Chapter 2


Chapter 2

Background

2.1        CSF is an emerging form of funding and many reviews have been undertaken to ascertain the merit of having a legislative framework designed to facilitate this type of funding. Also a number of countries have introduced a CSF regime, which provides some guidance on the possible forms that Australia could adopt. In this chapter, the committee looks at a number of reviews and public consultation processes that have informed the CSF framework outlined in the bill.

Review of regulations governing crowd-sourced equity funding

2.2        In June 2013, the then government released a 'strategic update', which provided an overview of the initiatives, and outlined a number of new initiatives, that represented the Australian Government's progress to embrace the country's digital future. In this publication, the government indicated that it would conduct a review of regulations governing crowd-sourced equity funding with the view to determine a best practice framework for CSEF.[1] In consultation with stakeholders, the review was to consider:

  • whether Australian corporations law appropriately facilitates CSEF;
  • whether international models can provide guidance; and
  • what would constitute a best practice framework for Australia to balance investor protections and consumer confidence with investment opportunities and access to capital for start-ups, having regard to existing regulations and the Future of Financial Advice (FOFA) reforms.[2]

2.3        The proposed review was intended to provide recommendations by April 2014 for a practical CSEF regime.[3] The Corporations and Markets Advisory Committee (CAMAC)[4] was asked to undertake the review.[5]

Corporations and Markets Advisory Committee

2.4        CAMAC considered the following questions:

  • in principle, should CSEF be facilitated in Australia?
  • (if so) does the existing law facilitate CSEF?
  • (if not) what policy option to facilitate CSEF should be adopted?
  • what issues arise in implementing the recommended policy option?[6]

2.5        As a starting point, CAMAC recognised that using legislation to facilitate CSEF had the potential to promote productivity and economic growth, provide employment opportunities in Australia and return financial and other benefits to crowd investors. It also noted that:

...lack of a supportive local regulatory environment for CSEF may result in worthwhile Australian entrepreneurs incorporating in other countries, or moving their businesses offshore, to enable their ideas or projects to be funded by the crowd.[7]

2.6        According to CAMAC, CSEF provided:

...the potential to bridge the capital gap for some start-ups and other small scale enterprises, and also help them move up the 'funding escalator' as their projects, and future prospects, strengthen. To that extent, crowd investors, collectively, have the potential to play an important, sometimes decisive, role in financing an enterprise at its crucial early stage, which may promote productivity and economic growth and foster employment, while, ideally, returning financial or other benefits to the crowd.[8]

2.7        On the downside, CAMAC recognised some possible negative effects of CSEF such as diverting funding from other worthwhile economic ventures and savings towards start-ups that eventually fail. Importantly it also identified possible financial risk for crowd investors, given that in many instances investors, in effect, were 'being asked to finance innovative projects that do not have the level of maturity that traditional financial market sources require'. CAMAC noted further:

It may involve retail investors, including those with low financial literacy or capacity, making investments in companies, many of which may fail, leading to the total loss of the funds invested. Even for ongoing projects, any return on an equity investment may be well into the future or never eventuate, and there may be no practical means in the meantime to realise the investment.[9]

2.8        Respondents to CAMAC's discussion paper strongly supported the facilitation of CSEF in Australia, 'in some form at least'. They made the point, however that:

...the full extent of this potential to successfully fund and develop innovative start-ups and other enterprises will only become clearer over time as the market develops and responds to new investment opportunities.[10]

2.9        CAMAC acknowledged that, at that stage in what was an evolving concept, arguments both for and against CSEF were speculative.[11] CAMAC also found that the law, as it stood, presented considerable difficulties for proprietary or public companies wishing to use CSEF.

2.10      While recognising that there were arguments both in favour and against facilitating CSEF, CAMAC concluded that CSEF should be facilitated. Such an initiative, CAMAC stated, had the potential 'to encourage the Australian start-up entrepreneurial sector, especially in the crucial early stages of project and product development'. Further:

...enterprises that are funded through CSEF and prove to be commercially successful may provide meaningful returns to their crowd investors, as well as creating employment and other consequential economic benefits.[12]

2.11      CAMAC proposed a model whereby an eligible issuer (a public company or an 'exempt public company') may seek funds from the crowd by offering its equity through a licensed online intermediary under specified conditions which, among things, included:

  • it was offering shares in the company;
  • the offer was a primary offer;
  • the offer did not exceed the issuer cap;
  • the offer disclosure requirements were complied with; and
  • the controls on advertising were complied with.[13]

2.12      With regard to the offer, CAMAC proposed that the issue cap not exceed $2 million in any 12 month period.[14]

2.13      According to CAMAC, consideration should be given to excluding companies with substantial capital (for example, more than $10 million) from raising funds through CSEF. It reasoned that they would no longer be start-ups or small scale enterprises, and would tend to 'have the financial capacity to make regulated public offers under Chapter 6D (fundraising) if they wished to raise additional capital'.[15]

2.14      The CAMAC model recognised the central role of intermediaries in bringing together issuers and crowd investors and recommended that each equity offer to the crowd be conducted through one intermediary only, operating online only. The intermediary should be appropriately licensed and comply with the various obligations attached to that licence including:

  • conducting limited due diligence checks on issuers;
  • providing a generic risk disclosure statement to crowd investors;
  • checking compliance with investor caps in some instances;
  • providing communication facilities between issuers and investors;
  • having, and disclosing information about, dispute resolution procedures and indemnity insurance; and
  • disclosing the fees they charge.[16]

2.15      In respect of crowd investors, the CAMAC model contained proposals to protect their interests, such as:

  • investment caps for crowd investors ($2,500 per issuer, and $10,000 for all issuers, in any 12 month period);[17]
  • requirement for crowd investors to acknowledge the risk disclosure statement before investing;
  • cooling-off rights and other withdrawal rights; and
  • reporting obligations by issuers to crowd investors.[18]

2.16      These proposals were intended to protect crowd investors in various ways, while drawing to their attention to the inherent risks that remain with this form of investment.[19] For example, CAMAC did not support any sanction being imposed on an investor who breached an investor cap, explaining that:

...these caps constitute formal recognition of the financial risks for crowd investors that are inherent in CSEF, given that in many instances they, in effect, are being asked to finance innovative projects that do not have the level of maturity that traditional financial market sources require.

2.17      CAMAC reasoned that the caps could 'act as a brake on excessive investment by most crowd investors, even if the cap is inadvertently or intentionally breached by particular investors in some cases'.[20]

2.18      Importantly, CAMAC noted that if retail investors with low financial literacy and or/capacity were to suffer significant losses the 'confidence of the crowd' could be undermined, placing the overall viability of CSEF as a source of funding at risk.[21]

Consultation process

2.19      The government's Industry Innovation and Competitiveness Agenda, released in October 2014, recognised the potential for CSEF to act as an alternative to traditional bank debt funding for Australian businesses. It announced that, building on CAMAC's report, the Assistant Treasurer would consult on a regulatory framework to facilitate CSEF. This consultation process would seek to ensure that 'any regulatory framework effectively balances the aims of reducing compliance costs, including for small businesses, and maintaining an appropriate level of investor protection'.[22] The government released a discussion paper, 'Crowd-sourced Equity Funding', in December 2014, as part of the consultation process on a potential regulatory framework to facilitate the use of CSEF in Australia. The paper was open for public comment from 8 December 2014 to 6 February 2015, and was supplemented by consultations and round tables.[23] The feedback from this consultation process was to inform the government's consideration of 'a future regulatory framework for CSEF in Australia'.

Financial System Inquiry

2.20      The Murray Inquiry into Australia's financial system (FSI), released by the government in December 2014, also recognised the difficulties SMEs face obtaining access to external financing. In its view, a 'well-developed crowdfunding system' could 'aid broader innovation and competition in the financial system'. It acknowledged that the risks associated with crowdfunding investments would 'require some adjustments to consumer protections', including capping individual's investments and the disclosure of risk. The FSI recommended the government continue the process 'to graduate the fundraising regime to facilitate securities-based crowdfunding'.[24] In more detail, the FSI recommended:

...facilitating crowdfunding by adjusting fundraising and lending regulation, streamlining issuers' disclosure requirements and allowing retail investors to participate in this new market with protections such as caps on investment.[25]

Government response

2.21      In its response to the FSI, released in October 2015, the government noted that the development of a crowd sourced equity funding market in Australia was 'an urgent priority for the government to support the funding needs of early stage innovators'.[26] The government accepted the FSI's recommendation and stated its commitment to develop a regulatory framework to facilitate crowd-sourced equity funding through the 2015–16 Budget.[27] Further, the government noted that the Minister for Small Business and Assistant Treasurer would consult on draft legislation to implement this framework by the end of 2015. The government would also consult the community on crowd-sourced debt funding in parallel with legislation to implement crowd-sourced equity funding.[28]

Productivity Commission

2.22      In November 2014, before the final FSI report was published, the Treasurer asked the Productivity Commission to undertake an inquiry into barriers to business entries and exits. It was to identify options for reducing these barriers where appropriate, in order to drive efficiency and economic growth in the Australian economy. The Productivity Commission's Business Set-up, Transfer and Closure draft report, released in May 2015, also supported the introduction of a CSEF framework.[29] It recognised the existence of 'significant regulatory barriers to the development of CSEF platforms'.[30]

2.23      In its final report, the Commission recommended that all businesses, public or private, that raise equity under CSEF arrangements should be regulated as 'exempt' public companies for a limited period. They would be subject to initial lower reporting and disclosure requirements than public companies raising funds and 'should face a $5 million per year cap in the amount that could be raised from unsophisticated and non-professional investors'.[31] It found that the proposed new regulatory framework for crowd-sourced equity should balance the financing needs of business against the risk preferences of different types of investors.[32]

International developments

2.24      It should be noted that Australia is not alone in its endeavour to introduce a regime designed to facilitate CSEF. In December 2015, the International Organization of Securities Commission (IOSCO) published the results of its fact finding survey, to 'enhance IOSCO's understanding of developments in members' current or proposed investment-based crowdfunding regulatory programs and to highlight emerging trends and issues in this area'. It noted that most regulatory regimes for crowdfunding have only recently been implemented, which showed a variety of approaches to regulate crowdfunding. Based on the responses from 23 IOSCO members, the survey found:

...despite certain commonalities and divergences in various jurisdictions, and the potential risks and positive rewards, crowdfunding regimes are in their infancy (or have not yet been launched) in most jurisdictions surveyed. Accordingly, this Report does not propose a common international approach to the oversight or supervision of on-going or proposed programs.[33]

2.25      The IOSCO contended, however, that when developing or investing in crowdfunding, it was 'important for regulators and policy makers to balance the need for supporting economic growth and recovery with that of protecting investors.[34]

New Zealand

2.26      Australia's near neighbour, New Zealand, enacted the Financial Markets Conduct Act 2013 to facilitate CSEF. Following the passage of this legislation, regulatory changes were introduced to authorise financial crowdfunding. Under this regime, companies seeking to raise funds must use a licensed equity-crowdfunding provider. The Financial Markets Authority is responsible for licensing.

2.27      According to Mr James Murray, Department of Business, Christchurch Polytechnic Institute of Technology, the main change that makes financial crowdfunding viable in New Zealand is 'exempting issuers from producing prospectuses and investment statements when making a regulated offer through an equity crowdfunding platform'. He indicated that the regulations were:

...not simply a relaxation of financial regulations but reflect a trade-off between different forms of regulation. Reduced disclosure recognises that standard financial disclosures by new and high-growth companies have little value, so they have been replaced by mandatory use of licensed crowdfunding platforms and a $2m limit on the amount that can be raised.[35]

2.28      The New Zealand model places no investor cap other than, as mentioned above, limiting the amount a company can raise through crowd-funding to $2 million in a 12-month period.[36] As at March 2015, there were three active platforms of the four licensed equity-crowdfunding providers.[37] CAMAC described the New Zealand regulatory regime as 'light touch'.[38]

Proposed CSF model

2.29      In August 2015, after taking account of the findings of the various reviews and international developments, the Australian Government released an outline of its proposed framework for CSF. This model reflected:

...many of the key aspects of New Zealand's approach, such as licensing and other gatekeeper obligations for intermediaries, reduced disclosure for companies raising funds, and a liberal approach to retail investor caps along with investor protections such as risk warnings for investors.[39]

2.30      During a subsequent four-week consultation period, over 50 submissions were received. The government undertook targeted consultation on the draft legislation, making further refinements based on the feedback it received before its introduction into parliament. The government also consulted with state and territory governments which, according to the Assistant Minister, agreed to these amendments to the Corporations Act.

2.31      A number of provisions in the legislation depend on regulations to provide specific detail on requirements. On 22 December 2015, the government released exposure draft regulations that set out the required contents of the CSF offer document, investor's risk acknowledgement, the risk warning and additional detail to support intermediaries to carry out their obligations. Submissions closed on 29 January 2016.[40]

Finding the right balance

2.32      The various reviews conducted in Australia found that although there was firm support for a regime, views on the specific model varied. The CSEF regimes introduced in various countries also demonstrate the diversity of approaches taken in designing a crowd fundraising scheme. After a period of wide consultation and refinement of proposals for a CSEF model, the Australian Government introduced its proposal into Parliament in December 2015.

2.33      As the Assistant Minister to the Treasurer noted in his second reading speech, the government consulted extensively on the design of the proposed crowd-sourced equity funding framework. It took into consideration the recommendations of the CAMAC review and international experience including the framework in New Zealand.[41]

2.34      The importance of balancing the needs of business and the interests of investors was a paramount consideration when formulating the framework. The Explanatory Memorandum noted that for CSF to be sustainable:

...any regulatory framework needs to balance reducing the current barriers to CSF with ensuring that investors continue to have an adequate level of protection from financial and other risks, including fraud, and sufficient information to allow them to make informed decisions.[42]

2.35        There was general agreement that the regulatory framework should minimise reporting and compliance obligations placed on issuers and provide adequate protection to small investors: that it should strike the right balance between promoting crowdfunding and ensuring investor protection and market integrity.[43] For example, during the consultation phase, ASIC's noted that its primary interest in the regulation of this potential source of funding for small businesses and start-ups was to ensure 'an appropriate balance between the effective administration of CSEF and the need for investors to be confident and informed.[44]

2.36      Submitters to this current inquiry made similar observations. They recognised the advantages of having a legislative framework to facilitate the use of CSF regime and supported the intention of the bill to introduce such a regime. For example, the Business Council of Co-operatives and Mutuals stated:

Crowd funding has emerged as a legitimate means for small business and start-ups, especially social enterprises to access modest amounts of funding to commence an enterprise or take their enterprise to the next level. New jobs are created through small business, particularly in rural and regional areas.[45]

2.37      All submissions recognised that the challenge was to find the right balance between creating an attractive capital raising option for small companies and protecting the interests of investors.

2.38      The government was of the view that its model detailed in the bill 'strikes the right balance between supporting investment, reducing compliance costs and maintaining an appropriate level of investor protection'.[46]

2.39      There was, however, a divergence of views on the correct balance, some expressing concerns that the government's proposed model would fall short of expectations and not deliver. Some thought that the eligibility requirements for a company were too restrictive, that the barriers to entry were too high. From their perspective, the proposed regime would in effect deny deserving companies the opportunity to raise funds through CSF. Others looked at the responsibilities and obligations imposed on the intermediaries and contended that they were too onerous and costly and would discourage people from providing this service. While some submitters argued the need to minimise cost and complexity, in their view, the legislation was too complicated to be easily understood.

Conclusion

2.40      In the following chapter, the committee explores the differences of opinions on the government's proposed CSF model. The committee considers, in particular, the provisions governing:

  • eligible CSF issuers—the requirement to be a public unlisted company and the asset test;
  • eligible offers—the cap placed on the amount that can be raised—$5 million—and the three-month period during which the offer is open;
  • offer documents and their required contents—consent requirements, warnings on risk, restrictions on advertising;
  • intermediaries—the requirement to hold an AFSL and their gate keeping responsibilities;
  • investors and investor protection—the cap on amount that can be invested, cooling-off period and financial literacy; and
  • monitoring and reviewing of the legislation.

Navigation: Previous Page | Contents | Next Page