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Brief Counsel

Crowd funding and peer-to-peer lending

05 August 2013

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​Lucky timing, and a policy commitment to promote innovation in capital markets, are about to put New Zealand among the early adopters in legislating for crowd funding and peer-to-peer lending as a source of fund raising.

The US did it in the Jumpstart Our Business Startups (JOBS) Act, which was passed last year but has yet to come into force.  Now our Government has seized the opportunity created by the Financial Markets Conduct Bill (FMCB) to make similar provision here.

What is crowd funding and peer-to-peer lending?

Both are internet based methods of raising money. Crowd funding is typically for small one-off projects with small donations from large numbers of people within a potential global audience of millions.  Established crowd funding platforms in New Zealand include PledgeMeBoosted and GiveALittle

Crowd funding transactions vary according to the nature of the product, but generally contributors to a non-charitable project will receive a small gift or reward.  For example, supporters of a coffee table art photography book may get a free copy, a free signed copy or a free signed copy and a signed photograph, depending upon the size of their contribution. 

Once the FMCB is in force, there will be greater flexibility to offer contributors an ownership stake in a business.

Peer-to-peer lending is reasonably conventional in that lenders expect to be repaid at an agreed interest rate. The leading international peer-to-peer sites are Prosper, Lending Club and Zopa.  

What is the current law?

Under current law, a widespread offer of “securities” through a crowd funding or peer-to-peer lending service will attract significant compliance costs, as even the provision of a small loan or equity contribution is likely to trigger mandatory disclosure and governance obligations, including the preparation of a prospectus and investment statement.

How will the FMCB deal with crowd funding and peer-to-peer lending?

From inception, the FMCB provided for a new category of “licensed intermediary”, offers through which would be exempt from the normal disclosure and governance requirements.  Initially this was intended to apply only to peer-to-peer providers but – during the FMCB’s evolution – it was decided to include crowd funding platforms.

While licensing is compulsory under the FMCB for other financial services, the regime for “licensed intermediaries” is voluntary.

Should crowd funding or peer-to-peer service providers wish to allow clients to offer equity or debt securities, they must be licensed to qualify for the exemption.  Should they not, they may be able to continue to provide their existing services to clients on a very narrow basis where only a limited number of targeted offers are made, or as a donation only, where there is no provision for contributors to participate in the business or derive a financial return.

Although the fine detail of the regulations is still being developed, recent Cabinet papers give a guide to the likely direction of the proposed exclusions. 

What will licensing require?

Because this is relatively new territory and no-one is sure how it will evolve or what the market response will be, the Government has opted for a flexible approach, subject to careful supervision by the Financial Markets Authority (FMA).

Proposed licensing requirements for the provider of a prescribed intermediary service include:

  • the platform being generally open to people meeting pre-defined criteria and the licence holder acting as a fair and neutral broker between those seeking funds and investors
  • FMA being satisfied that the key processes involved in the platform are fair, orderly and transparent
  • provision of prescribed information in a “service disclosure statement” to lenders or investors, and  written client agreements with lenders or investors
  • mechanisms for establishing the identity and creditworthiness of borrowers (in the case of peer-to-peer lending) and the good character and reputation of directors, senior managers or controlling owners (in the case of crowd funding)
  • FMA being satisfied with the way in which information about the service and the risks involved is disclosed to prospective lenders or investors, and
  • satisfactory background checks on the owners and operators of the holder of the market services licence.  

What limits are proposed on crowd funding and peer-to-peer lending?

No limits are proposed on how much an investor may invest or a lender lend in any given timeframe.  But a limit of
$2 million per 12 month period will be imposed on how much a borrower may borrow or an issuer may raise.

The same cap applies to the “small offer” (or “20/2/12”) exclusion in the FMCB - but such offers will be limited to 20 investors and may only be advertised to people meeting certain criteria. 

No such restrictions are currently planned for crowd funding and peer-to-peer lending, although Cabinet proposes that the $2 million cap for these services will include funds borrowed or raised by small offers.

How does this compare to other jurisdictions?

Australia has a 20/2/12 exclusion in place for small personal offers, but no specific exclusions for crowd funding or peer-to-peer lending.  However, the Australian Government is currently reviewing their legal framework to see how it can better accommodate crowd funding. 

New Zealand’s proposed approach may influence that review.

The US JOBS Act 2012 is more restrictive than the FMCB model in that it is subject to a number of conditions, including caps on how much people can invest.  Persons on less than $100,000 a year can invest the greater of $2000 a year or 5% of their income while investors on higher incomes can go to 10%.

The US exemption has not yet come into force as the required accompanying Securities Exchange Commission rules have not yet been finalised. 

It is worth noting that crowd funding and peer-to-peer lending has been most widely adopted in the European Union, particularly the United Kingdom, Italy and Spain.  Italy recently passed rules allowing for equity crowd funding, but this is limited to start-up companies in high innovation areas.

Our thanks to Philip Ascroft for writing this Brief Counsel. 

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