Fintech, Revolution in the Making

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1 Fintech, Revolution in the Making by Angeline Cheong May May and Brian Lye Mou-Yu In its early days, fintech (a portmanteau of financial technology) was associated with technological know-how applicable to back-end services provided by financial institutions. However, at the turn of the last decade, fintech enjoyed a meteoric rise to fame and is slowly reshaping the financial services sector in Malaysia. The relevancy of fintech is no longer confined to back-end services as demand for it, in respect of front-end services, is too great to ignore. Fintech refers to any technological innovations in the financial services sector, including innovations in respect of financial literacy and education, retail banking, investment and even crypto-currencies like bitcoin. Fintech grants business access to untrodden markets through alternative forms of financing via technology such as equity crowdfunding ( ECF ) and peer to-peer ( P2P ) funding. The emergence of these alternative forms of financing challenges the way conventional financial services and products are offered. With the rise of a new generation of investors, Securities Commission Malaysia ( SC ) saw tremendous potential in fintech and, as a result, announced an initiative, the Alliance of FinTech Community or known as affinity@ SC, 1 last year. According to the SC, affinity@sc strives to provide sound policy and regulatory guidelines to catalyse growth in the financial services sector. Following amendments to the Capital Markets and Services Act 2008 ( CMSA ) in September 2015, Malaysia not only became the first country in Southeast Asia to introduce a regulatory framework for ECF, but also witnessed the emergence of six licensed ECF operators: Alix Global, Ata Plus, Crowdo, Eureeca, pitchin and Propellar Crowd+. The Guidelines on Recognized Markets ( Guidelines ) issued pursuant to s 34 of the CMSA were drawn up to regulate ECF and P2P in Malaysia. The Guidelines were revised last month and came into effect on 2 May Salient features of the Guidelines Sections 7(1) and 34(1) of the CMSA require those who are desirous of establishing, operating or maintaining a derivatives market that is an electronic facility in Malaysia, to register the electronic facility as a registered electronic facility with the SC. The Guidelines also require that the person operating, providing or maintaining a stock market or a derivatives market in Malaysia; or if the stock market or derivatives market is located outside Malaysia and actively targets Malaysian investors, to be registered as a recognised market operator ( RMO ). The application for registration as a RMO must be made by the operator of the stock market or derivative market, and must be a body corporate or a limited liability partnership. It is worth nothing that the registered RMO may not automatically cease its operations without prior engagement with the SC, but the SC may withdraw the registration of the RMO should it fail to fulfil the requirements under the Guidelines. 1 SC Launches afinity@sc at World Capital Markets Symposium 2015, 3 September 2015 < 2 Available to view here: < pdf> Legal Herald. MAY

2 The salient features of the Guidelines are as follows: (i) Requirement to register The Guidelines provide that any person who wishes to establish, operate or maintain a stock market must be registered as a RMO. The potential RMO must be a body corporate or limited liability partnership. For registration purposes, the operator must, among others: (a) be able to operate an orderly, fair and transparent market; (b) ensure that its board, chief executive and any person who is primarily responsible for the operations or financial management are fit and proper; (c) be able to manage risks associated with its business and operations; and (d) ensure that it has sufficient resources for the operation of the recognised market. The RMO must not cease operations without prior engagement with the SC; however, the SC may withdraw the registration of a RMO if it does not meet the requirements and obligations under the Guidelines. (ii) Appointment of responsible person The RMO must appoint at least one responsible person who must be its chief executive or any person primarily responsible for operations and financial management. This individual will be the main contact person for the purpose of liaising with, and performing any duties as may be directed by, the SC. (iii) Reporting and disclosure requirements A RMO must submit to the SC an annual compliance report as evidence of the RMO s compliance with the conditions imposed by the SC and its latest audited financial statements, within three months after the close of each financial year or such further period that the SC may allow. A RMO is also required to immediately notify the SC of any breach or suspected breach of the Guidelines and/or related laws, material change in any information that was submitted to the SC and material change in circumstances which would adversely affect the RMO s ability to meet its obligations under the Guidelines. The revised Guidelines impose a new disclosure requirement on the RMO to ensure that it establishes and maintains policies and procedures to ensure that all documents and records of its participants be maintained for a period of not less than seven years. (iv) Islamic capital market products Where an Islamic capital market product is offered, on or through the recognised market, the RMO must appoint a Shariah adviser. This adviser must be either a person or corporation who is registered with the SC or a licensed Islamic bank, bank or investment bank approved to carry on Islamic banking business. The RMO is also required to disclose the name of the Shariah adviser appointed to advise on the offering of the Islamic capital market product and all information relating to the structure of the Islamic capital market product. 52 Legal Herald. MAY 2016

3 ECF under the Guidelines Obligations of ECF operator The obligations of the ECF operator are provided in Chapter of the Guidelines, one of which includes the requirement to carry out a due diligence on prospective issuers planning to use the platform. The scope of the due diligence exercise by the ECF operators includes taking reasonable steps to conduct background checks on the issuer, its board of directors, controlling owner and senior management. The scope of the due diligence exercise has been expanded to include senior management in the revised Guidelines. Operation of trust account An ECF operator must establish and maintain in a licensed institution, one or more trust accounts designated for the fund raised by an issuer hosted on its platform. An ECF operator is only permitted to release the fund raised after the full targeted amount has been met, it is satisfied that no material adverse changes occurred during the offer period and after the expiration of the six-day cooling off period. Following the All-Or-Nothing Model, the funds raised will be returned to investors in the event these conditions are not satisfied. In addition, should there be any material adverse changes relating to an issuer, the investors must be notified of such change. The investors will be given the option to withdraw their investment within 14 days after the said notification. The revised Guidelines inserted the definition of licensed institution as clarification that the financial institution must be a bank, Islamic bank or investment bank licensed by Bank Negara Malaysia. Managing conflict of interest Prior to the revision of the Guidelines, the ECF operator only had to disclose to the public controlling shares held within the issuer. The revised Guidelines have broadened this disclosure to include any shares held in any of the issuers hosted on its platform. Notwithstanding the above, an ECF operator s shareholding in any issuers hosted on its platform must not exceed 30%. Permitted and non-permitted issuers The Guidelines only allow for locally incorporated private companies (excluding exempt private companies) to be hosted on the ECF platform and the issuer is not allowed to be hosted concurrently on multiple ECF platforms. However, an issuer may be permitted to list on an ECF platform and P2P platform concurrently subject to disclosure requirements as may be specified by the platform operators. Limits to fund raised An issuer can raise up to RM3 million within a 12-month period, regardless of the number of crowdfunding projects that an issuer may seek funding for. However, an issuer is only permitted to utilise the ECF platform to raise a maximum of RM5 million, excluding its own capital contribution or any funding obtained through private placement exercise. Disclosure requirements Chapter details the relevant information required to be submitted by an issuer hosted on an ECF platform. The Legal Herald. MAY

4 revised Guidelines have removed the distinction between offerings below RM300,000 and offerings between RM300,000 and RM500,000 by replacing it with a single category of offerings below RM500,000. For offerings below RM500,000, an issuer is required to submit the audited financial statements of the company where applicable (for issuer which has been established for at least 12 months) and where audited financial statements are unavailable, certified statements or information by the issuer s management. As for offerings above RM500,000, audited financial statements of the company must be submitted. According to the revised Guidelines, an ECF operator must disclose and display prominently on its platform information regarding any contingency arrangement that is to be adopted by the ECF operator should it be unable to carry out its operations or cessation of business. An ECF operator may deny a prospective issuer access to its platform if it is of the view that the prospective issuer or the proposed offering is not suitable to be hosted on the platform. P2P under the Guidelines As a continuation of the SC s initiatives to nurture and facilitate market-based innovation in fintech, the SC has recently released a regulatory framework for P2P financing by inserting a new Chapter 13 in the Guidelines. It sets out the duties and responsibilities of a P2P operator and type of eligible issuers and investors of P2P. The P2P framework will enable eligible business and companies to raise funds from both retail and sophisticated investors via an online platform. It should be noted that P2P funding is not available for personal financing. All P2P operators must be a body corporate incorporated under the Malaysian Companies Act 1965 with a minimum paid-up capital of RM5 million. Parties interested in operating a P2P platform may submit their application to the SC from now till 1 July 2016 together with an application fee of RM5,000. Obligations of P2P operator Under Chapter of the Guidelines, the operator must, among others: (a) ensure there is in place an efficient and transparent risk scoring system to the investment note or Islamic investment note; (b) conduct proper due diligence on the prospective issuers intending to use its platform; (c) carry out investor education programmes; (d) inform investors of any material adverse change to the issuer's proposal; and (e) have in place processes to manage any default by issuers including using best endeavours to recover amounts outstanding to investors. Limits on funds raised Following the introduction of a P2P framework, locally registered sole proprietorships, partnerships, incorporated limited liability partnerships, private limited and unlisted public companies now all have access to an alternative source of funding. Unlike ECF, the SC does not limit the amount of funds that may be raised by an issuer via a P2P platform. However, the amount of funds that may be raised will hinge on the issuer s risk scoring rating. 54 Legal Herald. MAY 2016

5 P2P also does not limit investment opportunities to any particular class of individuals nor is there a cap on the amount of investment a sophisticated or angel investor may be permitted to make. However, retail investors are strongly advised to limit their investment exposure in P2P platforms to a maximum of RM50,000 at any given time. P2P operators who intend to impose a rate of financing of more than 18% per annum must procure prior approval from the SC. An issuer would only be allowed to keep the funds generated via the P2P platform provided that at least 80% of the target amount ( minimum target amount ) has been met. All monies obtained from investors are placed in a trust account until the minimum target amount is met and that no material adverse changes occurred during the offer period. The issuer is not permitted to keep any monies in excess of the target amount. Unlike the guidelines on ECF, the SC does not mandate any cooling-off period for investments made via P2P platforms. However, P2P operators have the discretion to provide a cooling-off period for investors on their respective platforms. Conclusion The revised Guidelines are a welcome change as their primary focus is to streamline the requirements for ECF and P2P financing, with an aim to enhance investor protection. With appropriate enabling factors involving transparent regulatory framework, effective investor platforms, adequate technological infrastructure and financial education and consequently investor confidence, fintech will undoubtedly continue to gain traction and significantly influence the way the financial services sector is currently operated LH-AG About the authors Angeline Cheong May May (cmm@lh-ag. com), is a partner in the Financial Services Practice Group at Lee Hishammuddin Allen & Gledhill. She is also a member of the Malaysian Venture Capital and Private Equity Association. Brian Lye Mou-Yu (blm@lh-ag.com), graduated from Cardiff University, UK and was called to the Bar of England and Wales in He is currently an associate in the Financial Services Practice Group. Legal Herald. MAY