Crowdfunding Conundrums

Why Policymakers Love Crowdfunding

Policymakers globally remain understandably obsessed with simultaneously sparking economic growth and supporting use of next-gen technologies. The Data Revolution. The Second Machine Age. The Fourth Industrial Revolution. The more nicknames we have for this technological transition, the clearer it becomes that momentum is building towards remarkable break-through innovation and growth.

Policymakers tired of dealing with the detritus of financial and economic crisis are catching the wave. They are starting to explore how public policy can facilitate responsible acceleration along the technology adoption curve.

In many ways, the FinTech sector seems to provide the perfect issue for a policymaker to love.

  • It holds the promise of providing fresh, abundant, possibly cheaper capital to economies starved of credit due to post-crisis overhangs. This is especially true in Europe, where banks dominate the credit markets and where non-performing loans continue to dampen banks' ability to serve their credit creation function. The IMF's Global Financial Stability Report recently quantified the extent of the credit drought in Europe particularly.

  • It holds the promise of reaching out to "underserved" communities. This includes not only low-income individuals but also entrepreneurs and small businesses that spark innovation and economic growth.

  • It holds the promise of sparking competitive forces to pull economies into new kinds of spending and innovation, creating a positive feedback loop for the economy as a whole. A good example of this stream of thinking was on display in Brussels today as the European Commission unveiled a "Reflection Paper" on Harnessing Globalization which includes, among other things, an intention to promote policies that facilitate funding and support for innovative companies in Europe.

Plus, let's face it, the technology toys and the lure of something new are always fun.

Two Ways To Think About Crowdfunding

Too often, policy discussions regarding crowdfunding are unnecessarily bifurcated. A stream of policy activity and analysis focuses on platforms where small businesses find equity and debt funding. Another stream focuses on consumer protection since most entrepreneurs fund their initial ventures using their personal consumer finance. Let's look at this in a bit more depth.

Funding Platforms: A range of companies provide entrepreneurs with early stage and seed capital through "online lending" platforms. The phrase can be misleading because sometimes funding flows occur through debt or equity issuance. For this reason the term "marketplace lending" has also entered our lexicon.

The U.S. Treasury Department provided an excellent snapshot of the broad range of credit and capital formation flowing through these platforms in its White Paper last year. The bottom line is that increasingly these platforms provide places where institutional and other large investors provide fudning to small companies.

This is not merely a realm of $5 contributions from individuals, although those platforms obviously also exist. The focus for today's post is on this institutional end of the market where firms that can have a significant impact on the economy increasingly experience their first encounter with third-party investors. Earlier today, SEC Commission Piwowar in a speech today seemed to indicate that enough capital formation is occurring through these platforms to serve as a deterrent for smaller companies to turn to traditional IPO markets.

Consumer Protection: Individuals seeking funding from alternative finance companies in the FinTech arena often are asked to provide different kinds of information about themselves and their companies. This can raise questions concerning data privacy and other consumer protection policy issues regarding the borrowers.

Because crowdfunding platforms technically fall between the cracks of existing regulatory oversight frameworks, it remains unclear which regulatory entities have jurisdiction over the consumer protection issues. The United States famously included within its post-crisis reforms the creation of a broad Consumer Financial Protection Board (CFPB) which would have authority to protect individuals regardless of how they interact with the financial system.

The CFPB has been active in the FinTech consumer protection arena. It increased its engagement again today by publishing a report on small business lending, launching a consultation and holding a field hearing in Los Angeles focused on whether and how small businesses need regulatory protection when seeking external finance for their companies and, just as importantly, what kinds of data should be collected from the providers of finance regarding small business lending. Since the CFPB is relying on Section 1071 of the Dodd-Frank Act for this activity, this means it can ultimately create regulatory reporting requirements for a broad range of non-bank lenders, including crowdfunding platforms.

What Comes Next -- Perspective

The regulatory framework will not change overnight. It will evolve with the FinTech sector. In a perfect world, securities and consumer protection authorities will cooperate to create a coherent framework. At present, at least in the United States, it seems that both groups of policymakers are operating in parallel. This creates the risk that conflicting and counter-productive standards could emerge over time. What is true domestically is also true internationally.

The FinTech RegTrends Report will be watching the evolution of this (and other) regulatory standards carefully for hints of policy trajectory shifts, using our proprietary patented process.

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