Regulatory Insight of Crowdfunding in the UAE
Concept and Its Evolvement
The Kickstarter community was given the opportunity to get behind a coloring book called, “Why Is Daddy Sad on Sunday: A Coloring Book Depicting the Most Disappointing Moments in Cleveland Sports.” The project’s creator, Scott O’Brien, set a goal of raising $2,000. He raised almost $24,000. The idea came to Scott when he was stuck in the traffic in Los Angeles. To explain it better, he could so do by simply using the Crowdfunding platform which was in the form of a donation.
Crowdfunding platforms are used for generating funds from a large group of people. It also has different names like crown financing, crowd investing and is defined as the collective co-operation by people who pool their funds, usually by means of the internet, to support initiatives by different organizations and people. It is used for different purposes, from raising funds for smaller projects to larger projects and essentially beneficial for SMEs to obtain financing. In the western world, it has taken shape in the last three decades however Google suggests that “Crowdfunding may seem like a new idea, but it actually has a long and rich history with roots going back to the 1700's”.
UAE has always shown its eagerness to adopt new technological concepts and with the advent and enormous success of financial free zones in the UAE, it has become a fascinating destination for investors. Recently, the Emirates have taken a step to regulate the Crowdfunding, and crowned themselves as a trendsetter, becoming the first country for such regulations amongst the Gulf countries. The Dubai Financial Services Authority (DFSA) issued regulations on Crowdfunding in 2017. It may be a vital need for this market because it houses several small and medium enterprises.
The UAE Banks in recent times have shown reluctance to extend financial support, especially to the small and medium enterprises (SMEs), unlike before. Half a decade before, it was easier to obtain funds from the UAE banks, however, this has not been the case for a while. This can, in particular, hamper the financial and economic growth of the country and may prevent investors from entering the market. SMEs are significant contributors to the UAE economy which comprises around 85% of businesses in the UAE, contributes to nearly 60% to the UAE GDP, and employs 60-65% of the UAE workforce. It is estimated that by 2020, the Global loan-based crowdfunding will reach more than USD 300 billion and global equity-based crowdfunding more than USD 93 billion.
Regulatory Framework in the DIFC (DFSA):
The Crowdfunding is not specifically regulated in the UAE as yet, however, it has been regulated through different models and other legislation. For instance, without obtaining any license (from the designated authority of the respective Emirate where the funds are to be raised), the individuals and corporations cannot carry out any fundraising activities. In Dubai, pursuant to Decree 9 of 2015 Organization of Fundraising in the Emirate of Dubai, any fundraising activities without obtaining the prior consent of Islamic Affairs and Charitable Activities Department are prohibited and any violation would lead to hefty penalties including fine OR imprisonment, or both.
Further, the Central Bank of the UAE regulates the banking activities (granting of loans by the banks) and the Securities Commodities Authority (SCA) regulates the financial activities in the UAE. Whereas in the financial free zones, the activities are regulated by the Dubai Financial Services Authority in Dubai International Financial Centre and the Financial Services Regulatory Authority (FSRA) in Abu Dhabi Global Markets.
In late 2017, the DFSA launched its regulatory framework for loan and investment based crowdfunding platform, with the objective of protecting the rights and obligations of the parties involved in specific crowdfunding activities, and its licensing and organization. It is imperative to highlight that it does not regulate any charity/donation based platforms as yet. These platforms are not to be used for investing in funds, managing assets, issuance of any securities, or any such activities. The Committee has, therefore, proposed set of rules to establish a new Financial Service “Operating a Crowdfunding Platform” which shall regulate both the Loan based Crowdfunding and Investment based Crowdfunding.
Investment-based crowdfunding activities could fit into some of the DFSA’s existing Financial Services and shall involve: (a). the operation of an electronic platform that facilitates the bringing together of persons who wish to obtain funding for a business or venture (Issuers) and persons who are willing to provide funding (investors), and results in the investor making an investment with the Issuers; and (b). the operator performing administrative functions in relation to any investment that results from operating the electronic platform.
As Investment-based Crowdfunding will (unlike a crowdfunding lending platform) involve the issue of security (normally shares), an Investment-based Crowdfunding Platform may result in an Issuer making an Offer of Securities to the Public as defined in Article 12 of the Markets Law. As a result, an Issuer would have to consider the Prospectus regime in the Markets Law and Rules. For start-ups and small and medium-sized companies, complying with the prospectus requirements for a small fundraising exercise may not be viable given the costs and resources involved in preparing a Prospectus. They have also proposed some exempt categories.
Prudential Requirements: The DFSA currently allows firms to set up a start-up, subsidiary of a non-DIFC firm or a branch of a non-DIFC firm. If an authorized firm is a branch, it is not normally required to hold capital in the DIFC.
The current status of the regulation of Crowdfunding requires that all those operating a loan-based crowdfunding platform in the DIFC, including those establishing a Branch, must hold capital according to the Category 4 Capital Requirements. The same is applicable for operating an investment-based crowdfunding platform in the DIFC.
Risk Disclosures: Under the regime, the operator is required to disclose the risk that a lender and borrower may be exposed to in the transaction. The regulations have also set out the language/statements to be included on the operator’s website for any such risks. It also requires the operators to specify the default rates of loans and failure rates that may be required, in the event of a default in payments or insolvency.
Due Diligence: The proposal on an investment-based crowdfunding platform, provides for the following minimum checks which the operators are required to comply with: a) the details of its incorporation and business registration, as well as the identity and place of domicile of each director, officer, and controller of the Issuer, b) the fitness and propriety of those referenced in a), for example checking if there have been any director disqualifications or convictions for fraud/dishonesty, c) the financial strength and past performance of the Issuer, and if the company is a start-up, its financial projections; d) the valuation of the Issuer’s business, its current borrowing levels, and the source of any existing borrowing (if applicable), e) the Issuer’s business proposal, f) the commitment of the Issuer to its business, for example, looking at the initial share capital and any flight risk exposure, g) details of any funds raised via the platform or elsewhere, and h) that the Issuer is complying with applicable laws in the jurisdiction in which it is incorporated.
The regulation also includes provisions relating to issuer restrictions, risk warnings and other disclosure requirements, fair treatment of investors, technological resources, business cessation plan, transfer facility, a cooling-off period, and restrictions of retail clients. This suggests that DFSA regulations protect the interest of the lenders, as well as, borrowers who are generating funds through these platforms and operators will have to abide by the strict compliance obligations, in order to safeguard and segregate the client assets. In the light of the above, it can be said that Crowdfunding platforms give the entrepreneur, a single platform to build, showcase, and share pitch resources, and this approach dramatically streamlines the traditional model.
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