FinTech (a newly coined word which stands for “Financial Technology”) is a portmanteau of financial technology, which illustrates an emerging financial services sector in the 21st century.
FinTech refers to non-financial players using technology to offer new and innovative financial products and services (primarily through software) that mirror the services traditionally offered by banks and financial institutions.
Some examples of FinTech solutions are such as payment (Apple, Google, PayPal, Amazon and Alibaba have payment solutions that replace physical wallets and credit cards), lending platforms (Zopa, Lending Club, Funding Circle that match lenders and borrowers on their online platforms) and investment strategies (Wealthfront that uses data analytics to dispense online personal financial advice and investment management services).
FinTech is driving the financial sector to be more efficient by providing greater access to market-based financing through the application of technology solutions such as the Internet or mobile apps, reducing costs for companies, providing a stronger focus on customer service, making it more convenient, and allowing higher transparency and the exploitation of network effects.
FinTech is an umbrella term for a number of alternative financing methods such as peer-to-peer (“P2P”) lending, equity crowdfunding (“ECF”) and merchant financing by electronic marketplace operators to merchants.
Other digital financial products and services that are also considered part of FinTech include digital currencies which operate independently of any central authority or banks and payment and remittance systems which bypass traditional banking channels.
Governments and regulators around the world (including Malaysia) have started recognising the growing importance of FinTech and the need to provide policy and regulatory framework to grow and accelerate innovation in the FinTech industry.
In Malaysia, the Capital Markets and Services Act 2007 was amended by Parliament in 2015 to legally recognise and regulate ECF and P2P platforms.
ECF refers to an act of raising fund from investors primarily through an online platform where business owners give away a portion of their equity in their business venture to investors, in exchange for an investment fund. P2P lending, on the other hand, provides investors with an option to earn interest by lending money to business owners based on their risk appetite.
New ECF and P2P Lending Guidelines
In February 2015, the Securities Commission of Malaysia (“SC”) released Guidelines to facilitate ECF platforms. Following the issuance of the ECF Guidelines, the SC announced in June 2015 the approval of 6 registered ECF platform operators (Alix Global, Ata Plus, Crowdonomic, Eureeca, pitchIN and Propellar Crowd+).
It is worth noting that Malaysia is the first country in the ASEAN region to introduce a progressive ECF framework. I had discussed ECF and the mechanisms of ECF platform in my previous article published in July 2015.
As part of SC’s continued effort to nurture and facilitate market-based innovation in FinTech under the [email protected] initiative, the SC has recently released other guidelines to facilitate P2P lending (“P2P Lending Guidelines”). P2P platform facilitates businesses or companies to raise fund from both retail and sophisticated investors through an online platform. An individual is not allowed to seek personal financing via a P2P platform.
With the release of the P2P Lending Guidelines, investors may now use P2P platforms to buy securities in the form of an investment note or Islamic investment note, which are issued by businesses or companies.
Once purchased, the issuer of the investment note or Islamic investment note will be obliged to pay the investors over a period of time, with interest or profit.
When an issuer applies for funding on a P2P platform, the P2P operator will have to assess and assign a risk score to the investment note or Islamic investment note by evaluating the issuer’s suitability, which includes the issuer’s credit history and capacity to repay. Unlike the framework for ECF, there is no limit imposed by the SC in relation to the amount of fund an issuer may raise on a P2P platform. There is also no investment limit imposed on sophisticated and angel investors. For retail investors, P2P operators have an obligation to advise retail investors to limit their investments to a maximum of RM50,000 so as to manage the risk exposure of retail investors.
Operators interested in operating a P2P platform may submit their application to the SC from 2 May 2016 to 1 July 2016. All P2P operators must be locally incorporated and have a minimum paid-up capital of RM5 million.
The P2P Lending Guidelines impose certain obligations on a P2P operator. Among others, the P2P operator must;
- ensure that there is an efficient and transparent risk scoring system in place;
- it must carry out a risk assessment on prospective issuers;
- monitor and ensure compliance of its rules;
- that the issuer’s disclosure document lodged with the P2P operator is verified for accuracy and made available to investors;
- it must have in place processes to monitor anti-money laundering requirements, manage any default by issuers including using its best endeavours to recover amount outstanding to investors as well as carry out investor education programmes.
- The rate of financing must not exceed 18% per annum.
The scope of due diligence to be exercised by a P2P operator would include taking reasonable steps to conduct background checks on the issuer to ensure fit and properness of the issuer, its boards of directors, senior management and controlling owners, verify the business proposition of the issuer as well as carry out assessment on the issuer’s creditworthiness.
An issuer is allowed to keep the amount of fund raised provided that it must have at least raised 80% of its targeted amount.
However, the issuer may not keep any amount which exceeds the targeted amount. In addition, an issuer may list on a P2P platform and ECF platform concurrently provided that such information is disclosed to the platform operators.
In order to protect the investors, it is mandatory for P2P operators to ensure that the fund raised from investors are first placed into a trust account until the minimum target of 80% of the targeted amount is met. Any repayments by an issuer will also be placed into the trust account.
Furthermore, P2P operators must provide investors with all relevant information to enable investors to make an informed investment decision and understand the risks of their investment.
Risks and Challenges
This being said, as with any mode of investments, investing through FinTech comes with certain risks.
A business capitalized through FinTech arguably possesses greater risks of failure compared to other businesses that have been financed through the traditional method of start-up financing. The success of one business may not be assessed merely by the amount of funding one is granted.
A promising business will inevitably fail without a well thought out business plan and support structures. Crowdfunded businesses may not have the necessary experience or guidance of seasoned venture capitalists who can help them drive their business through the challenges of its development stage.
In addition, businesses seeking for crowdfunding or borrowing money on a P2P platform may very well be mediocre investment opportunities considering businesses may only consider ECF or P2P as a last resort to seek financing after failing to seek investments from angel investors and venture capitalists or by other traditional means.
Technology can be a double-edged sword.
The IT security of such ECF and P2P platforms will be a major concern. Living in a digital era, there have been far too many cases where cyber criminals managed to break into impregnable data repositories of companies, steal credit card details and even personal data of clients.
Needless to say, ECF and P2P platforms are faced with similar risks as well. ECF and P2P platform operators will have to take such risks into account and strengthen their cybersecurity rather than merely abide by the minimum requirements provided by regulations governing such platforms.
ECF and P2P platform operators must ensure that proper risk management systems and credit assessing systems are in place. This is especially so for P2P lending platforms as investors will be providing funding to businesses based on their risk appetite. P2P operators must accurately rate businesses by their level of creditworthiness to prevent situations where borrowers refuse or are unable to repay their loans.
The world of financing is changing rapidly and disrupting the incumbent financial systems and institutions.
According to a study released by Accenture, global investments in FinTech ventures has tripled from USD 928 million to a whopping USD 2.97 billion and such figure is predicted to be escalated to USD 6 to 8 billion by 2018. Such an increase suggests that the global investment in FinTech has grown much faster compared to the traditional venture capital investment overall.
Disruptive technologies have changed the way we live and do business.
The emergence of ECF and P2P platforms is another innovative example of how technologies are disrupting the traditional means of funding, democratizing access to capital as well as offering up more investment opportunities to everyone.