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Entry No 10

1. Introduction 1.1 To maintain Hong Kong's position as an international financial center, it is utmost important to constantly review our regulatory regime and take initiative to adapt it to new circumstances. Inevitably, the dynamic global financial sphere has posed challenges to our lawmakers: what should be the appropriate regulatory response to financial innovations? The emergence of crowdfunding is a typical example of such kind. 1.2 This essay outlines the background of the emergence of global crowdfunding market, reviews the legal position of Hong Kong on crowdfunding and makes recommendations on regulatory frameworks on certain types of crowdfunding with reference to other jurisdictions. It must be stressed that Hong Kong should legislate on crowdfunding to avoid lagging behind other countries in this area of financial innovations. 2. Background of crowdfunding Definition of crowdfunding 2.1 The World Bank defines crowdfunding as “an internet-enabled way for businesses or other organizations to raise money in the form of either donations or investments from multiple individuals.”1 Specifically, crowdfunding can be further classified into four categories:

(1) donation crowdfunding: individuals give money to a fundraiser for charitable causes through an online portal;

(2) reward crowdfunding: individuals make contributions to

a business in return for rewards (e.g., products produced from the business) through an online portal;

1 World Bank, Crowdfunding’s Potential for the Developing World, InfoDev, Finance and Private Sector Development Department, Washington, DC, 2013, p. 8.

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(3) peer-to-peer lending: lenders are being matched with borrowers for acceptance and provision of unsecured loans through an online portal;

(4) equity crowdfunding: individuals invest in a business through an online portal and in return gain equity stakes in the business.2

Category (1) and (2) are regarded as “community crowdfunding” with no financial return involved while category (3) and (4) are regarded as “financial return crowdfunding” that prospect of financial return is involved.3 It is hence emphasized that the impact of financial return crowdfunding on securities regulations is more complex and demanding than community crowdfunding.4 Emergence of crowdfunding 2.2 Crowdfunding has exploded in popularity in the United States after the 2008 financial crisis as an alternative funding means to early-stage enterprises that found great difficulties in raising finance from traditional forms of capital formation (i.e. via banking institutions and venture-capital). 5 Crowdfunding soon expanded worldwide. The growth of global crowdfunding industry has been tremendous in recent years: the total funding volume surged from US$2.7 billion in 2012 to US$16.2 billion in 2014 and was expected to grow to US$34.4 billion by the end of 2015.6 Crowdfunding in Hong Kong 2.3 Crowdfunding has been emerged in Hong Kong in recent years and successful local projects supported by crowdfunding have been publicized in media. 7 The Financial

2 E. Kirby and S. Worner, ‘Crowd-funding: An Infant Industry Growing Fast’, Staff Working Paper of IOSCO Research Department, 2014, pp. 8-10. 3 Ibid. 4 Space-tec Capital Partners, ‘Crowdfunding Innovative Ventures in Europe: The Financial Ecosystem and Regulatory Landscape’, A Study Prepared for the European Commission DG Communications Networks, Content & Technology, 2013, p. 2. 5 A.R. Stemler, ‘The JOBS Act and Crowdfunding: Harnessing the Power—and Money—of the Masses’, Business Horizons, vol 56, 2013, p. 272. 6 A. Zeoli, ‘Crowdfunding: A Look at 2015 & Beyond!’, Crowdfund Insider, 31 December 2015, http://www.crowdfundinsider.com/2015/12/79574-crowdfunding-a-look-at-2015-beyond/ (accessed 1 February 2016). 7 A. Chiu, ‘Ten Great Hong Kong Projects Made Possible by Crowdfunding’, South China Morning Post, 26 August 2015, http://www.scmp.com/lifestyle/article/1852694/ten-great-crowdfunded-projects-hong-kong-connection (accessed 1 February 2016).

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Services and the Treasury Bureau claimed that it has been monitoring the development of crowdfunding activities in Hong Kong and has decided to set up a steering group to study issues relating to crowdfunding.8 3. Legal position of crowdfunding in Hong Kong Lack of specific regulatory framework 3.1 Hong Kong does not have a statutory definition of crowdfunding. There is neither registration system for crowdfunding portals nor specific rules governing crowdfunding activities. And hence, there is no specific statutory duty imposed on crowdfunding participants, including the fund providers, fundraisers and online portal operators. In a general sense, crowdfunding activities can be legally conducted in Hong Kong providing that existing laws have not been violated. Currently, there are various popular community crowdfunding (e.g., FringeBacker and Umadx, etc.) and peer-to-peer lending (e.g., e.g., Golend and Welend, etc.) portals operating in Hong Kong. They target the financing needs of local individuals and organizations. In contrast, equity crowdfunding is still underdeveloped. Laws governing community crowdfunding 3.2 Community crowdfunding does not involve any form of financial investment return and hence it falls outside the scope of securities and money lending laws in Hong Kong. 3.3 Donation crowdfunding is subject to existing laws governing charitable fundraising activities in general. For instance, approved charitable donation9 via crowdfunding portals can qualify for a tax deduction under the Inland Revenue Ordinance (Cap 112). 10 There is no licensing requirement for conducting online donation activities, unlike fundraising in public places. Individuals or organizations (regardless of whether they are charitable as defined in case law or not11) are not required to seek prior approval

8 HKSAR Government, ‘LCQ1: Regulation of Crowdfunding’, Press Release, 18 March 2015, http://www.info.gov.hk/gia/general/201503/18/P201503180402.htm (accessed 1 February 2016) 9 Inland Revenue Ordinance (Cap 112) s 2(1). 10 Ibid. s 26(c). 11 For definition of charities, see Special Commissioners of Income Tax v Pemsel [1891] 3 Tax Cases 53

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from authority for initiating online fundraising activities, except those lottery-related.12 However, it is not true to think of donation crowdfunding as absolutely free from regulation. Indeed, a donee who knowingly initiates fraudulent donation crowdfunding activities may commit the offence of obtaining property by deception13 in contravention of the Theft Ordinance (Cap 210) and access to computer with criminal or dishonest intent14 in contravention of the Crimes Ordinance (Cap 200). 3.4 One of the primary reasons for people to give money to a fundraiser in a reward crowdfunding is of the expectation of receiving rewards (typically, end products to be supplied by the fundraiser). It appears that fund providers can enjoy consumer protection and fundraiser has to fulfill the obligation to deliver the rewards to fund providers subject to a contract of pre-sale and pre-purchase of rewards that may has been formed between them. Accordingly, failure to deliver rewards may constitute a breach of contract. In case a fundraiser initiates a reward crowdfunding project under which he or she has no reasonable grounds for believing that he or she will be able to offer to supply the rewards , but still accepts payment from fund providers, the fundraiser may have committed the offence of bait advertising 15 and wrongly accept payment16 under the Trade Descriptions Ordinance (Cap 362). Laws governing financial return crowdfunding 3.5 In comparison with community crowdfunding, financial return crowdfunding has received more attention from the authority. In May 2014, the Securities and Futures Commission (the “SFC”) issued a notice (the “SFC Notice”) reminding people engaging in financial return crowdfunding activities of the potential application of relevant securities laws and regulations.17 3.6 Peer-to-peer lending that involves business of lending of money is in principal governed by the Money Lenders

12 Gambling Ordinance (Cap 148) s 22(1)(a)(i). 13 Theft Ordinance (Cap 210) s 17. 14 Crimes Ordinance (Cap 200) s 161. 15 Trade Descriptions Ordinance (Cap 362) s 13G. 16 Ibid. s 13I. 17 Securities and Futures Commission, ‘Notice on Potential Regulations Applicable to, and Risks of, Crowd-funding Activities’, Notice issued by the Securities and Futures Commission, 7 May 2014.

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Ordinance (Cap 163) (the “MLO”). An operator of peer-to-peer lending portal may fall into the statutory definition of a money lender even though it may not provide credit to borrowers directly but solely match borrowers with lenders. Such portal operator can be regarded as a money lender if it advertises or announces himself or holds himself out in any way as carrying business of making loans.18 There are certain exempted categories to money lender provided in the MLO19 but it is difficult for an online portal that conducts peer-to-peer lending in a regular nature to rely on any of them. As a result, for an online portal to carry on ordinary peer-to-peer lending business, the portal operator has to hold an authorized money lender’s licence20 and ensures that its business practices are in compliance with the MLO. 3.7 Equity crowdfunding is subject to existing laws (particularly the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (the “C(WUMP)O”) and the Securities and Futures Ordinance (Cap 571) (the “SFO”) ). Both of them regulate and restrict certain types of investment being promoted to and sold to the public in Hong Kong. It is noted that a typical equity crowdfunding activity that pools small contributions made by a large group of retail investors (which is not exclusive to high-net-worth or professional investors) through an online portal may likely be in conflict with existing rules. 3.8 Equity crowdfunding that involves an offer of shares or debentures by an incorporated company to the Hong Kong public to purchase is governed by the C(WUMP)O. The information in an equity crowdfunding portal contributed by a company in relation to the securities offered to prospective investors for subscription can constitute an issue of prospects in view of the circumstance that online portal is to be accessed and read by the public. 21 It is unlawful to issue prospectus of a company in Hong Kong if it does not fulfill certain disclosure and registration requirements unless an exemption (e.g., offer to not more than 50 persons, offer solely to professional investors, offer for which total consideration payable not exceed HK$5 million and offer with minimum denominations of

18 Money Lenders Ordinance (Cap 163) s 2. 19 Ibid. sch 1. 20 Ibid. s 7. 21 Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) s 2.

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HK$500,000, etc.) set out in the 17th Schedule of the C(WUMP)O applies.22 3.9 Equity crowdfunding that involves an offer of securities or interest in collective investment scheme (e.g., a profit sharing arrangement being offered to investors without establishing a shareholder relationship) is governed by the SFO. It is unlawful to issue an advertisement, invitation or document that contains an invitation to the Hong Kong public to enter into certain investment agreements, including the subscription of securities and participation in a collective investment scheme unless the issue is authorized by the SFC or an exemption (e.g., offer exempted under the 17th Schedule of the C(WUMP)O, offer solely to professional investors and offer not to the public, etc.) set out in section 103 of the SFO applies. 23 In view of the wide scope of invitation to public, information available on an online portal relating to the equity crowdfunding activities likely falls into the scope of advertisement, invitation or document to the public of investment products as abovementioned. 24 3.10 As pointed out in the SFC Notice, equity crowdfunding portal may involve in carrying on certain regulated activities,

including type 1 (dealing in securities), type 4 (advising on securities), type 6 (advising on corporate finance), type 7

(providing automated trading services) and type 9 (asset management). These activities are prohibited without being licensed or registered to do so by the SFC. 25 The SFC Note also stated that crowdfunding portal operators should comply with the requirements under Part III of the SFO relating to automated trading services 26 and recognized exchange companies 27 in consideration of the nature of services they provide and type of products they offer. 4. Regulatory framework for crowdfunding in other jurisdictions Regulatory framework for community crowdfunding

22 Ibid. s 38 and s 342. 23 Securities and Futures Ordinance (Cap 571) s 103(1). 24 Ibid. s 103(10). 25 Ibid. sch 5. 26 Ibid. s 95. 27 Ibid. s 19.

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4.1 There is no illustrative example of enactment of specific regulatory regime for community crowdfunding. It appears that regulators around the globe see no urgency for the amendment of the existing charities-related and commercial laws to facilitate the growth of community crowdfunding. Regulatory framework for financial return crowdfunding 4.2 In contrast, several jurisdictions have made progress in the implementation of a tailor-made regulatory framework for financial return crowdfunding in order to facilitate the access by enterprises (especially start-ups and small and medium enterprises (“SMEs”)) to financial return crowdfunding. Here are some examples:

Canada: in May 2015, six provinces announced the implementation of equity crowdfunding exemptions through Multilateral CSA Notice 45-316 (the Start-up crowdfunding exemption orders).28

China: in July 2015, nine leading authorities jointly published the Guiding Opinions on Promoting the Healthy Development of Internet Finance introducing the general requirements on both peer-to-peer lending and equity crowdfunding.29

France: in May 2014, legal framework for both peer-to-peer lending and equity crowdfunding has been adopted through modifying the monetary and financial Code (Ordinance no. 2014-559).30

Germany: in June 2015, the Kleinanlegerschutzgesetz (German Retail Investor’s Protection Act) that governs

28 See https://www.bcsc.bc.ca/Securities_Law/Policies/Policy4/PDF/45-316__Multilateral_CSA_Notice___May_14__2015/. (accessed 1 February 2016) 29 See http://www.mof.gov.cn/zhengwuxinxi/zhengcefabu/201507/t20150720_1332370.htm (accessed 1 February 2016) 30 See http://www.amf-france.org/en_US/Acteurs-et-produits/Prestataires-financiers/Financement-participatif---crowdfunding/Cadre-reglementaire.html?langSwitch=true. (accessed 1 February 2016)

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the equity crowdfunding was approved by the Federal Council.31

Italy: in December 2012, the Commissione Nazionale per le Società e la Borsa confirmed the Decreto Crescita Bis (Italian Growth Act 2.0) that governs equity crowdfunding.32

New Zealand: in September 2013, the Financial Markets Conduct Act was that governs both peer-to-peer lending and equity crowdfunding was passed by the Parliament.33

Spain: in March 2014, the Anteproyecto de Ley (Draft Bill) XX/2014 was passed to regulate both peer-to-peer lending and equity crowdfunding.34

United Kingdom: in October 2013, the Financial Conduct Authority published Consultation Paper 13/3 outlining the proposals on regulating financial return crowdfunding.35

In March 2014, Policy Statement 14/1 was published confirming the relevant final rules.36

United States: the Jumpstart Our Business Startups Act was signed into law in 2012 to establish a regulatory structure for small companies to raise capital through equity crowdfunding. 37 In December 2015, corresponding final rules were adopted by the Securities and Exchange Commission.38

31 See https://www.bafin.de/SharedDocs/Veroeffentlichungen/DE/Meldung/2015/meldung_150710_kleinanlegerschutzgesetz.html. (accessed 1 February 2016) 32 See http://www.sviluppoeconomico.gov.it/index.php/it/component/content/article?id=2025079. (accessed 1 February 2016) 33 See http://www.legislation.govt.nz/act/public/2013/0069/latest/whole.html. (accessed 1 February 2016) 34 See http://www.mineco.gob.es/stfls/mineco/prensa/ficheros/noticias/2014/140228_sleg6607.pdf. (accessed 1 February 2016) 35 See https://www.fca.org.uk/news/cp13-13-regulatory-approach-to-crowdfunding. (accessed 1 February 2016) 36 See https://www.fca.org.uk/news/ps14-04-crowdfunding. (accessed 1 February 2016) 37 See https://www.sec.gov/spotlight/jobs-act.shtml. (accessed 1 February 2016) 38 See https://www.sec.gov/news/pressrelease/2015-249.html. (accessed 1 February 2016)

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4.3 As for jurisdictions that have not yet introduced crowdfunding-related laws, some of them have already started consultation on regulatory issues in relation to crowdfunding. For example, Australia (the consultation paper was published by the Treasury in August 2015) 39 and Singapore (the consultation paper was published by the Monetary Authority in February 2015) 40 . Apparently, regulators around the globe tend to create a regulatory environment promoting the development of crowdfunding with supportive legislation rather than suppressing the growth of crowdfunding by enactment of deterrent legislation. 5. Need for Hong Kong to legislate on crowdfunding Responding to global trend of easing restriction on crowdfunding 5.1 Crowdfunding is considered as one of the big financial innovations that may have a positive and lasting impact on society.41 It is innovative in the sense that it utilizes social media to pool small contributions from many individuals to fund business ideas that may otherwise be undercapitalized.42 It is obvious that crowdfunding is a remarkable creation in the era of fintech that carries an importance greater than ever before. Sadly, Hong Kong is the only international financial center that is lagging behind in this area when almost every other country in the region is ahead of Hong Kong in terms of producing legislation to accommodate equity crowdfunding.43 It has been commented that the current regulatory regime of Hong Kong is overly stringent, which is considered as a hindering factor to the development of crowdfunding.44 In view of the global trend of easing restriction on crowdfunding, it is implausible that Hong Kong should maintain status quo while regulators around the globe have taken a proactive attitude towards crowdfunding.

39 See http://treasury.gov.au/ConsultationsandReviews/Consultations/2015/Facilitating-crowd-sourced-equity-funding. (accessed 1 February 2016) 40 See http://www.mas.gov.sg/news-and-publications/media-releases/2015/mas-sets-out-proposals-for-securities-based-crowdfunding.aspx. (accessed 1 February 2016) 41 R.J. Shiller, ‘Capitalism and Financial Innovation’, Financial Analysts Journal, vol 69, no. 1, 2013, p. 21. 42 Z.J. Gubler, ‘Inventive Funding Deserves Creative Regulation’, Wall Street Journal, 31 January 2013. 43 KPMG, Making Hong Kong a FinTech Centre, June 2015, p.29 44 Our Hong Kong Foundation, The Ecosystem of Innovation and Technology in Hong Kong, December 2015.

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Facilitating financing needs of local start-ups and SMEs 5.2 Crowdfunding can be a viable alternative source of financing particularly for start-ups and SMEs, which may face difficulties in obtaining institutional credit facilities (e.g., due to absence of profitable record, lack of collateral assets, and conservative credit policies of banks etc.), accessing to venture capitalists (e.g., due to high intermediary fees, limited business network and rigorous policies of the venture capital or private equity firms, etc.) and listing in the stock market (e.g., due to rigorous and stringent listing, prospectus and disclosure rules, etc.). Study shows that crowdfunding is particularly relevant for its role in job creation and economic growth due to its potential to provide equity funding to young and innovative firms. 45 In Hong Kong, start-ups and SMEs constitute over 98% of business establishments and employ about 50% of workforce in the private sector.46 It is beneficial not only to start-ups and SMEs if they can legitimately utilize the crowdfunding as a new source of financing, but also to the sustainable growth of the economy of Hong Kong as a whole. Mitigating the potential risks of crowdfunding

5.3 The SFC Notice has highlighted various potential risks involved in participating in securities-related crowdfunding activities, including risk of default (investors may suffer from a total loss of investment when crowdfunding projects fail), risk of illiquidity (investors are difficult to resale the securities issued by the fundraisers due to absence of secondary market), dilution of stock value (investors may suffer from a fall in their ownership percentage due to subsequent stock issuance), risk of portal failure (investors may suffer from a total loss of investment when crowdfunding portals cease to operate), risk of fraud (investors may suffer from a total loss of investment in case of crowdfunding spam), portal operating outside Hong Kong (it is costly for investors to raise cross-border lawsuit against parties involved in extraterritoriality crowdfunding activities), information asymmetry and lack of transparency (investors are in an adverse position in acquiring full and accurate information about the crowdfunding

45 Organisation for Economic Cooperation and Development, OECD Technology and Industry Scoreboard 2013: Innovation for Growth, 2013, p.13 46 See https://www.success.tid.gov.hk/english/aboutus/sme/service_detail_6863.html. (accessed 1 February 2016)

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projects), cyber security (investors may suffer from loss of investment or personal data due to cybercrimes or damage to the computer system of the crowdfunding portals), illegal activities (crowdfunding projects may involve money laundering or illegal commerce that intend to deceive the public).

5.4 Although there are significant potential risks associated with crowdfunding, calling a halt to it is neither the best nor sole option. Doubtlessly, crowdfunding cannot be properly functioned without appropriate set of rules accompanying. In view of the regulator experiences elsewhere in the world, it is possible to establish a sound regulatory regime so as to unleash the potential benefits of crowdfunding as a new financing and investment option on the one hand and effectively mitigate the potential risks inherent in crowdfunding investment on the other hand.

6. Recommendations on regulatory regime for crowdfunding in Hong Kong

Maintaining status quo for community crowdfunding 6.1 It is proposed that there is no necessity to introduce new legislation on community crowdfunding. With reference to relevant statutes of Hong Kong, it has been explained that existing laws have covered fraudulent crimes that community crowdfunding may be involved. In consideration of the rising popularity of community crowdfunding in Hong Kong, it seems inappropriate to impose new rules to restrict or prohibit community crowdfunding without an overriding need to do so. However, relevant government bodies can provide more clear and precise guidelines to the public about the nature of operation of community crowdfunding as well as the legal rights and liabilities concerned. Introducing a specific regulatory regime for peer-to-peer lending 6.2 It is proposed that there is a need to introduce specific regulatory regime for peer-to-peer lending. The major advantage is that it can strengthen the confidence of market participants in engaging in the peer-to-peer lending industry. Although in principal peer-to-peer lending is governed by the MLO, the existing laws do not distinguish the business nature of per-to-peer lending from conventional money lender’s business. It implies that there is no

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specification of the statutory commitments of peer-to-peer lending portals. The new regulatory regime is expected to clarify the legality of conducting peer-to-peer lending business in Hong Kong and also offer a greater protection to borrowers and lenders who entered into loan agreement through the matching services provided by the peer-to-peer lending portals. 6.3 It is recommended that Hong Kong should establish its regulatory regime for peer-to-peer lending based on the relevant legislation enacted in the United Kingdom that focused on the eligibility of peer-to-peer lending portals. In the United Kingdom, peer-to-peer lending has become a kind of regulated activities under the title of “operating an electronic system in relation to lending” of which “operating an electronic system which enables the operator (“A”) to facilitate persons (“B” and “C”) becoming the lender and borrower.” 47 Referring to this statutory definition, a specific type of licence and registration for peer-to-peer lending (the “Peer-to-peer lending’s licence”) should be incorporated into the MLO: person intends to conduct conventional money lenders’ business (without the elements of peer-to-peer lending) should register for the money lender’s licence while person intends to engage in peer-to-peer lending should register for the Peer-to-peer lending’s licence. Certain restrictions on money lender’s business stated in the MLO, if see fit and appropriate, should still be

applicable to the Peer-to-peer lending’s licensees. Moreover, the peer-to-peer lending portals should be registered as a Hong Kong incorporated company or an overseas company registered with the Hong Kong Companies Registry. Furthermore, all variations of peer-to-peer lending (companies lending to companies, companies lending to individuals, individuals lending to individuals and individuals lending to companies) should be subject to regulation. 6.4 The licensees of the Peer-to-peer lending’s licence should be required to fulfill the following statutory requirements:

have fit and proper management: prospective licensees should satisfy and continue to satisfy after the grant of such licence and registration the licensing court that they are fit and proper to be so licensed or registered;

47 Article 36H of The Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) (No.2) Order 2013.

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maintain sufficient financial resources: licensees should maintain a minimum paid-up share capital as well as a minimum liquid capital and are obliged to report the corresponding information at a regular basis to the Registrar of Money Lenders;

give adequate pre-investment risk warning to prospective lenders : licensees should ask the prospective clients to read the risk acknowledgment statement that outlines the potential risks (particularly, the possibility of suffering a total loss in investment) of peer-to-peer lending and confirm that they fully understand the contents of the risk acknowledgment statements prior to investment;

provide a cooling off period: licensees should provide a mandatory cooling off period that allows both borrower and lender to withdraw without penalty from the agreement;

handle client money properly: licensees should comply with the client money rules in terms of monies received from lenders and in terms of acting as a conduit for borrower repayments. Similar requirements stipulated in Securities and Futures (Client Money) Rules (Cap 571I) can be adopted;

comply with disclosure obligations: licensees should inform prospective lenders of fair, clear and not misleading information 48 of the borrowers (e.g., a description of what due diligence is performed, the estimated level of risks associated with loans, the procedures for dealing with loans in late payment or default, etc.);

take appropriate measures against operational failure and compliance risks: licensees should adopt reliable procedures to maintain cyber security and also

48 The meaning of fair, clear and not misleading can be found in COBS 4.2 Fair, clear and not misleading communication in the Financial Conduct Authority Handbook.

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address compliance issues properly particularly money laundering and personal data privacy.

Introducing a specific regulatory regime for equity crowdfunding 6.5 It is proposed that there is a need to introduce specific regulatory regime for equity crowdfunding, specifically, allowing unlisted public companies to acquire funding from retail investors through a registered equity crowdfunding portal under the supervision of the SFC. 6.6 It is recommended that Hong Kong should introduce specific registration requirements for a new type of intermediary, which runs online portal to facilitate equity crowdfunding between issuers and investors.49 It should be done so by regarding the provision of equity crowdfunding portal services as a new type of regulated activities to the existing list as defined by the SFO. In the meanwhile, companies of which offer securities through the registered equity crowdfunding portal can be exempted from the prospectus and disclosure requirements subject to the existing C(WUMP)O but instead subject to a reduced disclosure requirements (a template offering document disclosure). In effect, corresponding amendment to the 17th Schedule of the C(WUMP)O by inserting a new exemption rule in relation to the issuance of securities through registered equity crowdfunding portals can serve this purpose. 6.7 Registered equity crowdfunding portals should comply with the codes and guidelines imposed on registered intermediaries issued by the SFO.50 As for the diligence concern, registered equity crowdfunding portals should take appropriate measures to perform due diligence, e.g., conduct a background check of the prospective issuers and deny provision of intermediary services for their equity issuance if there is a reasonable basis for believing that fraud or illegality are involved. Registered equity crowdfunding portals should also have legal obligation to give adequate pre-investment risk warning

49 New Zealand and the United States adopt a registration system specifically designed for equity crowdfunding activities. See https://fma.govt.nz/compliance/role/crowdfunding-platforms/ and https://www.sec.gov/divisions/marketreg/tmcompliance/fpregistrationguide.htm#_ftn2 respectively. (accessed 1 February 2016). 50 Securities and Futures Ordinance (Cap 571) s 399

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(particularly, the possibility of suffering a total loss in investment and the absence of secondary market) to prospective investors, ask them to read the risk acknowledgment statements and confirm that they fully understand the contents of the risk acknowledgment statements prior to investment. 6.8 To be eligible to issue securities through registered equity crowdfunding portals, issues should be public limited companies (incorporated in Hong Kong or overseas companies registered with the Hong Kong Companies Registry). Private limited companies should be excluded from the class of eligible issuers in order to preserve the unique company structure with a maximum number of 50 shareholders and restriction on public subscription of securities. Public companies listed in the stock exchange should also be excluded from the class of eligible issuers so as to avoid duplication of function of equity crowdfunding and current stock exchange market. It has been reported that almost all jurisdictions with a specialized equity crowdfunding regime have placed a limit on size and timing of an offering (i.e. an eligible issuer cannot exceed a certain amount of issuances during any specified rolling period via all registered crowdfunding portals).51 Similar rules should be adopted in Hong Kong and the cap on size of issuance should be meaningfully higher than HKD$5 million so as to distinguish the new exemption rule in relation to the issuance of securities through registered equity crowdfunding portals from the existing exceptions set out in the C(WUMP)O.

6.9 To prevent taking the crowd away from crowdfunding, eligible investors should not be confined to high-net-worth and professional investors. However, an investment cap on the maximum amount per investor (e.g., a lump-sum maximum amount or a certain proportion to investors’ investable assets) for equity crowdfunding projects should be applied in order to cap the maximum possible loss borne by investors. The major purpose of doing so is to effectively mitigate downside risk to retail investors.

This aligns with the measures adopted by most jurisdictions with a specialized equity crowdfunding regime. 52 As for protection of shareholders’ rights, shares offered through registered equity

51 The Board of the International Organization of Securities Commissions, Crowdfunding 2015 Survey Responses Report, December 2015, p. 16. 52 Ibid. pp. 22-3.

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crowdfunding portals should be attached with mandatory anti-dilution clauses (e.g., tag-along right). 7. Conclusion 7.1 It has been witnessed that global crowdfunding market has grown substantially over the past few years and regulators around the globe have given their answers to the question of what should the appropriate regulatory response to the emergence of crowdfunding be. This essay suggests preliminary answer to such question from the perspective of Hong Kong. 7.2 It is recommended that specific regulatory regimes for two types of crowdfunding activities, peer-to-peer lending and equity crowdfunding, should be introduced to Hong Kong. The proposed regulatory frameworks outlined in this essay aim to achieve a balance between the promotion of crowdfunding and investor protection. It is believed that these recommendations can be practically implemented and are beneficial to Hong Kong.

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Crowdfunding’, South China Morning Post, 26 August 2015. Gubler, Z.J., ‘Inventive Funding Deserves Creative Regulation’,

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