Crowdfunding and shadow banking... and other online financing developments Sara Hanks CEO, CrowdCheck, Inc. Medellin, December 4, 2014
Definitional problems What is crowdfunding? Definition of investment crowdfunding has evolved in the US What is shadow banking? Again different definitions Are some forms of crowdfunding a type of shadow banking? Or vice versa?
Looking at it another way... The elements of traditional finance: the significance of intermediaries Bank takes deposits, lends to consumers and businesses Transforms maturities and risk Involved in both lending and borrowing Emphasis on reputation Continuing involvement with transactions Investment bank underwrites offerings Potentially left with unsold securities Reputation/gatekeeper issues are important The need for regulated intermediaries
The new financing model Non-traditional products, non-traditional participants New forms of securities and new distribution models Originate to distribute models Banks or investment banks generate loans owned by SPVs, package and tranche them, potentially retain no risk ABSs, CDOs, etc. Role in the financial crisis New lenders (hedge funds, etc.) enter market Doesn t matter whether loans/lenders or bonds/securities May invest own equity or may borrow to lend, thus acting as true shadow bank Add the ability to distribute/connect online Unregulated or not-yet-regulated intermediaries
The influence of technology Access of investors to broader range of investment opportunities Granularity in investment and recordkeeping Access of issuers seeking capital to more sources of funds Aggregation sites and deal-searching algorithms Algorithms not just for major players Customization of investment without need for traditional intermediaries
The changing role of intermediaries Don t need intermediary to find investment opportunities Not looking to intermediaries balance sheets End investors are acting as new type of intermediary Both borrower and lender for own account General disintermediation
What is crowdfunding? Sale of securities online to large number of unsophisticated investors in small amounts Frequently using some form of social validation Typically aimed at small businesses Typically with reduced regulatory burden Debt or equity securities Special considerations for debt securities in the US
Crowdfunding and overlap with other online financing US has accredited crowdfunding (to sophisticated investors); registered (regulated) crowdfunding Regulation A: intersection between crowdfunding and deals registered with SEC for retail distribution Widely distributed private placements to HNW investors Not crowdfunding unless there s a website to execute deals?
P2P Origins truly peer based Regulatory considerations in US led to complex structure Originally social aspect Still applies in some affinity sites But fair lending rules diminished social aspect Crowdsourced rate-setting failed The shift to marketplace lending
Overlap P2P and shadow banking P2P is essentially originate-to-distribute model; originators of loans retain nothing But individual assets instead of pooled assets Sites that source deals together with dealseeking algorithms permits customized creation of portfolios Same players (hedge funds, banks) as in true shadow sector; their involvement results in P2P being renamed marketplace lending
Operation of online platforms Some online platforms are purely matching service P2P platforms end up usurping crowd ratesetting role The concept of curation and broker-dealer/ investment adviser roles
Areas of regulation touched Banking: deposit-taking Banking: lending Banking: risk retention and risk assessment/ reserve requirements Regulation of entities distributing securities Regulation of investment advice Investor protection Disclosure Limitation of certain types of investors
Policy objectives of regulation of online finance Capital formation Investor protection Different classes of investors treated differently? Difference between full disclosure end merit regulation Orderly markets
US regulatory context Debt and equity securities must be registered or exempt Exemptions are dependent on ability of investors to take care of themselves Special light regulation of CF Lending licenses; states No special rules for P2P Existing rules fit uncomfortably Other shadow activities regulated by reference to regulatory status as opposed to function SIFIs
US crowdfunding rules $1 million per year limit Limits on investment amount $2,000 to $100,000 depending on income or net worth Detailed rules regarding disclosure by issuer Intermediary required: must be broker or funding portal, gatekeeper role, including education
The role of the crowd Crowd madness versus the wisdom of the crowd In truth, many types of crowd Role of social validation Originally thought to be essential to crowdfunding Diminishing role in P2P finance Limited role on platforms for accredited investors Usefulness depends on how crowd is managed
Lessons from the US for online financing Crowd role might be limited Keep it simple: types of securities Keep it simple: disclosure Especially financial, especially for true startups Intermediaries have to be able to filter, curate, set rates They introduce inexperienced issuers and inexperienced sellers Education function Liabilities
Sara Hanks sara@crowdcheck.com +1 202 345 1225