CROWDFUNDING NEWSLETTER: SEPTEMBER 2019
REGULATORY FRAMEWORK FOR CROWDFUNDING PLATFORMS IN THE UAE
Fig.1 (Text Source https://www.startups.com/library/expert-advice/history-of-crowdfunding)
In its simplest sense, crowdfunding is solicitation of funds (in small amounts) from multiple investors through a web-based platform or social networking site for a specific project, business venture or social cause. It is becoming an increasingly popular way to connect entrepreneurs in need of finance with investor in search of various forms of returns. What is interesting is that modern day crowdfunding’s history can be traced to as early as 1700s, roughly three centuries before the launch of ‘Artist Share’ the first dedicated Crowdfunding platform (refer Fig.1) ———— Crowdfunding has grown in both scope and its acceptance amongst investors in recent years around the world and the UAE is no exception in this regard. The regulators in UAE have laid down the various regulations for crowdfunding, some of which have been discussed below.
ABU DHABI GLOBAL MARKET (“ADGM”)
Guidance – Regulatory Framework for Private Financing Platforms
The Guidance is issued under Section 15(2) of the Financial Services and Markets Regulations, 2015 (“FSMR”). It must be read in conjunction with FSMR, the relevant Rulebooks of the Financial Services Regulatory Authority (“FSRA”) and the Guidance & Policies Manual (“GPM”) of the FSRA. This Guidance includes the authorization criteria that applicants must satisfy to be authorized to undertake the regulated activity of ‘Operating a Private Financing Platform’ (a “PFP Operator”) in addition to their ongoing regulatory requirements. This Guidance, together with the applicable ADGM Regulations and FSRA Rules governing PFP Operators, is collectively referred to as the “PFP Framework”
In accordance with this Guidance, the following are key aspects to be taken care of by a PFP Operator: The PFP must be available only to ‘Professional Clients’. 
- Any security that is being offered to the public must be accompanied by a prospectus, unless it qualifies as an Exempt Offer (or in simple terms a private placement).
- In order to target retail clients, the PFP must get special approval from FSRA and in such circumstance, the FSRA may impose other appropriate conditions or safeguards;
- The PFP Operator is obligated to procure enough information from the projects/ SMEs (“PFP Prospect”) to ensure its validity and such PFP Prospect must be a Body Corporate; and
- If there is any other activity which is being undertaken by the PFP Operator which may be considered as a ‘Regulated Activity’, separate Financial Services Permission may be required for such activities.
- It proposes that the PFP Operator appoints an Eligible Custodian to hold the Client Assets (including Client Money and Client Investments). If the PFP Operator does not appoint a Custodian, then the PFP Operator is obligated to comply with the higher capital requirements as well as other obligations applicable to a custodian in relation to custody of the client assets / client money.
Specifically, please see below a preliminary list of compliances to be adopted:
- Policies and Procedures: The PFP Operator must show that it has adequate and appropriate resources, is fit and proper, capable of being effectively supervised and has in place adequate compliance arrangements, policies and procedures. These policies are required to address a wide array of matters including client onboarding, transaction monitoring, IT Security, Risk Management, Internal Audit, Compliance Monitoring, Business Continuity and Disaster Recovery and the like.
- Capital Requirement: PFP Operator must always maintain capital resources in excess of Capital Requirement, which is to be the higher of the Base Capital Requirement or Expenditure-Based Capital Minimum.
*AAE means ‘Annual Audited Expenditure’.
- Controllers/Substantial Shareholders: The PFP applicant must be able to demonstrate that it or its group has a track record in corporate finance or related business of a minimum of five (5) years. The FSRA may also consider the track record of the applicant’s controllers or substantial shareholders and qualifications of the PFP applicant’s key individuals.
- Systems and Controls: PFP Operator must have governance and control models addressing risk management, compliance arrangements, internal audit functions and conflict of interest.
- PII: PFP Operator must maintain Professional Indemnity Insurance Cover to appropriate the nature, size and risk profile of its business
THE DUBAI FINANCIAL SERVICES AUTHORITY (“DFSA”)
DFSA has launched its regulatory framework (“DFSA Framework”) for loan, investment-based and property crowdfunding platforms, the first such regulatory framework in the GCC countries. The DFSA Framework aims to license, organize and protect the rights and obligations of all parties involved in specific crowdfunding activities which provide finance solutions for SMEs in the region.
Requirements of Crowd Funding
DFSA has created a separate category called ‘Operating a Crowdfunding Platform’ which be carried on only by a body corporate incorporated under the DIFC Companies Law. DFSA Framework clearly prescribes that the following activities cannot be undertaken from a Crowdfunding platform:
- Managing Assets;
- Advising on Financial Products;
- Managing a Collective Investment Fund; or
- Advising on Credit
A crowdfunding operator must not Operate a Crowdfunding Platform that facilitates a Person investing in the following kinds of investments through the platform:
- Warrants, Unit in Collective Investment Schemes (like fund) or Structured Products; or
Types of Crowdfunding Platform
Under the said license there are 3 (three) categories of crowdfunding platform:
The capital requirement for such an Authorized Firm is calculated as the higher of the applicable base capital requirement or the expenditure-based capital requirement.
- The base capital requirement for Operating a Crowd Funding Platform is USD 140,000; and
- The expenditure-based capital requirement is calculated as mentioned in Rule 3.7.2 of the DFSA PIB Rulebook.
Obligation to issue a Prospectus: A person is not eligible to make an offer of securities to the Public in or from the DIFC; or have securities admitted to trading on an Authorized Market Institution, unless there is an Approved Prospectus in relation to the relevant Securities.
Operational Risk: An Authorized Firm must implement and maintain an Operational Risk policy which enables it to identify, assess, control and monitor Operational Risk.
Compliance for Retail Investors: A Crowdfunding Operator will need an endorsement on its License to deal with Retail Clients if it carries on its activities with a user that is a Retail Client.
PII: A Crowdfunding Operator is not required to obtain a PII policy if it has taken appropriate steps to try to obtain that insurance for its business, but no cover is reasonably available. The exclusion ceases to apply if PII cover does become reasonably available to the Operator, in which case the operator must obtain the policy as soon as practicable.
SECURITIES AND COMMODITIES AUTHORITY (“SCA”) AND CENTRAL BANK INITIATIVE
SCA is also under process to introduce an initiative for crowdfunding SMEs, in collaboration with the Organization for Economic Co-operation and Development. This initiative shall also aim to offer a platform like crowdfunding for companies operating in free zones to facilitate their access to funding. Similarly, the Central Bank governor had indicated the Central Bank’s intention to regulate crowdfunding platforms as part of measures to boost financing for small and medium enterprises.
As of now, we can only speculate the future of crowdfunding, but judging by its incredible growth in recent years, we can derive that it’s maturing from a novelty into an alternative to raise capital. It is giving alternative options to small investors and allowing them to diversify their investment better rather than increasing concentration risk by allocating too much capital to one investment. The crowdfunding industry in the Middle East is now at a turning point. While these new opportunities are allowing entities to access capital, crowdfunding has also introduced new challenges for regulators. Undoubtedly, there are risks present in crowdfunding, it is nevertheless a huge boon for emerging growth companies to help obtain necessary financing in order to expand nascent operations. Specific laws or regulations in this area should therefore necessarily try to find a balance between investor protection while also providing the desired push for growth.
 Under the FSRA Regulations, there are three routes through which a Person may be considered as a ‘Professional Clients’: (a) ‘deemed’ Professional Clients; (b) ‘Service-based’ Professional Clients; and (c) ‘assessed’ Professional Clients
Authored by Barkha Doshi (Associate) with inputs from Akshata Namjoshi (Senior Associate).