel across activities is most unsure). These findings are also similar among commonly from unregulated-but-not- jurisdictions which do not regulate ECF, prohibited activities to formally regulated where 64% of respondents are planning to ones, and particularly towards bespoke change their approach. For ICOs, the markets regulatory frameworks. As a result, the which are most likely to see a change in the share of jurisdictions that actively regulate regulatory framework are those where the alternative finance is set to grow. This can be activity is regulated under existing securities seen in Figure 7.1 below. regulations. Figure 7.1: Regulation of alternative finance One might expect policymakers with the - current and future state most longstanding regulatory frameworks to be the most keen to make changes. 80% However, the relationship between the age of regulatory frameworks and the likelihood 70% of further revision60 is rarely significant. The 60% only case where it is significant - in the case Share of jurisdictions 29% of regulatory frameworks for P2P lending – a 50% negative correlation is found. 40% 21% The survey findings point to a rapid rate of 30% 15% regulatory change, and it is unsurprising 20% 39% that regulators are seeking support in order to manage this efficiently and impactfully. 10% 22% 22% Over three quarters (76%) of the regulators 0% surveyed were interested in receiving further P2P ECF ICO support in developing their approach to % of jurisdictions regulating as of early 2019 regulatory innovation. However, only about % of jurisdictions likely to introduce regulation in 2019 or 2020 one third (32%) of respondents stated that they had receive support in this domain. 60 To test this, a simple probability variable was created for the purposes of this analysis. Any respondent who claimed they were planning to change the regulatory framework was assigned a value of 1. Any respondent claiming to be unsure was assigned a value of 0.5, and any respondent claiming they did not plan changes was assigned a value of 0. The correlation between change probability and age was then tested for statistical significance. 74 Regulating Alternative Finance – Results from a Global Regulator Survey Figure 7.2 below sets out the levels of support support. Note that respondents were able to regulators have received from various types state that they were seeking support, even if of institutions, together with the demand for they had received support in the past Figure 7.2. Regulators’ demand for and use of support on regulatory innovation 70% 65%  61% 58%  60%  50% 45%  40% 30% 23%  17% 20%  13%  6% 10%  0% Multilateral Institutions (e.g. Donors, Associations Associations World Bank Group, IMF, foundations etc of financial of financial regional development banks) regulators regulators Received support     Seeking support Multilateral institutions such as the World There is also a strong appetite for co- Bank Group are providing significant learning from other regulators, with 58% of support to regulators on alternative finance respondents expressing a desire for support activities, with approximately one in four from associations of financial regulators. respondents indicating they have received This is perhaps unsurprising given the earlier technical assistance . As might be expected, finding that regulators are strongly influenced multilateral institutions tend to focus on by benchmarking against other jurisdictions medium and low income jurisdictions. when developing their approach to the Jurisdictions in the upper middle income regulation of alternative finance activities. bracket were proportionately over-weighted amongst respondents. Patterns in the supply and demand for Examining the demand-side, 65% of external support on regulatory innovation respondents wish to receive support, or The type of support received differs by further support, from multilateral institutions. income level and by region. This is illustrated This is closely followed by a desire for further in Figure 7.3 below. Regulators in high- support from academic research institutions income jurisdictions were almost twice as and think tanks. As one respondent shared: likely to have received support from academic research institutions and think tanks than “In order to make supervisory and those in medium and low-income jurisdictions financial regulation authorities (23% and 12% respectively). This difference is increase their expertise in the use of largely accounted for by the relatively limited crowdfunding, regional and international engagement between academic research organizations must provide training institutions and think tanks with regulators programs to help address technical and in Latin America and the Caribbean, and legal facets of it.” Sub-Saharan Africa – just 4% of surveyed regulators in each of these regions have received support from this source. 75 7. The future of the regulation of alternative finance Figure 7.3: Support received, by source, income level, resource management mode, and region 16% JURISDICTIONS INCOME 6% High Income 26% 23% GROUP 34% 8% Medium or Low Income 19% 12% 25% MANAGEMENT MODE 8% Not resource rationing 21% RESOURCE 19% 31% 7% Resource rationing 21% 12% 29% 6% Europe and Central Asia 24% 24% 35% 0% SELECTED REGIONS Latin America and the Caribbean 22% 4% 21% 8% Sub-Saharan Africa 8% 4% 27% 15% Other 31% 31% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Multilateral Institutions (e.g. World Bank Group, IMF, regional development banks) Donors, foundations and bilateral funders Associations of financial regulators Academic research institutions, think tanks Regulators in high income jurisdictions were Regulators in lower-income jurisdictions also much more likely to be receiving support (34% of respondents) were more likely to from their fellow regulators, with 26% of high have received support from multilateral income jurisdictions receiving this versus institutions, such as the World Bank, than just 19% in the case of medium and low regulators in high-income jurisdictions (16% of income jurisdictions. Associations of financial respondents). However, demand for support regulators are currently the most common from such institutions did not vary significantly source of support for regulators in high between the two groups, with 80% of income jurisdictions. This may be explained regulators in low-income jurisdictions and by the role of organizations such as IOSCO 81% of regulators in high-income jurisdictions and the Financial Stability Board. Regulators seeking support. in Sub-Saharan Africa reported the lowest incidence of support from associations of financial regulators, at 8% of respondents. 76 Regulating Alternative Finance – Results from a Global Regulator Survey Regulators in Latin America and the Surprisingly, donor groups were similarly Caribbean were most likely to report having active in lower and higher-income jurisdictions received support from multilateral institutions, (8% and 6% respectively), despite a much with 35% highlighting this. This compares to higher percentage of regulators in lower- 21% of regulators in Sub-Saharan Africa and income jurisdictions seeking further support 29% in Europe and Central Asia. from this source (64% and 39% respectively). Figure 7.4: Demand for support on regulatory innovation, by source, income level, resource management mode, and region 81% JURISDICTIONS INCOME 39% High 65% 77% GROUP 80% 64% Medium or Low 75% 75% 75% MANAGEMENT MODE 44% Not resource rationing 65% RESOURCE 67% 86% 69% Resource rationing 79% 86% 59% 29% Europe and Central Asia 47% 53% 87% 83% SELECTED REGIONS Latin America and the Caribbean 70% 83% 88% 71% Sub-Saharan Africa 88% 79% 81% 35% Other 73% 81% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Multilateral Institutions (e.g. World Bank Group, IMF, regional development banks) Donors, foundations and bilateral funders Associations of financial regulators Academic research institutions, think tanks An alternative to the analysis presented in this perspective, the sharpest dividing line Figure 7.3 is to compare support received between those regulators which have received across all potential sources – that is, focusing external support in their regulatory response on whether a regulator has received any to alternative finance activities is between support at all regardless of source. From regulators who are actively rationing their 77 supervisory resources61 and those that are not: 44% of resource-rationing regulators have received support from at least one, compared to only 27% of regulations that are not resource- rationing. Demand for support on regulatory innovation is unequivocally high among regulators, with typically little differential by income group. This is illustrated in Figure 7.4 below. Support is generally most demanded from multilateral institutions, followed closely by academic research institutions and think tanks, and associations of financial regulators. Demand for support is, on average across the four sources, highest among regulators in Sub- Saharan Africa, Latin America and the Caribbean: the average percentage indicating demand among the different sources is 81% in both broad regions. Resource rationing regulators are, as might be expected, more likely to be seeking support than those who are not. However strong demand for support is still reported among those who did not self-report resource constraints. Towards a supportive future It is clear from this study that regulators around the world believe that alternative finance is a force for good and understand the benefits which it can bring about for access to finance, financial inclusion, competition in financial services, job creation and economic growth. There is also a desire among regulators to make the necessary changes to bring this about, and plans are being made to do so. However, it is also clear that there is a large and unmet demand for support among regulators to help bring about this change. This is in part due to limited technical expertise and resource constraints, though regulators across the spectrum report demand for support. Comparison and benchmarking among regulatory peers, in part through associations of financial regulators, provides a source of inspiration for many regulators, without diminishing the demand for support from a variety of other external sources. A significant and coordinated effort is therefore required among external stakeholders to spur and support the development of enabling regulatory frameworks for alternative finance and, in turn, bring about the advantages conferred by the sector. 61 As previously stated, resource rationing need not result from a regulator having limited resources in absolute terms; the term is used to refer to regulators who indicated that it is harder to supervise alternative finance than more traditional industries because of limited resources. 1. Introduction and research motivation  Annexes 79 Annexes Annexes Annex 1: List of survey respondents by jurisdiction* JURISDICTION NAME OF REGULATOR Abu Dhabi, United Arab Emirates Abu Dhabi Global Market - Financial Services Regulatory Authority Albania Albanian Financial Supervisory Authority Angola Comissão do Mercado de Capitais Argentina Comisión Nacional de Valores Astana International Financial Centre, Kazakhstan Astana Financial Services Authority (AFSA) Australia Australian Securities and Investments Commission Austria Financial Markets Authority Bahrain Central Bank of Bahrain Belgium Financial Services and Markets Authority Bhutan Royal Monetary Authority of Bhutan Bolivia Autoridad de Supervisión del Sistema Financiero Brazil Comissão de Valores Mobiliários - CVM (Securities Commission) Brunei Darussalam Autoriti Monetari Brunei Darussalam Bulgaria Financial Supervision Commission Burundi Banque de la Republique du Burundi Cabo Verde General Audit of Securities Market (AGMVM) Economic and Monetary Community of Central Africa (CEMAC) Central African Financial Market Supervisory Commission (COSUMAF) Chile Comisión para el Mercado Financiero China China Securities Regulatory Commission Colombia Financial Regulation Unit - Ministry of Finance Comoros Central Bank of Comoros Costa Rica Superintendencia General de Valores (SUGEVAL) Czech Republic The Czech National Bank Democratic Republic of Congo Banque Centrale du Congo Djibouti Banque Centrale de Djibouti Dominican Republic Superintendencia del Mercado de Valores de la República Dominicana Estonia Finantsinspektsioon Fiji Reserve Bank of Fiji Finland Finnish Financial Supervisory Authority (Fin-FSA) France Autorité des Marchés Financiers (AMF) Greece Hellenic Capital Market Commission Guinea Banque Centrale de la République de Guinée Guyana Bank of Guyana Honduras Comisión Nacional de Bancos y Seguros India Securities and Exchange Board of India Ireland Central Bank of Ireland Isle of Man Isle of Man Financial Services Authority Italy CONSOB Jersey Jersey Financial Service Commission 80 Regulating Alternative Finance – Results from a Global Regulator Survey JURISDICTION NAME OF REGULATOR Kazakhstan National Bank of Kazakhstan Kenya Capital Markets Authority Kosovo Central Bank of the Republic of Kosovo Kuwait Capital Markets Authority Latvia The Financial and Capital Market Commission Lebanon Capital Markets Authority Liberia Central Bank of Liberia Libya Central Bank of Libya Lithuania Bank of Lithuania Madagascar Commission de Supervision Bancaire et Financière Malaysia SC Malaysia Maldives Capital Market Development Authority Malta Malta Financial Services Authority Marshall Islands Banking Commissioner Mauritania The Central Bank of Mauritania Mauritius Financial Services Commission Mexico Comisión Nacional Bancaria y de Valores Morocco Autorité Marocaine du marché des capitaux Mozambique Banco de Moçambique Nauru Republic of Nauru Nepal Securities Board of Nepal (SEBON) New Zealand Financial Markets Authority Nicaragua Superintendencia de Bancos y de Otras Instituciones Financieras Nigeria Securities & Exchange Commission Norway Finanstilsynet (Norwegian Financial Supervisory Authority) Organization of Eastern Caribbean States Eastern Caribbean Securities Regulatory Commission Palestine Palestine Capital Market Authority (PCMA) Panama Superintendency of Securities Market Papua New Guinea Bank of Papua New Guinea Paraguay Comisión Nacional de Valores Peru Superintendence of Securities Market Portugal Portuguese Securities Market Commission (CMVM) Qatar Qatar Financial Market Authority Qatar Financial Centre Qatar Financial Centre Regulatory Authority Quebec, Canada Autorité des marchés financiers Republic of Serbia Securities Commission Romania Financial Supervisory Authority Russia The Bank of Russia Rwanda Capital Market Authority Samoa Central Bank of Samoa Saudi Arabia Capital Market Authority South Africa Financial Sector Conduct Authority South Korea Financial Services Commission Spain Comisión Nacional del Mercado de Valores Sudan Central Bank of Sudan Suriname Centrale Bank van Suriname Taiwan, China Financial Supervisory Commission Tajikistan National Bank of Tajikistan Tanzania Capital Markets and Securities Authority Thailand The Securities and Exchange Commission The Bahamas Securities Commission of The Bahamas 81 Annexes JURISDICTION NAME OF REGULATOR Trinidad and Tobago Trinidad and Tobago Securities Exchange Commission Tunisia Conseil du Marche Financier Turkey The Capital Markets Board of Turkey Uganda Capital Markets Authority Uruguay Central Bank of Uruguay United Kingdom Financial Conduct Authority United States Commoditiy Futures Trading Commission Vanuatu Reserve Bank of Vanuatu Zimbabwe Securities and Exchange Commission of Zimbabwe Jurisdictions are listed alphabetically and named according to the relevant World Bank guidelines and common * practices. Annex 2: Unweighted base sizes For the purposes of transparency, this Annex contains reference tables of the number of observations underlying each of the Figures in this report. Greater caution should be taken when interpreting and generalizing findings that are based on very small base sizes. TABLE A2A: UNWEIGHTED BASE SIZES - SIMPLE TABLES AND GRAPH FIGURE NUMBER BASE 1.1 N/A 1.2 N/A 1.3 75 2.1 99 2.2 99 2.3 99 3.2 99 3.3 99 4.8a 84 4.8b 84 5.5 87 6.1 92 6.3 17 6.4 92 of which respondents with a RegTech programme 14 6.5 36 of which respondents with a Regulatory Sandbox 26 of which respondents with an Innovation Office 21 of which respondents with a RegTech Programme 14 7.2 78 82 Regulating Alternative Finance – Results from a Global Regulator Survey TABLE A.2B: UNWEIGHTED BASE SIZES - BREAKDOWNS BY ACTIVITY BASE SIZE BY ACTIVITY FIGURE NUMBER P2P ECF ICO 2.7 (sector supervisors) 29 44 18 2.7 (non-sector supervisors) 70 55 81 3.1 to 3.5 98 99 99 3.6 23 35 9 3.7 to 3.8 97 97 98 3.9 (Triggers) 30 45 22 3.9 (Elements) 42 62 37 3.10a 22 38 19 3.10b 24 40 20 4.1 to 4.6 20 34 7 4.7 (Pre-existing or exemption-based) 9 17 N/A 4.7 (Bespoke) 12 21 N/A 5.1 (with remit) 23 38 14 5.1 (no remit) 37 41 47 5.2 20 32 13 5.3 16 26 6 5.4 13 21 10 7.1 98 99 99 TABLE A.2C: UNWEIGHTED BASE SIZES - BREAKDOWNS BY RESPONDENT CHARACTERISTICS BASE SIZE BY BASE SIZE BY BASE SIZE BY JURISDICTION RESPONDENT'S RESPONDENT'S RESOURCE BASE SIZE BY RESPONDENT'S REGION INCOME GROUP JURISDICTION MANAGEMENT MODE Medium Remit Over No Remit over Europe and Latin America Sub- Figure High No Resource Resource or Low Alternative Alternative Central & the Saharan Others Number Income Rationing Rationing Income Finance Finance Asia Caribbean Africa 1.4a-c 29 35 32 45 41 36 20 17 15 25 2.4 - 2.5 33 55 41 47 49 39 20 18 18 32 2.6 29 24 53 N/A 30 23 17 7 9 20 3.11 N/A N/A N/A N/A N/A N/A 8 10 8 16 5.6 31 56 41 46 N/A N/A 22 18 19 28 6.2 33 49 N/A N/A 51 41 N/A N/A N/A N/A 7.3 24 54 N/A N/A 43 35 17 16 19 26 7.4 24 54 N/A N/A 43 35 17 16 19 26 83