To start with, alternative finance refers to financial channels, processes and instruments that have emerged outside of the traditional finance system which normally involves regulated banks, capital markets and insurance. Some examples of alternative financing activities are reward-based crowdfunding, equity crowdfunding, revenue-based financing, online lenders, peer-to-peer consumer and business lending, and the invoice trading third-party payment platforms. These activities take place over the Internet, which serves as their online marketplace.
Understanding the concepts
Crowdfunding is the practice of funding a business venture by raising small amounts of money from a large number of people (the ‘crowd’), typically over the Internet.
- Reward-based crowdfunding involves individuals contributing small amounts of money to projects in return for some kind of reward, which is usually non-monetary. The size of the reward depends on an individual’s contribution.
- Equity crowdfunding (ECF) is the process whereby people invest in an early-stage company that is not listed on the stock market in exchange for shares in that company.
- Revenue-based financing is a method of raising capital for a business from investors who receive a percentage of the enterprise’s ongoing gross revenues in exchange for the money they invested.
- Marketplace lending: Marketplace Lenders (MPLs) are online platforms that enable investors to lend to retail and commercial borrowers. Unlike banks, MPLs do not take deposits or lend themselves; as such they do not take any risk onto their balance sheets. They make money from fees and commissions received from borrowers and lenders.
- Initial Coin Offering (ICO): An Initial Coin Offering (ICO) is the cryptocurrency industry’s equivalent to an Initial Public Offering (IPO). ICOs act as a way to raise funds, whereby a company looking to raise money to create a new coin, app, or service launches an ICO.
The World Bank recently published a report (Global Regulator Survey) intending to understand the global regulatory landscape of Alternative Finance. The survey was jointly conducted with the Cambridge Centre for Alternative Finance (CCAF). The survey focused on Peer-to-Peer (P2P), marketplace lending, equity crowdfunding (ECF), and initial coin offerings (ICOs). The survey then analysed how regulators from one hundred and one (111) countries, including both developed and developing ones, are regulating and supervising these online alternative finance activities.
|% of Region’s
|% Of Region’s GDP Accounted For||% of Region’s
|East Asia and Pacific||14||37||70||69|
|Europe and Central Asia||27||45||65||66|
|Latin America and the Caribbean||26||57||85||84|
|Middle East and North Africa||13||57||51||26|
Table: Geographic distribution of respondents
Some of the key findings from the recent global regulator survey are:
The potential of alternative finance speaks to a new set of regulatory objectives: Policymakers globally are keen to explore the promise of alternative finance. A clear majority are optimistic about its potential to improve Medium and Small-scale Enterprises’ (MSMEs’ 79%) and consumers’ (65%) access to finance and stimulate competition in financial services (68%). Such expectations chime with regulators’ emerging priorities, as many now have statutory objectives to support financial inclusion, economic policies or competition.
Alternative finance is still typically unregulated – but bespoke regulation is catching on: Despite a boom in alternative finance regulation since 2015, the relevant activities are still not formally regulated in most countries – only 22% of countries formally regulate Peer-to-Peer (P2P) lending, as opposed to 39% for ECF (Equity Crowdfunding) and 22% in the case of Initial Coin Offerings (ICOs). Where these activities are regulated, some countries apply to them pre-existing regulatory frameworks (for example for securities). More often, they are subject to bespoke regulatory frameworks, particularly in the case of Peer-to-Peer (P2P) lending (12% of countries) and ECF (22% of countries).
While regulation is not the norm today, by mid-2021 most countries will be regulating ECF (Equity Crowdfunding) and more than a third intend to regulate Peer-to-Peer (P2P) lending and ICOs; bespoke frameworks will likely become even more common. Regulatory change, however, is not limited to unregulated sectors becoming regulated; it also includes revisions of pre-existing frameworks (legislation), often in favour of bespoke ones. In the case of ECF (Equity Crowdfunding), taking all of these types of change into account means that half of all countries are likely to see changes to their legal or regulatory frameworks over the next two years.
Alternative finance regulation is about making the sector safe at scale: Alternative finance regulation seeks to make the sector fit for the mass market, including both individual investors and MSMEs (Medium and Small-Scale Enterprises). Ensuring liquidity or minimising the potential for capital losses does not appear to be prioritised over those goals. This may be an indication of how regulators interpret their consumer protection mandates concerning alternative finance.
Alongside Anti-Money Laundering/Know Your Customer (AML/KYC) requirements, regulators’ top priorities are protections against misleading promotions or the misuse of client money. Depending on the activity in question, between 93% and 100% of regulatory frameworks impose requirements for the clarity and fairness of promotions; between 100% and 88% impose sector-specific AML/KYC requirements, and over 80% impose the segregation of client assets, where applicable.
Initial Coin Offering (ICO) regulation, where it applies, appears to be less prescriptive than regulation of Peer-to-Peer (P2P), lending or ECF (Equity Crowdfunding). There seems to be a greater acceptance among supervisors that investors in this sector should take responsibility for losses and conducting their due diligence, and regulation is largely built on the assumption that such offerings are largely disintermediated.
Alternative finance regulation isn’t ‘light-touch’: There is little evidence yet of regulators purposefully creating light-touch regulatory frameworks for alternative finance. If anything, purpose-built regulatory frameworks tend to have more obligations in place than pre-existing ones. Indeed, bespoke frameworks (regulations) tend to prioritise checks on investor exposure, rigorous due diligence on fundraisers, client money protection and appropriate online marketing standards.
That said, regulators respond to feedback from the alternative finance sector – which has often proactively called for formal regulation of their activities. Those regulators that treat promoting competition as a statutory or strategic objective are particularly likely to report they have considered such calls when developing their approach.
As supervision stretches their resources, regulators are turning to innovation
Alternative finance supervisors see fraud, capital loss and money laundering as significant risks. Enforcement cases are also common, particularly in unregulated ECF (Equity Crowdfunding) and ICO sectors. Thus, the supervisory resources dedicated to these activities globally have grown fast since 2017: by over a third in the case of ICOs and unregulated ECF (Equity Crowdfunding) sectors, and about one-sixth in the case of P2P lending.
Despite this, it is often more difficult for regulators to supervise alternative finance than traditional sectors. Reasons for this include limited technical expertise, limited funding, and regulators are thus looking for more innovative solutions to overcome these limitations in regulation and supervision. Among respondent regulators, 22% have created regulatory sandboxes, 26% have innovation offices, and 14% have active RegTech/SupTech (Regulatory Technology/Supervisory technology) programmes.
Based on regulators’ responses, the number of sandboxes and RegTech/SupTech programmes could double and triple respectively in the coming years. In terms of sheer numbers, it seems that innovation offices have the most quantifiable impact to date, having assisted twelve times as many firms as sandboxes – over 2,100 in total, against just 180 for sandboxes. However, proponents of the sandbox might argue that for particular ‘policy-testing’ orientated sandboxes, the purpose is not to increase the number of innovative firms supported but to facilitate policy learning, design and review.
In Ghana, the Securities and Exchange Commission (SEC) made public its intention to introduce a regulatory sandbox licence to contain innovations related to the capital market (currently outside its existing regulatory framework). Similarly, the Governor of the Bank of Ghana, Dr. Ernest Addison, at the 23rd National Banking Conference held on 26 November 2019 in Accra revealed: “The Bank is also in discussion with key stakeholders to explore a pilot project (in a sandbox environment) on central bank digital currency with the possibility of issuing an e-cedi in the near-future”.
It is also worth stating that the Bank of Ghana under the Payment Systems and Services Act, 2019 (Act 897) as amended, regulates institutions which carry on payment services and electronic money business. In connecting the facts, it is clear that the existing regulatory frameworks do not contain the alternative finance activities. In this regard, consolidated supervision of the financial sector with the establishment of a Financial Stability Council should help mitigate the emerging risks that can disrupt the entire sector going forward.
Thank you for reading. I welcome your feedback or comments on this script. God bless You!
This script was written by a Chartered Banker with a flair for feature writing. He works for a company which provides financial services. Apart from his work schedules, he edits or proof-reads corporate material for his colleagues, executive managers – including distinguished professionals working in various fields outside Banking. Through this column, his articles feature on third-party online media platforms in Ghana and outside. Email: Kwaku.Anumu@gmail.com
“World Bank; Cambridge Centre for Alternative Finance. 2019. Regulating Alternative Finance: Results from a Global Regulator Survey.”