A bumpy road ahead for Asia fintech

Author: | Published: 21 Apr 2016
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Across the region’s most mature markets, regulators are approaching financial technology in very different ways

Crowdfunding has emerged as an alternative means of fundraising for start-ups in most developed Asian jurisdictions, but legal constraints have weakened its potential in Hong Kong.

The Financial Services Development Council (FSDC) published a report on March 18 detailing suggestions on how the government could reconcile existing regulations with new rules for equity crowdfunding.

Counsel acknowledge that regulators are keen on incorporating new funding channels, they stop short of agreeing that simply adjusting the current system could bring about change.

"The definition of 'security' under the Securities and Futures Ordinance (SFO) was clearly not written with fintech in mind," says Mark Parsons, partner at Hogan Lovells in Hong Kong, adding: "The scope of the definition makes it difficult for most models of equity and debt crowdfunding to operate without authorisation under the SFO."

Equity crowdfunding is the process whereby a start-up raises money from small public investors, who will become shareholders of the company in return, through various social media platforms.

Today, all types of crowdfunding and peer-to-peer lending fall under the SFO, and the winding up and miscellaneous provisions of the Companies Ordinance.

Two internet-specialist
banks are expected to
be given official
banking licences
in Korea at the
end of this year

Jay Lee, Simmons & Simmons­

The SFO prohibits companies from inviting the public to engage in a collective investment scheme, while requiring them to meet all disclosure and registration requirements before offering any shares. "We haven't yet seen that in Hong Kong or any move by the city's regulators to, for example, open up or exempt parts of crowdfunding from the SFO requirements," says Parsons.

The FSDC report, which came four months after the US allowed companies to raise up to $1 million within 12 months through crowdfunding, looks at different methods of regulating fintech activities.

Suggestions proposed include the granting of conditional exemptions to professional crowdfunding investors, the licensing of crowdfunding platforms and the imposition of risk-exposure limits.

With the US having set an annual $100,000 cap on individuals investing through crowdfunding, the FSDC mooted imposing a limit on the amount companies would be allowed to raise and invest.

"Crowdfunding is not blocked or banned, but you need to make sure that you and everyone else involved in the distribution have the appropriate licences from the SFC," says Parsons.

While the regulatory landscape for fintech remains relatively strict, counsel say market overseers are becoming more active in helping fintech start-ups with compliance issues.

"My impression is that the regulators in Hong Kong are very open-minded to risk-based moderation of regulatory requirements, where their legislation accommodates it and provided that the risks are properly assessed," observes Parsons.

Northern revolution

Authorities in Japan and Korea, meanwhile, are making headlines with a raft of new proposals that show they are promoting new fundraising and banking platforms.

Late last year Korea's financial watchdog, the Financial Services Commission (FSC) issued temporary banking licences to the country's internet giant Kakao and telecom operator KT Corporation. But political wrangling over an amendment to the Banking Act could mean internet-specialist banks are designated as second-tier savings banks if voted down by the opposition party.

Existing regulations prohibit industrial companies from owning more than four percent of voting shares in a financial institution, thereby preventing banks from being monopolised by industrial giants.

Today, Kakao Corp, which runs KakaoTalk, owns 10% of the Kakao bank while a group of financial institutions, including Korea Investment Corporation, takes up the rest. KT Corp, on the other hand, owns eight percent of K-bank but in reality both Kakao Corp and KT Corp possess only four percent of voting shares of their respective banks.

The definition of
'security’ under the
Securities and Futures
Ordinance was clearly
not written with fintech
in mind

Mark Parsons,
Hogan Lovells

"The problem is that the operation of these banks will be heavily reliant on KakaoTalk's popularity and the company's internet and SNS technology and system," says Jay Lee, partner at Simmons & Simmons in Hong Kong

The Korean government submitted a draft bill to parliament late last year allowing information technology companies to own up to 50% of these internet-specialist banks. But counsel argue such a deregulatory plan could be derailed depending on the outcome of upcoming elections.

"There is a big argument within the industry and among regulators that non-banking companies in these internet-specialist banks should be allowed to own up to 50% of internet-specialist banks," says Lee, adding: "It is expected that two internet-specialist banks will be given official banking licences at the end of this year to conduct banking activities including taking deposits."

While there is a great deal of uncertainty surrounding the creation of internet-specialist banks in Korea, Japan has recently approved a set of bills giving formal recognition to bitcoin as a functional currency.

The bills passed by its Cabinet in March have also set a precedent for banks to start or acquire new settlement systems, and for bank holding companies to purchase IT-related ventures.

The recognition of bitcoin as legal tender has come amid an exodus of Japanese entrepreneurs seeking funding overseas following a $650 million cyber heist on the Tokyo-based Mt Gox bitcoin exchange in 2014.

Japan's Financial Services Agency hopes that upcoming changes allowing banks to gain full ownership of non-financial companies will attract investors to tap the domestic funding pool. This will be complemented by the expected passage of a bill to establish a new regulatory framework on virtual currency exchanges next month.