Abu Dhabi and DIFC PFP/ Clearing House
Global financial markets have witnessed unprecedented growth in the techniques and platforms in peer to peer lending over past two decades due to various factors such as improvements in technology backing such platforms, real-time access to funds, ability to obtain unsecured personal or corporate loans among others. This also meant that peer to peer lending does not directly fit within the fundamental principles of the traditional financial industry because of the same reasons. Initially, peer-to-peer platforms majorly monetized on the funding with social circles and the benefits of disintermediationi as the concept of crowdfunding for SMEs to unknown borrowers was still an untested experiment. However, the growth and reach of the internet and ultimately the convergence of the financial sector with technology (FinTech) opened up new doors of opportunities globally. Eventually, this gave birth to the need to regulate a diversified, robust and unclassified sect of the industry. Therefore, it is pertinent for us to understand the regulatory approach to such platforms (commonly known as private financing platforms or PFPs) to comprehend the legalities and risks surrounding the same in our dynamic and global economy.
In today’s world, such platforms provide enhanced functions such as real-time virtual interface and conduct thorough (KYC and) due diligence on the parties’ bank accounts. This article aims to apprise the readers on the regulations laid down by the Financial Services Regulatory Authority (the FSRA), which is the financial services’ regulator of the Abu Dhabi Global Markets (the ADGM). After observing the growing need to regulate the sector and the potential that PFPs bring into the current marketplace, the FSRA issued the Guidance – Regulatory Framework for Private Financing Platformsii (referred to as the Guidance in this article) on 10 September 2018. The regulation has demarcated the limits and set the provisions for operating private financing platforms in instruments and various types of entities. The Guidance was issued according to the authority placed on the FSRA as per section 15 (2) of Financial Services and Markets Regulations of 2015. Therefore, it is pertinent for us to understand who is deemed to be operating a private financing platform as per the provisions of the FSRA before moving forward. A person is deemed to be running a private financing platform iniii seven different scenarios as per the FSMR: -
- introduces two (2) people over an electronic platform for one of them to provide credit to the other;
- introduces two (2) people over an electronic platform for one of them to buy a specified instrument;
- introduces two (2) people over an electronic electronic platform for one of them to buy a particular tool which would create a debtor-creditor relationship with the other person for the supply of goods or providing services;
- agrees with a specific person for conducting the above mentioned activities;
- facilitates such agreements (IV);
- holds and/ or controls funds from clients or arranges custody for such funds in the above scenarios;
- conducts a facility on PFP which provides a person to offer its rights as per mentioned above.
The Guidance applies to PFPs for private equity funding, PPP (private placement programs) and invoice financing platforms that raise funds from qualified investors including HNIs (high net-worth individuals), VC (venture capital), angel investors etc. The FSRA has advised investors of the risks associated with the PFP transactions including loss of money (since borrowing entities may have weak financial status), issues related to liquidity (as investors may not be able to exit the transactions as quickly), inadequate information on the PFP prospects, technical problems or failures in the platform and/ or conflict of interests.
Fundamentals of the Guidance and Initial Regulatory Compliance
The FSRA has restricted the access of PFPs (primarily) to professional investors due to the risks associated with such transaction and lack of knowledge of such threats to the general public. The FSRA may consider permitting non-professional clients who have an adequate understanding of the dangers and substantial experience in the sector to participate on a case by case basis. However, the FSRA has clearly laid down that only a corporate entity is permitted to be a PFP Prospect as it would not be appropriate for individual persons to obtain private funding through such platforms for business purposes. Further, financing through these platforms would not work effectively for entities that are being set up or have recently been set up since neither the platform operators nor the clients would have the opportunity to conduct thorough due diligence due to lack of sufficient information. The FSRA may prefer PFP operators to appoint third party custodians with requisite licenses in order to ensure the safety of the clients' funds - however, the regulator may consider alternative options for 'custody' when appropriate safeguards are in place. The FSRA will review the application of a proposed PFP operator in line with the threshold conditions mentioned in General (GEN) Rulebook, which requires applicants to:
I. Have substantial resources;
II. Be fit and proper;
III. Be (capable of) being supervised in an effective manner; and
IV. Have compliance standards in place. Specifically, the regulator will consider the
- Business model;
- proven track record of minimum five (5) years in corporate finance or similar activities;
- Compliance requirements of the directors and partners;
- Appointment of professionals such as senior executive officer, finance officer, compliance officer and money laundering reporting officer;
- Compliance and governance systems;
- Capital requirements and
- PII or professional indemnity insurance.
The applicants may also be required to demonstrate the technology and its compliance with the regulations laid down by the FSRA.
Ongoing Governance and Requirements
The guidance requires PFP operators to comply with the rules mentioned below during their operations:
I. Risk analysis - the holder of an FSP (financial service provider) license should list and inform the clients of the risks involved in participating in the transaction.
II. Due diligence - The operator should maintain a minimum standard of due diligence on the PSP prospect (including an independent verification where necessary). The PFP operator may or may not provide the information that they acquire to the clients; however, they are mandated to disclose the selection and acceptance criteria for any particular transaction to be listed on the platform. It will enable the investors to make an informed decision before flushing funds to any particular PFP prospect. Further, they are also required to submit all such information to the regulator for review.
III. PFP operators are permitted to use forums to identify the interests of clients analyze the interests of clients on any particular transaction and in such situations, the operators are not required to meet the compliance criteria mentioned in (i) and (ii). although they are placed with the responsibility to discard any misleading or fraudulent posts.
IV. Marketing (business development) - the FSRA FSRA has explicitly restricted the mass advertising of its platform; however, FSPs are permitted to promote the general information of its platform to the general public.
V. Disclosure of information - informally attributed one of the most critical aspects of compliance in the present global market. PFP operators have the responsibility to divulge the following information to the clients
- Operations of the PFP including details about the transactions, process for participation, custody of assets etc.;
- review of the PFP operator;
- operator's rights and liabilities;
- options and remedies the clients can resort to if a failure occurs on the part of the PFP prospect or the operator;
- Notifications of any material amendments to the PFP transaction; and
- other information as per the FSRA provisions.
VI. Exit options - this provides that PFP operators can permit clients to sell their positions (or exit the facility) to other clients of the PFP operator.
VII. Intermediaries - PFP operators may utilize SPVs (special purpose vehicles) in transactions established in the ADGM for effective regulatory oversight.
Applicants should also be aware of the implication of Islamic Finance Rules on PFP operators who deals in any Islamic Financial Business in the ADGM or makes offers on Shari'a-compliant securities in the ADGM. We would recommend that the applicants contact and visit the FSRA or a lawyer with adequate knowledge of the abovementioned requirements to obtained detailed information.
i. disintermediation (noun): the elimination of an intermediary in a transaction between two parties -
ii. The author has referred to VER01.10092018 of the Guidance while drafting this article. It is advisable for readers to either contact the FSRA or
the Corporate Practice at STA before arriving at any decision.
iii. Specifically, Schedule 1, Chapter 17C, Section 73E (2) of the FSMR