China UK Equity Crowdfunding Regulatory and Market Comparison Study

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June 2017

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1. EXECUTIVE SUMMARY ...... 4

TRENDS WITHIN THE UK MARKET ...... 4

TRENDS WITHIN THE CHINESE MARKET ...... 4

UK REGULATION AND POLICY ...... 5

CHINESE REGULATION AND POLICY ...... 5

UK PLATFORMS’ PERSPECTIVE ON THE CHINESE MARKET ...... 6

CHINESE PLATFORMS PERSPECTIVE ON THE UK MARKET ...... 6

2. INTRODUCTION ...... 7

METHODOLOGY ...... 7

CHINA AND THE UK’S ‘GOLDEN ERA’ ...... 7

DEFINING EQUITY CROWDFUNDING ...... 8

3. UNDERSTANDING UK EQUITY CROWDFUNDING ...... 10

SIZE, GROWTH AND PERFORMANCE OF THE UK MARKET ...... 10

UK MARKET TRENDS ...... 12

UK CROSS-BORDER ACTIVITY ...... 13

CASE-STUDIES AND BUSINESS MODELS IN THE UK MARKET ...... 14

THE HISTORY AND DEVELOPMENT OF THE UK EQUITY CROWDFUNDING MARKET ...... 17

REGULATION OF UK EQUITY CROWDFUNDING ...... 19

2016/17 FCA REGULATORY REVIEW ...... 21

UK POLICES RELATED TO THE EQUITY CROWDFUNDING MARKET ...... 23

UK CROWDFUNDING ASSOCIATION (UKCFA) ...... 25

4. UNDERSTANDING CHINESE EQUITY CROWDFUNDING ...... 26

DEFINING CHINESE EQUITY CROWDFUNDING ...... 26

SIZE AND GROWTH OF THE CHINESE MARKET ...... 28

CHINESE MARKET TRENDS ...... 29

CHINESE CROSS-BORDER ACTIVITY ...... 32

CASE-STUDIES AND BUSINESS MODELS IN THE CHINESE MARKET ...... 33

THE HISTORY AND DEVELOPMENT OF THE CHINESE EQUITY CROWDFUNDING MARKET ...... 36

REGULATION OF CHINESE EQUITY CROWDFUNDING ...... 37

REGULATORY REVIEW IN CHINA ...... 39

CHINESE POLICES RELATED TO THE EQUITY CROWDFUNDING MARKET ...... 42

NATIONAL INTERNET FINANCE ASSOCIATION OF CHINA (NIFA) ...... 44

5. CHINA UK CROSS-BORDER INVESTMENT REGULATIONS PRIMER ...... 45

6. UK PERSPECTIVE ON THE CHINESE MARKET ...... 50

7. CHINESE PERSPECTIVE ON THE UK MARKET ...... 53

8. APPENDICES ...... 56

APPENDIX - OVERVIEW OF INTERNATIONAL REGULATION OF EQUITY CROWDFUNDING ...... 56

APPENDIX: UK STAKEHOLDERS ...... 59

APPENDIX: CHINESE STAKEHOLDERS ...... 60

APPENDIX – ABBREVIATIONS ...... 62

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1. Executive summary

Trends within the UK market

- The UK Equity Crowdfunding market has experienced rapid growth over the last 3 years. The amount invested through equity crowdfunding has grown from £28 Million in 2013 to £332 Million in 2015 and the number of deals increasing from 175 in 2013 to 720 in 2015. - Data on 2016 performance indicates a slow-down in deals and volume in Q1 & Q2. This is in line with the rest of the investment market. - While the model is used to invest in companies across a range of sectors, the most popular sector for equity-based crowdfunding is property, followed by technology; food & drink; internet and E-Commerce; media and publishing. - Equity crowdfunding made up 16.5% of the UK market for seed and venture stage investment in 2015. Recent figures suggest that it has grown to 21% in 2016.1 Trends within the Chinese market

- A savings ratio of 30% (compared to 5.60% in the UK) and central bank base rates below the rate of consumer price inflation have combined to create huge demand for alternative investment products in China. - From a base of 32 platforms that raised approximately 1 billion CNY (£118.6 million)2 in 2014, the market grew fivefold in 2015 to 130 platforms that raised approximately 5.2 billion CNY (£615.7 million). - Growth continued into the first half of 2016, with 144 platforms engaged in equity crowdfunding raising 3.6 billion CNY (£427 million), only to stall in the

1 http://about.beauhurst.com/the-deal-2016-overview Beauhurst, The Deal - 2016 2 £GBP 1 = 8.43 CNY (exchange rate as of March 2017) This is the exchange rate used through the document.

third quarter following a regulatory review and a loss of investor confidence. - Despite its significant growth, equity crowdfunding remains a small proportion of the total market for alternative investments. For example, the size of the Chinese equity crowdfunding market is around 0.5% that of the Chinese P2P market which raised 975 billion CNY (approx. £115.6 billion) in 2015. This is in part due to a lack of regulatory clarity.

UK Regulation and policy

- The Financial Conduct Authority (FCA) is responsible for regulating equity-based crowdfunding in the UK. A key feature of UK regulation is that platforms are allowed to facilitate investments from retail / unsophisticated investors. - In 2016 the FCA announced its review of current regulation, focusing on: levels of due diligence and financial promotion carried out by platforms; and innovation within the market. - Policies and tax reliefs such as the Enterprise Investment Scheme (EIS), the Seed Enterprise Investment Scheme (SEIS) and Social Investment Tax Relief (SITR) have helped grow the UK market.

Chinese Regulation and policy

- While the Chinese government has announced polices in support of internet financing and equity crowdfunding, the regulatory environment remains uncertain and subject to ongoing review. There is no clear catch-all regulation or regulatory body for equity crowdfunding in China. - Existing equity crowdfunding platforms in China adhere to one of two sets of regulations for 1) financial institutions or 2) internet financing platforms. Neither set of regulations satisfactorily covers all forms of equity crowdfunding as it exists in China, although revisions to the Securities Act (expected early 2017) may address the current limbo. - For now, however, nominee structures and secondary markets (through issue of shares) are barred, and regulations to monitor and minimise personal foreign exchange transactions effectively block individual investments in cross-border equity crowdfunding. - Regulatory uncertainty and the government’s hesitancy in this area is brought about by a wish to strike a balance between encouraging new forms of financing for entrepreneurs, providing new forms of investment services to investors, protecting less sophisticated ‘retail’ investors, guarding against outflows

of private capital and avoiding the fraudulent activity that has beset the P2P industry. - While there are many wealthy individuals in China there is not a mature retail investment environment. Information failures and regulatory uncertainty combine to create barriers to entry to the market.

UK platforms’ perspective on the Chinese market

- UK platforms are interested in the Chinese market, but currently have little or no activity in China. Key areas for improvement include: - More clarity on regulation of the Chinese market. - More insight into the Chinese market, particularly into which sectors are most suited to equity-based crowdfunding. - More clarity on: the Chinese government’s position on a foreign platform operating in China; Chinese investors bringing money out of China by investing in UK businesses; and overseas investors taking stakes in Chinese businesses via equity-based crowdfunding.

Chinese platforms perspective on the UK market

- Chinese investors have a sense of the potential of the UK market: it offers a stable and transparent regulatory environment and access to new ‘advanced’ / ‘high’ technology that could be scaled for the Chinese market. - However, the same opportunities exist on a larger scale in the US, and at time of writing this is a market with which Chinese investors express greater familiarity and security. - Governments, and industry, in both the UK and China may need to invest in pilot projects to exchange knowledge and investment in more structured ways, including experimentation with new technologies i.e. ‘bitcoin’, ‘block chain’ and to provide a proof of market to investors.

— 2. Introduction This paper is intended as an introduction to equity crowdfunding for both UK and Chinese professionals, investors, regulators and policy makers. It seeks to support China and the UK to cooperate through equity crowdfunding. This paper is the first phase developing a framework for cooperation identify how Chinese and UK businesses can cooperate through equity crowdfunding.

This paper can be read in linear fashion, or dipped into as a point of reference to promote further research into individual elements of the respective markets. It is not intended to replace the need for further due diligence, nor do we attempt to offer any legal opinion on the regulatory mechanisms described.

The work has been carried out on behalf of the British Government’s China Prosperity Fund by BOP Consulting, the UK innovation charity Nesta and ZhouYue Crowdfunding Industrial Park. The partners do not warrant any of the information contained herein as the basis of any investment decision.

Methodology

Equity crowdfunding is still a comparatively new field, and it is too early to assert authoritative statistical analysis or development of ‘grounded’ theory on its operation. Our method for this study reflects this; we have used a mix of published and unpublished secondary sources to provide the basis for a desk-based analysis of current market trends and regulatory conditions.

The comparative nature of the study also means that there are different levels of data available on the UK and Chinese market. It is worth nothing that historically there has been more research on trends and growth of the UK market, while there has been relatively little research into the Chinese market.

Research, carried out through consultations with equity crowdfunding platforms in China and the UK, including a round-table event for platforms and policy makers from both countries held in Guiyang in October 2016, has been used to support our analysis. China and the UK’s ‘Golden Era’

In the past decade, governments in both the UK and China have looked to strengthen political, economic, and trade ties. Press releases spoke about the

relationship between the two companies entering a ‘golden era,’ with former Chancellor George Osborne seeking to identify the UK as China’s ‘best partner in the West.’ 3

The growth in trade and investment between the United Kingdom and China has been significant; since 2002, UK exports to China have quadrupled to £12.5bn making China the UK’s 6th largest export market taking 3.6% of its goods and services.4

The UK has successfully focused on attracting Chinese investment and developing London’s financial centre into the world’s second largest CNY clearing hub. The UK attracted some US$12 billion of Chinese foreign direct investments in 2014 – more than France and Germany combined. London accounts for two thirds of offshore CNY payments outside mainland China and Hong Kong. 5 The UK was the first member state to apply for membership of the Asian International Infrastructure Bank (AIIB), despite opposition from the US.6

Defining Equity Crowdfunding

Crowdfunding, is a way of financing projects, businesses and loans through small contributions from many sources, rather than large amounts from a few. Equity crowdfunding (see Figure 1) is one of the four main types of crowdfunding (the other three being donation, rewards, and peer-to-peer lending).7

Type of crowdfunding Definition

Donations crowdfunding Non-investment model in which no legally binding financial obligation is incurred by fund recipients to donors; no financial or material returns are expected by the donor.

3 http://www.bbc.co.uk/news/uk-34621254 4 https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/211157/UK_Exports_to_China_-_Now_and_in_the_future.pdf 5 Foreword by Rupert Goodman dl Chairman and Founder FIRST http://www.firstmagazine.com/Publishing/SpecialReportsDetail.aspx?RegionId=4&SpecialReportId=9115 6 http://www.youngchinawatchers.com/brexit-lose-lose-outcomes-for-chinas-relations-with-the-uk-and-eu/ 7 http://www.nesta.org.uk/publications/pushing-boundaries-2015-uk-alternative-finance-industry-report

Rewards crowdfunding Donors have an expectation that the fund recipient will provide a tangible but non-financial reward or product in exchange for their contribution.

Equity-based crowdfunding Sale of shares, mostly in early stage firms, to retail, sophisticated and institutional investors.

Loan-based crowdfunding Secured and unsecured loans between individuals/institutions and either SME businesses or individuals (also known colloquially as “P2P lending”)

Debt-based security crowdfunding Individuals purchase debt-based securities (typically a bond or debenture) at a fixed interest rate. Lenders receive full repayment plus interest paid at full maturity

Figure 1 Types of Crowdfunding

— 3. Understanding UK Equity Crowdfunding This section sets out an overview of the equity crowdfunding market in the UK, including main trends in the market, its growth and the current state of regulation of the market. Its purpose is to provide a common basis for comparison with the market in China. A more comprehensive review or analysis of the market is made difficult by a number of factors. Firstly, there are gaps in the evidence available, particularly on investor returns as there have been very few exits. Secondly, it is too early to judge if the slowdown in Q3 is a temporary result of uncertainty in the market (with Brexit being a factor), the slowdown of the real- estate market, or the more permanent result of market saturation.

Size, growth and performance of the UK market

UK equity based crowdfunding has seen rapid annual growth in the last few years. As documented by the annual benchmarking survey of the sector by Nesta and the University of Cambridge, the market has gone from facilitating £28 million worth of investment in 2012 to £332 million in 2015. In 2015 the market reported a growth of 295% over the previous 12 months (see Figure 2).8

The growth in market volume has brought with it an increase in equity crowdfunding platforms operating in the UK, market, with the number of FCA authorised equity crowdfunding platforms increasing from 14 in 2015 to 23 in July 20169.

8 http://www.nesta.org.uk/publications/pushing-boundaries-2015-uk-alternative-finance-industry-report 9 https://www.fca.org.uk/publication/call-for-input/call-input-crowdfunding-rules.pdf

Equity-based Crowdfunding Market Volume by Year and by Quarter (2013 to 2015)

350 331.64 295% 86.58 Equity-based Crowdfunding (Real 300 Equity-based Estate) Crowdfunding (Real Estate) Equity-based Crowdfunding 250 (excluding Real Estate) All Quarters 200 81.70

245.03 Q4 150 £ millions Equity -based 69.58 Crowdfunding Q3 100 (excluding Real 200 Estate) 54.99 Q2 50 84 Q1 28 38.76 0 2013 2014 2015 2015 (excluding Real Estate)

Figure 2 : Graph of UK equity-based crowdfunding market volume

While equity crowdfunding, along with the other forms of crowdfunding, is often labelled as ‘alternative finance’, the rapid growth in the volume of investments made through equity crowdfunding since 2013 has seen this form of finance become an established and significant part of the market for investment in start- ups. The 2015 Nesta / Cambridge market study found equity crowdfunding accounted for 15.6% of all UK seed and venture stage equity investment in 2015,

with the number of deals rising from 175 in 2013 to 720 in 2015.10 Recent estimates suggest that the share grew to 21% in 2016.11

In Q3 2016 several leading UK equity crowdfunding platforms began publishing more data about their portfolio, such as average internal rate of returns. Seedrs announced IRR of 14.44% and SyndicateRoom indicated a rise in value of 35%.12 However, there have been very few exits in the market to date. At this time IRR should not be used as a benchmark for the actual performance of the market and how likely investors are to receive such levels of return.13

It is worth noting that, like the rest of the UK equity finance market, equity crowdfunding data for the first half data of 2016 indicates a slowdown in both number and volume of deals14. It is not yet known if if this was because of deals being postponed owing to the uncertainty surrounding Brexit, the slowdown in parts of the UK real estate market, or wider economic factors.

UK Market Trends

A key feature of the crowdfunding model is its flexibility - both in terms of the size of campaigns and types of projects that use crowdfunding to raise finance. However, with this in mind, studying the UK market has given us some insight in to the average size of campaigns, the most popular sectors on UK platforms, and trends in volume and type of investments made.

The 2015 Nesta benchmarking report showed the average project size was £523,978, with projects receiving funding from an average of 77 investors and investors having an average portfolio of four to five investments on a platform. Just over a quarter (27%) of the 68,306 investors on equity crowdfunding platforms were identified as sophisticated or ‘High Net Worths’ (HNW).

Equity crowdfunding is being used to fund ventures and start-ups in a range of sectors. Real estate crowdfunding is one of the most popular sectors and has grown to make up around a quarter (£87m) of the total equity crowdfunding market in 2015. The 2016 Nesta report on the UK market defined real estate equity

10 http://www.nesta.org.uk/publications/pushing-boundaries-2015-uk-alternative-finance-industry-report 11 http://www.forbes.com/sites/davidprosser/2017/02/10/how-crowdfunding-took-on-private-equity-and-won/#3da6f5f54922 12 Please note that the IRR published by Seedrs and SyndicateRoom were calculated using different methodologies are therefore not directly comparable

13 http://www.thememo.com/2016/09/30/crowdfunding-this-is-where-to-put-your-dough/ 14 http://about.beauhurst.com/hubfs/Beauhurst_The_Deal_H1_16.pdf

crowdfunding as, ‘Direct investment into property by individuals, usually through the sales of a registered security in a Special Purpose Vehicle (SPV)’. UK real estate crowdfunding covers property projects such as residential buy-to-let, direct equity investments in commercial real estate15, new-build developments, residential conversions and develop-to-let.

Beyond real estate, the most popular sectors funded on equity-based crowdfunding platforms in 2015 were technology, food and drink, Internet and e-commerce, and media and publishing.

Activity and performance levels within different sectors vary across platforms. For example, Seedrs, one of the UK’s largest equity crowdfunding platforms in 2016, reported that its best performing sectors were food and beverage (22.8% non-tax adjusted IRR), home and personal (17.8% non-tax adjusted IRR) and finance and payments (16.91% non-tax adjusted IRR)16. On SyndicateRoom, another of the larger UK platforms, 34% of the companies who have raised finance are from the life science sector.17

UK Cross-border activity

To date, information on cross-border flow of investment suggests it to be low. Studies indicate that in 2015 the reported cross-border inflow (non-UK based investors investing in UK equity crowdfunding campaigns) was 11.6% of total value and the reported outflow (UK investors investing via UK platforms in non- UK campaigns/companies) was 4.89%. While the volume of in- and outflow remains relatively low, platform data indicates significant international interest in the UK market.18 For example, Seedrs has reported that it attracted investors from over 75 countries in 2016.19

Several UK platforms have opened offices outside the UK in an attempt to increase their international activity20. For example, Seedrs has set up offices in

15 http://bridgingandcommercial.co.uk/article-desc-6171_new-commerci 16 http://www.crowdfundinsider.com/2016/09/89883-seedrs-drives-irr-14-44-since-2012/ 17 https://www.syndicateroom.com/about-us/success-stories 18 http://www.nesta.org.uk/publications/pushing-boundaries-2015-uk-alternative-finance-industry-report 19 http://www.forbes.com/sites/trevorclawson/2016/10/21/crowdfund-expansion-seedrs-moves-into-europe-with-eu-financial-services-passport/#d16daf978b53 20Case study info for Crowdcube and Seedrs (See 3.4)

Portugal, USA, Netherlands and Germany21, and CrowdCube has opened offices in Spain where it successfully completed 17 fundraises in 2015.22 Case-studies and Business models in the UK Market

As described previously, equity crowdfunding can be defined as the sale of shares, mostly by early stage firms, to retail, sophisticated and institutional investors using an online platform.

Within this broad definition the different platforms operate a variety of business models for equity-based crowdfunding. There are also ‘hybrid’ models: we find platforms that cater solely for angel investor networks rather than the ‘crowd’ of retail investors; and some platforms (e.g. Syndicate Room) where co-investment with experienced business angels is promoted on a platform as a form of reassurance of deal quality for less sophisticated investors.

In the UK, platforms either offer investors ‘direct ownership’ structures in which an individual investor manages their own shares, or a ‘nominees’ structure in which the platform manages the shares on the investors’ behalf.23

- Platforms with direct ownership structures claim this offers investors a greater sense of ownership of the firm as they communicate directly and without intermediary fees. However, communicating with multiple shareholders can be a burden for small businesses. Many platforms that offer direct ownership models only offer class B shares that limit investor voting rights. - Platforms with nominee share structures advocate their approach on the grounds that it reduces the administrative burden on firms, as they only need to deal with the Nominee (often the platform) who acts on behalf of the investors. This model is also promoted on the basis that it can reduce the risk of share dilution (the firm issuing further shares that reduces the price of existing ones).

In addition to the differences between the nominee and direct ownership approach, platforms also operate different fee structures. For example, some platforms do not charge investors but do charge firms. Others charge both investors and firms, claiming that this approach aligns its interests more with investors.24

Within the growing real-estate equity-crowdfunding sector, investments are usually made by individuals into a property development project via a Special

21 http://www.forbes.com/sites/trevorclawson/2016/10/21/crowdfund-expansion-seedrs-moves-into-europe-with-eu-financial-services-passport/#d16daf978b53 22 http://www.crowdfundinsider.com/2016/07/87629-first-crowdcube-spain-receives-regulatory-approval-participatory-funding-platform/ 23 For example, Crowdcube offers investors direct ownership while Seedrs uses a nominee structure. See case studies 24 see case studies section.

Purpose Vehicle (SPV) operated by the platform25.

Examples of UK crowdfunding platforms

Crowdcube

Crowdcube is the UK ‘s first equity crowdfunding platform (launched in 2011) and is regulated in both the UK and Spain26. Crowdcube operates through a direct ownership model: each investor has a direct responsibility to manage their investment and only charges fees to firms seeking investment27. Although Crowdcube lists projects from a broad range of business sectors, the most popular sectors for investment on the platform are internet, technology and food and drink.

As of Q3 2016, Crowdcube had successfully funded over 440 projects and cumulatively raised over £165m. Crowdcube has had two successful exits: E-Car Club in July 2015, and Camden Town Brewery in December 2015. Crowdcube does not provide data on the number of project failures. However, alongside the two first exits in the market, it has hosted the UK’s biggest equity crowdfunding failure: Rebus Group went into liquidation eight months after raising £800k, raising concerns about the platform’s due diligence process.

Seedrs

Seedrs (launched 2012) 28 was the first equity-based platform to be FCA regulated and is currently the largest platform by number of deals, having successfully funded over 380 deals and cumulatively raised over £150m. 29

Seedrs operates a nominee structure, which allows the platform to negotiate on behalf of all investors. It applies fees both to firms seeking to raise funds and

25 http://www.nesta.org.uk/publications/pushing-boundaries-2015-uk-alternative-finance-industry-report 26 www.crowdcube.com 27 https://www.crowdcube.com/fees 28 www.seedrs.com 29 http://about.beauhurst.com/hubfs/Beauhurst_The_Deal_H1_16.pdf

to investors30. Seedrs has offices in the UK, Portugal, USA and Netherlands. It funds a variety of business sectors: the three most popular (in terms of number of funded deals) are food and beverage (11%), finance and payments (11%) and travel, leisure and sport (10%).

Seedrs recently published a performance portfolio which stated its Internal Rate of Returns for investors (IRR) was 14.44%31. Seedrs has offered several exit opportunities to investors. winemaker and craft brewer Chapel Down, and Coinsilium, an accelerator for early stage blockchain technology companies. Both raised finance on Seedrs whilst already trading publicly on the ISDX Growth Stock Market.32 In addition, in November 2016 FreeAgent, an accounting software company which closed £1M on Seedrs in 2015, raised £10.7M on the Alternative Investment Market (AIM). This was thought to be the first time a company had gone on to IPO after raising finance through equity crowdfunding.33

As of June 2017, Seedrs also began offering secondary market functionality to the platform. This secondary market allows investors to buy and sell shares from each other over the first week of every month34.

No data is published on the actual number of project failures. However, in the last 15 months has seen a number of failed projects that went into liquidation shortly after raising funds. The most recent of these was Pronto, a food and drink project, which raised £800k and failed after three months in Sept 2016.

SyndicateRoom

SyndicateRoom (launched March 2013)35 has a focus on early stage British businesses. SyndicateRoom is a pioneer of co-investment, requiring projects to have a lead investor (either business angel or institution) that must fund 25% of the deal before opening the investment to others. It is also the first platform to

30 https://www.seedrs.com/learn/blog/seedrs-news/features-updates/seedrs-referrals-and-fees 31 https://assets.seedrs.com/documents/portfolio_update_2016.pdf 32 In September 2014, Chapel Down raised more than £3.95m investment through Seedrs having been trading on ISDX Growth Stock Market since August 2010, making them the first publicly-listed company to offer its shares through equity crowdfunding. Coinsilium, raised £1,126,047 through Seedrs in December 2015 while concurrently launching trading on ISDX Growth Stock Market.

33 https://www.crowdfundinsider.com/2017/01/94357-seedrs-hits-85m-invested-159-crowdfunding-campaigns-2016/ 34 https://www.seedrs.com/secondary-market

35 https://www.syndicateroom.com

offer its investors access to the public equity market through the platform (from March 2014) and invest in Real Estate Investment Trusts (REITs). SyndicateRoom initially had a direct ownership model but in November 2015 changed to a nominee structure. Fees are only applied to firms raising funds on the platform.36

As of Q3 2016, SyndicateRoom had successfully funded £57m, and 70 out of 72 firms of the firms it has helped raise funds were still trading. Syndicate recently celebrated its first exit after Oval, a medical company, was acquired by SMC Ltd two years after its initial crowdfunding investment in 2014.37

Property Partner

PropertyPartners (launched February 2015) 38 exclusively funds the purchase and management of buy-to-let and commercial property via Special Purpose Vehicles (SPVs). The platform uses a nominee structure and offers dividends to investors based upon monthly rental income and capital growth of the investment in line with the proportion of their ownership. There are fees for both the investors and firms offering investment.

As of Q3 2016 PropertyPartners had invested £37m in 245 properties and has a secondary market for investors seeking to exit their investment.

The History and Development of the UK Equity Crowdfunding Market

Equity crowdfunding first took place in the UK in 2011. The industry has seen several key developments in the last five years, including regulation by the Financial Conduct Authority (FCA) and rapid growth.

36 https://www.syndicateroom.com/faqs/what-are-the-fees-for-companies-listing-on-syndicateroom 37 https://www.syndicateroom.com/blog/oval-medical-syndicaterooms-first-exit 38 www.propertypartner.co

Figure 3

Regulation of UK Equity Crowdfunding

The UK regulator, the FCA, is responsible for the regulation of investments, and the communication of a financial promotion in relation to securities39. Equity crowdfunding platforms operating in the UK have to meet the FCA principles and core business conduct rules around disclosure, client money and financial promotion, as well as prospectus rules and the Companies Act. Firms selling equity over €5m are also subject to the requirements of EU Markets in Financial Investment Directive (MIFID).40

In October 2013, the FCA consulted on formalising a bespoke regime for the financial forms of crowdfunding41. Before and during the consultation, FCA spoke with key stakeholders, such as UK platforms and industry bodies, to gather information and evidence as the basis for its regulatory policies42. Following this consultation, the FCA created a new category, ‘Non-Ready Realizable Securities’ (NRRS) 43, which covers equity or debt securities for small/medium firms, that are difficult to price, offer no or limited access to a secondary market, or are not listed on a recognised exchange44. NRRS include but are not limited to investments made through crowdfunding platforms.

In March 2014, an FCA policy statement set out rules to allow a broader range of investor, including retail, to use equity crowdfunding platforms.45 The rules that came into force in April 2014 enable platforms to make direct offers to:

- professional clients - sophisticated retail clients (that are either certified or self-certified) - High Net Worth retail clients (that are certified) - retail clients who are advised, or - retail clients who commit to invest no more than 10% of their assets and meet appropriate test requirements.

39 https://www.fca.org.uk/publication/thematic-reviews/crowdfunding-review.pdf 40 http://ec.europa.eu/transparency/regdoc/rep/10102/2016/EN/10102-2016-154-EN-F1-1.PDF 41 https://www.fca.org.uk/publication/consultation/cp13-13.pdf 42 https://www.crowdfundinsider.com/2016/10/91529-bruce-davis-md-abundance-shares-insight-perspective-fca-regulatory-review/ 43 A NRRS – is a security which is not: a readily realizable security i.e it is illiquid / unlisted, a packaged product or a non-mainstream pooled investment 44 https://www.fca.org.uk/publication/consultation/cp13-13.pdf 45 https://www.fca.org.uk/publication/policy/ps14-04.pdf

A distinctive feature of UK regulation is that FCA rules allow retail clients to invest. However, retail access is restricted because the FCA recognises equity crowdfunding as high-risk, owing to the increased likelihood of failure among the type of early-stage ventures that the finance model attracts.46 Although some platforms will accept very modest investments (Crowdcube, for example, will accept investments as low as £10), platforms are required to perform an ‘appropriateness test’ on retail clients to ensure that they understand the risks of the investments. Currently the exact format of this test is not prescribed by FCA, and is left for platforms to devise. However, platforms must ask retail clients if they have taken professional advice on the investment or to self-declare they will invest no more that 10% of their investable funds.

UK regulation identifies two other types of investor: ‘sophisticated’ and ‘High Net Worths (HNW)’.

Sophisticated investors are certified by meeting one of the following criteria:

1) They have been a member of a business angel organisation. 2) They have had more than one investment in an unlisted company. 3) They have worked in the private equity sector. 4) They have been a director of a company with a turnover of £1 million or more.

HNW are defined as those who earn at least £100,000 a year, or have at least £250,000 in assets (not including their home). In November 2014, FCA also issued guidance to all firms about promotion of investments via social media which, because of the online nature of equity crowdfunding and its promotions, are particularly relevant to the sector.47

46 http://www.forbes.com/sites/trevorclawson/2016/10/21/crowdfund-expansion-seedrs-moves-into-europe-with-eu-financial-services-passport/#d16daf978b53 47 https://www.fca.org.uk/publications/finalised-guidance/fg15-4-social-media-and-customer-communications-fca’s-supervisory

2016/17 FCA Regulatory Review

The FCA committed to review the crowdfunding sector in 2016 to ensure the rules it announced in 2014 remained appropriate. In July 2016, the FCA issued a ‘Call for input’ paper48, which flagged several areas in the industry that might require additional regulation:

Preferential treatment of institutional over retail investors: The Nesta industry report found there is a growing trend for institutional involvement within the alternative finance market, particularly in peer-to-peer lending where they estimate that in 2015 institutional investors funded 32% of loans in peer-to-peer consumer lending, and 26% of peer-to-peer business loans. As the volume of institutional investors increases in the sector, 49 there is concern over an increased risk that platforms may discriminate between investors by offering better terms to large institutions. While institutional involvement in equity-based crowdfunding is considerably lower than for P2P lending, accounting for an estimated 8% of investments, it is becoming increasingly commonplace. The FCAs concerns, which focused on P2P lending, may therefore also be relevant for equity-based crowdfunding if platforms offer better terms to large institutions such as venture capital funds, than to small retail investors.

The FCA call asked for opinions on any potential conflicts of interest between the needs of project owners, investors and the platforms’ own need to be profitable which could adversely impact the sector’s customers. An Interim Review of the call published in December 201650, reported complaints of preferential treatment of institutional investors in the form of: ‘early, exclusive or effectively exclusive access to loans’, ‘greater access to information about borrowers provided by the originating platforms’, ‘option to opt-out from lending to segments of the market’, ‘retail investors were being exposed to loans pre-screened and rejected by institutional investors without knowing this’. They also note that institutional investors may bring benefits to retail investors in the form of increased due diligence of projects. The interim review highlighted an additional risk from the development of secondary markets where institutional investors may exploit the information asymmetry, disadvantaging less sophisticated retail investors.

Due diligence of projects: the current FCA rules allow platforms to decide their own approach to due diligence to projects, and only require that platforms disclose how much due diligence has been done to enable investors to decide for themselves if they need to do further research. This raises a potential conflict of interest whereby it may be in the platforms interest to maximise their profits by getting as many projects through the door as possible, but in the interest of investors for projects to be subject to a higher standard of due diligence. The perception that an increasing numbers of projects are failing shortly after raising

48 https://www.fca.org.uk/publication/call-for-input/call-input-crowdfunding-rules.pdf 49 http://www.nesta.org.uk/publications/pushing-boundaries-2015-uk-alternative-finance-industry-report 50 https://www.fca.org.uk/publication/feedback/fs16-13.pdf

finance has led to a question of whether new rules are needed requiring platforms to set a minimum level of due diligence on projects. In the interim review, the FCA report that the majority of their respondents to the call did not recommend introducing minimum levels of due diligence.

Appropriateness test: the FCA will be reviewing how platforms apply appropriateness tests to ensure investors are classified correctly in line with regulatory requirements and may issue guidance to the sector.

Disclosure: the FCA is considering expanding mandatory disclosure by platforms about projects, to include:

- The amount each project has raised since pitch - The number of projects that have failed after successfully fundraising - Showing only money funded by people unconnected to the project to ensure investors are not misled about the level of interest in the projects - The UK the Government is considering offering equity crowdfunding inside the Innovative Finance Individual Savings Account (IF-ISA) tax free wrapper, which is likely to attract less informed investors. To address this the FCA is considering setting a higher bar of mandatory disclosure of information for investment opportunities that qualify for the ISA. - In the Interim report published in Dec. The FCA reported that they ‘remain concerned that standards of disclosure do not meet our expectations’ and are considering further rules on disclosure.

Development of new business models: The FCA notes the expansion of business models highlighted by Nesta’s ‘Pushing Boundaries’ report51 into new types of investment, such as mini-bonds/convertible notes, real estate investment trusts (REIT), and accelerator funds that may require new rules to be introduced to reduce the risks of regulatory arbitrage. The interim review adds that the complicated nature of mini-bonds means there is added risk of retail investors misunderstanding the risks involved and there may be gaps in the regulation of the SPVs involved in real estate crowdfunding.

The FCA will use the information from this call for input, along with research targeting its various areas of consideration, to identify if there is a case to consult on strengthening regulation for the sector in 2017. The paper also highlighted that, as of Q2 2016, there were 23 FCA authorised investment-based crowdfunding firms and 11 appointed representatives.

51 http://www.nesta.org.uk/publications/pushing-boundaries-2015-uk-alternative-finance-industry-report

UK Polices related to the Equity Crowdfunding Market

Equity-based crowdfunding has been credited with popularising seed stage equity investment and, consequently, increasing the level of seed-stage equity investment in the UK. 52

The UK has two prominent tax relief schemes to incentivise funding through equity finance, which are both widely used by equity crowdfunding firms to encourage investment. The Enterprise Investment Scheme (EIS)53 introduced in 1994 was designed to help smaller higher-risk trading companies to raise finance by offering a range of tax reliefs to investors who purchase new shares in those companies 54.

The Seed Enterprise Investment Scheme (SEIS) 55, launched in April 2012, focuses on helping small, early-stage companies raise equity finance by offering tax reliefs to individual investors who purchase new shares in those companies.

Another incentive, Social Investment Tax Relief (SITR), was launched in 2014 to boost social enterprise. However, unlike EIS and SEIS deals, which are often exclusively featured through platforms, there is no clear picture yet as to if or how much the scheme has been utilized by the crowdfunding sector.

As Figure 4 shows, the benefits/rules of EIS and SEIS are similar, enabling firms to easily follow SEIS start-up investment with EIS

SEIS (2012) EIS (1994) SITR (2014) Aim Designed to help Designed to help Designed to high risk small small early-stage encourage investment companies raise companies raise in social enterprises equity finance equity finance Investor benefits

52 http://british-business-bank.co.uk/wp-content/uploads/2015/03/050315-Equity-report-FINAL.pdf 53 https://www.gov.uk/government/publications/the-enterprise-investment-scheme-introduction/enterprise-investment-scheme 54 https://www.gov.uk/government/publications/the-enterprise-investment-scheme-introduction/enterprise-investment-scheme 55 https://www.gov.uk/guidance/seed-enterprise-investment-scheme-background

Upfront income 50% up to max 30% up to max 30% up to max tax relief qualifying investment of £1m, investment of £1m, investment of which can be carried which can be carried £100,000 held for back to previous tax back to previous tax three years that can year year be carried back to earlier tax year Inheritance tax 100% 100% - relief Capital gains 50% tax relief for re- Tax deferral for the Tax deferral for the life investment life of the qualifying of the qualifying investment investment Growth / profit Tax Free Tax free Tax free

Figure 4 UK tax investment schemes used by UK equity crowdfunding firms

Following the 2015 announcement of the Innovative Finance Individual Saving Account (IF-ISA) for Peer-to-Peer lending and debt-based debentures, the UK government has also consulted on the possibility of incorporating equity crowdfunding into the popular tax-free wrapper of Individual Savings Accounts (ISA) that currently enables investors to invest up to £15,240 in eligible saving or investment products.56

In addition to tax incentives, the UK government is looking at other ways to promote awareness of equity crowdfunding and other sources of alternative finance to UK businesses. The British Business Bank co-ordinates the development of an annual business finance guide, available to UK businesses online and through chartered accountants, which promotes both traditional and alternate forms of finance. And the Department for Business Energy and Industrial Strategy (BEIS – formerly BIS) has implemented an SME referral scheme requiring banks and traditional finance providers to refer those SMEs refused funding to designated portals which offer alternative sources of funding.57

56 https://www.gov.uk/government/publications/income-tax-crowdfunding-and-individual-savings-accounts/income-tax-crowdfunding-and-individual-savings-accounts 57 https://www.gov.uk/government/consultations/sme-finance-help-to-match-smes-rejected-for-finance-with-alternative-lenders

UK Crowdfunding Association (UKCFA)

The UK Crowdfunding Association (UKCFA) was launched in 2012 as a membership organisation for the crowdfunding platforms in the UK. The association lobbies in the UK for a regulatory landscape that is supportive of crowdfunding whilst offering robust levels of consumer protection. Building on this the UKCFA describes how its main aim is to:

- Promote crowdfunding as a valuable and viable way for UK businesses, projects or ventures to raise funds. - Be the voice of all crowdfunding businesses in the UK (donations, loans and equity) to the public, press and policymakers. - Publish a code of practice that is adopted by UK crowdfunding businesses.58

UKCFA is funded by member subscriptions (40 member platforms, 30 UK supporting organisations, and a number of international organisations) and is run by a group of industry representative directors59. It engages with UK Government via the Crowdfunding All Party Political Group (APPG)60 and through consultations with key stakeholders such as HM Treasury (HMT), HM Revenue and Customs (HMRC), Department for Business, Energy and Industrial Strategy (BEIS) and the FCA).

58 https://www.ukcfa.org.uk/ 59 https://www.ukcfa.org.uk/about-us/ 60 http://www.publications.parliament.uk/pa/cm/cmallparty/register/crowdfunding-and-non-banking-finance.htm

— 4. Understanding Chinese Equity Crowdfunding The alternative investment market in China, of which equity crowdfunding forms a small percentage, is configured very differently from that in the UK. The difficulty of presenting a clear picture is exacerbated both by a lack of data transparency and a very different (and frequently ambiguous) set of regulatory policies. With those caveats, and the further qualification that this is not intended either as a comprehensive guide to the market or a legal reference, here we attempt an overview of the equity crowdfunding sector in China.

Equity crowdfunding exists in a quasi-regulated state in China. It is effectively limited to institutional and ‘sophisticated’ investors and the regulatory position is under constant review. While government is keen to harness the potential in equity crowdfunding to support the development of entrepreneurialism in China, this enthusiasm is countered by concerns about risk to ‘unsophisticated’ investors i.e. retail investors and the general public. The government is concerned that retail investors and the public do not understand the potential risks associated with equity crowdfunding, and that any widespread market failure and investor loses would be damaging to the government. This is reflected in unclear regulation conditions which attempt to strike a balance between encouraging new forms of financing for entrepreneurs, providing new forms of investment services to investors, protecting retail investors and avoiding the fraudulent activity that has beset the P2P industry.

Defining Chinese Equity Crowdfunding

A restricted version of equity crowdfunding exists in China that is not available to retail investors and the general public. Currently, there are strict criteria for users who wish to access investment opportunities through Chinese platforms and a plethora of regulations affecting platforms who offer investment opportunities. Unlike in the UK, equity crowdfunding in China is typically limited to accredited, sophisticated and institutional investors. The Chinese government wants to mitigate the risk to less experienced investors and the potential subsequent political implications.

This section defines equity crowdfunding from a Chinese context. Regulations and laws pertaining to equity crowdfunding are detailed in section 4.7.

The word crowdfunding in Chinese 众筹 (zhongchou) is typically associated with reward based crowdfunding platforms. Unlike equity crowdfunding, reward crowdfunding offers clear and explicit benefits and returns to the crowd. The Chinese government is keen to ensure the public understands both the greater

risks associated with, and the current lack of explicit regulations pertaining to equity crowdfunding. 61 Consequently, equity crowdfunding 股权众筹 (ququan zhongchou), whereby the ‘crowd’ i.e. the general public or a large number of people, can invest and purchase registered securities is considered unregulated and illegal in China. There are several restricted versions of equity crowdfunding available in China and these are typically described in China as ‘non-public equity financing through the Internet’ or ‘private equity financing through Internet’. These restricted versions of equity crowdfunding have a quasi-regulated status which is explained in this section.

According to the Guidance to Promote the Healthy Development of Internet Finance (‘Guidance’)62 issued July 2015 by a consortium of government ministries and regulatory bodies, equity crowdfunding refers to ‘activities that raise small sums of equities publicly through the Internet’.

The Announcement to Inspections of Internet Equity Financing Activities (‘Announcement’)63 issued August 2015 by China Securities Regulatory Commission (CSRC) recognizes the general term ‘equity crowdfunding’ and proposes three categories of equity crowdfunding: 1) public equity crowdfunding; 2) non-public equity financing through the Internet and 3) private equity financing through the Internet.

The three categories are loosely defined in the Announcement as follows:

1) ‘Public equity crowdfunding’ is open to the general public. The value of each share is supposed to be comparably small (i.e. a small percentage of the total funding target or a larger percentage of a small funding target), and there are many individual investors i.e. the crowd. 2) ‘Non-public equity financing through the Internet’ is not open to the general public. There are strict requirements for people who want to access and participate in the investment opportunities through a platform. This form of financing is usually for accredited individual investors and the number of investors per investment opportunity is limited. 3) ‘Private equity financing through the Internet’ is not open to the general public. It is similar to traditional offline equity financing. Investors could be institutional or accredited investors. This form of fund raising typically applies to relatively large investment opportunities.

As per the Guidance and the Announcement, ‘public equity crowdfunding’ activities must get approval from the CSRC. However, as the CSRC has no regulations pertaining specifically to the approval of ‘public equity crowdfunding’ as defined in the Guidance, ‘public equity crowdfunding’ is both unregulated and illegal.

61 http://www.zczj.com/column/2016-10-13/content_9107.html 62 2015 年 7 月 18 日十部委《关于促进互联网金融健康发展的指导意见》 63 2015 年 8 月 7 月证监会《关于对通过互联网开展股权融资活动的机构进行专项检查的通知》2015 年 8 月 7 月

‘Public equity crowdfunding’ platforms - platforms that offer investment opportunities to the general public - are viewed as facilitating ‘illegal fund-raising’.64

Chinese platforms, which in the UK would be considered as providing equity crowdfunding services, are defined in the Announcement as, ‘non-public equity financing through the Internet’ or ‘private equity financing through the Internet’.65 Regulations pertaining to ‘non-public equity financing through the Internet’ and ‘private equity financing through the Internet’ are detailed in section 4.7.

For the purposes of this report, unless stated otherwise, when we reference equity crowdfunding in China we are referencing all three versions of equity crowdfunding as defined in the Announcement. Size and Growth of the Chinese Market

In 2014, crowdfunding platforms in China initiated 3,091 equity crowdfunding projects that raised approx. 1 billion CNY (approx. £118.6 million).66 By the end of 2014, there were 32 equity crowdfunding platforms in China.67 In 2015, equity crowdfunding platforms in China raised 5.19 billion CNY (approx. £615.7 million) in total, a fivefold increase from the previous year. By the end of 2015, the number of platforms had risen to 130. 68 In the first half of 2016, 144 platforms engaged in equity crowdfunding and 3,254 projects69 raised total 3.6 billion CNY70 (approx. £427 million). However the most recent data from August to November 2016 indicates that the sector has severely contracted, with the total funds raised in November 2016 estimated to be 200 million CNY (approx. £23.7 million).71 This is due to changes in the regulatory environment (see 4.8) and a loss in confidence in the sector (see 4.3).

Note - Information on the size and volume of individual investments is not available.

64 2015 年 8 月 7 月证监会《关于对通过互联网开展股权融资活动的机构进行专项检查的通知》2015 年 8 月 7 月 65 http://www.askci.com/news/2015/08/21/113442yo97.shtml Announcement to Inspections of Internet Equity Financing Activities65, China Securities Regulatory Commission, August 2015). 66 http://www.199it.com/archives/337065.html 67 http://www.chinabgao.com/stat/stats/43525.html 68 http://finance.sina.com.cn/roll/2016-01-16/doc-ifxnrahr8378737.shtml 69 http://www.zczj.com/news/2016-08-01/content_8140.html 70 http://bank.jrj.com.cn/2016/12/30112321910637.shtml 71 http://bank.jrj.com.cn/2016/12/30112321910637.shtml

Chinese Market Trends

- Research suggests there is a savings ratio72 of approximately. 30% in China.73 74 - i.e., that Chinese citizens save some 30% of their earned income. - The Consumer Price Index (CPI) increased by 2.0% in 2014, while interest rates remained at 1.75%.75 The low interest rate has stimulated enormous demand in China for alternative investment products. - Compared with other alternative finance sectors the market size of equity crowdfunding is relatively small. For example, the size of the Chinese equity crowdfunding market is around 0.5% that of the Chinese P2P market which raised 975 billion CNY (approx. £115.6 billion) in 2015.76 Ongoing regulatory review (see 4.8) and the government’s cautious attitude hinders the sector’s development. 77 - Starting in 2015, large technology and e-commerce companies including Alibaba78, JD79, 36080 and Xiaomi81 established their own equity crowdfunding platforms. These companies leverage their brand and existing user base to support entrepreneurs looking to raise funds.82 - More recently vertical and specialised equity crowdfunding platforms have started to emerge, including industry-specific platforms for agriculture83, automobile84, real estate85 and restaurants86. - Pending regulation for ‘public equity crowdfunding’ (equity crowdfunding that is accessible to the general public), the sector has become known for serving wealthy and more sophisticated individual and institutional investors: angel investors and venture capital firms.87

72 savings ratio = (residents average revenue – residents average expenses)/ residents average revenue 73 http://money.163.com/16/0519/17/BNEOIDU800253B0H.html 74 The savings ratio published by World Bank contains also corporate savings (64%) which is not representative for residential savings ratio. 75 http://money.sohu.com/20150923/n421884047.shtml 76 http://p2p.hexun.com/2016-01-04/181584365.html 77 https://zhuanlan.zhihu.com/p/21533461 78 https://www.antsdaq.com 79 https://dj.jd.com/index.html 80 https://t.360.cn 81 https://www.antsdaq.com 82 http://www.100ec.cn/detail--6304102.html 83 http://www.hhgoat.com/home/yx/?cj=yhq9418 84 http://www.qichezhongchou.cn 85 They have closed down after the regulation issued on October 2016 (See 4.7) 86 http://www.kaoputou.com 87 http://www.weiyangx.com/224466.html

- Due to the risks associated with start-up and early stage investment, some platforms exclusively offer investment opportunities in mature businesses: both 360 88 and Xiaomi 89 choose to encourage institutional investors, rather than individual investors.90 - In June 2016, the press reported investor suspicions of fraudulent behaviour with Hongli Energy’s campaign on the platform 36Kr.91 Sales revenue in 2015 released by Hongli Energy through the campaign didn’t match the figure disclosed in its annual report. 36Kr was also accused by investors of not fulfilling its due diligence responsibilities. This case negatively impacted subsequent campaigns on 36Kr and damaged confidence in the sector. 92 - In October 2016 the government announced it was undertaking a review of the entire Internet Finance sector, including equity crowdfunding (see 4.8). The review, due to be completed early 2017, is intended to clean up the industry and further protect investors.93 - The suspected case of fraud and the recent government review has led to a reduction in the number of platforms offering equity crowdfunding services and the amount of money raised through platforms still offering equity crowdfunding services. (See - Figure 5 and Figure 6, below.)

88 https://t.360.cn 89 https://www.antsdaq.com 90 http://www.weiyangx.com/224466.html 91 https://www.36jr.com 92 http://www.tmtpost.com/1920834.html 93 10 月 13 日国务院办公厅印发《互联网金融风险专项整治工作实施方案的通知》http://www.gov.cn/zhengce/content/2016-10/13/content_5118471.htm

80 76 70 66 61 60 50

40 33 27 30 20 18 20 10 0 2015 First half Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 year 2016

Figure 5. Number of equity crowdfunding platforms that have ceased offering equity investment opportunities 94

94 http://bank.jrj.com.cn/2016/12/30112321910637.shtml

6000 5190 5000

4000

3000

2000

659 795 1000 604 432 540 594 472 373 228 248 206 0 2015 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16

Figure 6. Total raised on equity crowdfunding platforms (million GBP) 95

Chinese Cross-border activity

Outbound

Individual outbound cross-border investment is heavily regulated and restricted in China. This is related to the government’s wish to preserve its foreign currency reserve, maintain the CNY exchange rate, prevent money laundering and limit the emigration of wealthy people.96 Personal Foreign Currency Management

95 http://bank.jrj.com.cn/2016/12/30112321910637.shtml 96 http://finance.qq.com/a/20161212/008364.htm

Implementing Regulation97 limits individuals to $50,000 in currency exchange and overseas transactions per year.

Qualified institutional investors - business that have an investment approval certificate - need to seek further clearance for any outbound investment. (see section 5). Outbound investment of this type has become more restricted in recent times as the Chinese government attempts to slow down capital outflows.98

Established in 2015, the platform 优客投 (youketou) offers dedicated outbound cross-border investment opportunities to accredited investors (see 4.5). There is no evidence of other platforms offering outbound cross-border investment opportunities to individuals or qualified institutional investors.

Inbound

There is no evidence of individual or institutional inbound cross-border investment through equity crowdfunding in China. Existing platforms are limited to offering investment opportunities to accredited domestic investors (see 4.7)

Note - for further information on regulations pertaining to outbound and inbound cross-border investment, see section 5.

Case-studies and Business models in the Chinese market

The restricted forms of equity crowdfunding available in China (see 4.1) predominantly attract sophisticated and institutional investors. Platforms are not open to the ‘crowd’.

Unlike in the UK, there is no public data available for individual platforms; Chinese platforms have not to date volunteered data comparable to that available for their UK counterparts. Consequently, there is little known of the average campaign sizes, number of investors and the types of companies that have successfully and unsuccessfully used equity crowdfunding in China. It is unclear if equity crowdfunding is providing businesses and start-ups with new sources of funding and investors with new investment services as the government hopes.

Unlike in the UK, the nominee model is not encouraged in China (see 3.5 and 4.7): platforms tend to offer investment in companies directly or via a special

97 《个人外汇管理办法实施细则》 98 http://finance.qq.com/a/20161212/008364.htm

purpose vehicle (SPV).

Platforms in China tend to operate on a commission-based business model, similar to UK platforms.

There follows an overview of some of the main platforms operating in China. Where available, we provide details of their business model and sectors of focus.

Angel Crunch (天使汇) - angelcrunch.com

Angel Crunch, established in 2011, is one of the longest standing investment platforms in China. It aims to support start-up businesses in finding ‘angel investors’. The platform targets sophisticated experienced investors. It has strict requirements for investors to gain access to the platform, including evidence of prior investment experience and an existing portfolio. Angel Crunch’s model resembles that of Syndicate Room in the UK in that a project is required to have a lead investor before it is available to other investors on the platform. A lead investor must purchase a minimum of 5% and maximum of 50% of the equity on offer, and must have a history of at least one successful investment exit.

SPVs, typically Limited Partnerships, are set-up for projects with more than three investors. The platform offers a form of nominee structure for projects with less than three investors. The platform charges a 5% commission to investees and 5% commission on dividends earned.

Dajia Tou (大家投) - dajiatou.com

Dajia Tou, established in 2012, aims to enable small businesses to solicit investment from the ‘crowd’. While there are still minimum requirements for investors to gain access to the platform, the threshold for what qualifies as an investor is lower than Angel Crunch. The platform targets less sophisticated investors; but heavily vets all business and projects available through the platform.

SPVs are set-up for all projects that raise funds successfully. Funds collected are authorized and managed by the Industrial Bank of China (CIB). The platform charges a 5% commission from businesses who successfully raise funds through the platform.

JD Dongjia (京东东家) - dj.jd.com

JD is one of China’s top three E-commerce platforms. JD’s online private equity financing platform, JD Dongjia launched in March 2015 and has raised a total amount that exceeds 1.1 billion CNY and involves more than 60,000 investors.99 JD Dongjia offers a similar investor lead model to Syndicate Room and Angel Crunch; a lead investor must purchase a minimum of 30% and maximum of 80% of the equity on offer.100

Mic Finance (米筹金融) - micfinance.com

Xiaomi Technology is one of the best-known manufacturers of mobile and intelligent devices in China. Established in March 2016, Mic Finance is a Xiaomi subsidiary and supports Xiaomi’s diversification beyond hardware manufacturing. Mic Finance’s stated aim is to support entrepreneurship through equity crowdfunding 101 and to help small businesses develop new technologies.102 Xiaomi’s move into the Internet finance sector illustrates an appetite and the potential in China for large technology companies such as Xiaomi to make use of equity crowdfunding to support and develop their core business.

Youke Tou (优客投) - youketou.com

Youke Tou, established in April 2015, is the first platform in China to focus on cross-border equity crowdfunding, with most investment opportunities in the US and Australia. Priority sectors include cultural and creative industries, real estate, technology and education. The minimum fund raising target is typically more than 10 million CNY. The platform targets High Net Worth domestic accredited investors who are looking for overseas investment opportunities. Cross-border payments are managed by an unspecified ‘third party’; it is unclear how the platform adheres to existing cross-border investment restrictions for individuals (see

99 http://tech.sina.com.cn/i/2016-05-06/doc-ifxryahs0170257.shtml 100 http://www.zczj.com/news/2015-10-12/content_4230.html 101 http://it.sohu.com/20160615/n454419062.shtml 102 http://finance.qq.com/a/20161217/009291.htm

5).

The History and Development of the Chinese Equity Crowdfunding Market

Regulation of Chinese Equity Crowdfunding

This section describes relevant regulations and bodies, and their role in equity crowdfunding. While the government has announced polices in support of internet financing and equity crowdfunding, the regulatory environment remains uncertain and in a state of ongoing review (see 4.8). There is no clear catch-all regulation or regulatory body for equity crowdfunding in China. Existing equity crowdfunding platforms that operate in China adhere to one of two sets of regulations for 1) financial institutions or 2) internet financing platforms. Neither set of regulations satisfactorily covers all forms of equity crowdfunding as it exists in China. As a result, equity crowdfunding currently exists in a quasi-regulated state.

Financial Licences

Financial Licences 金融牌照 is a series of formal licences issued by one of the main regulatory bodies in China that regulate Chinese financial institutions.103 There are many types of financial licences, including Bank License, Trust License, Third Party Payment License and many others.104 Financial licences are typically issued to traditional financial institutions: for example, banks, insurance companies, trust funds and securities traders. Some emerging Internet companies involved in the finance service industry, for instance Alibaba and JD, have also applied for relevant financial licenses.

Currently there is no financial institution licence specific to equity crowdfunding. However, the China Securities Regulatory Commission (CSRC) typically regulates financial institutions that enable businesses to solicit investment from investors through the Internet. Existing platforms that operate under a financial licence include Zhongchou105 and JD Dongjia.

Internet Financing Platforms

In December 2014, CSRC issued ‘pilot draft’ regulations for comment, called Private Equity Crowd Funding Administrative Measures (pilot draft). 106 The draft regulations require all equity crowdfunding platforms to report to and register with CSRC and apply to become a member of the Securities Association of China (SAC). This requirement only applies to platforms which do not have financial institution licenses. The draft regulations provide criteria for platforms and investors

103 China Insurance Regulatory Commission (CIRC) looks after insurance companies and insurance agencies. China Banking Regulatory Commission (CBRC) looks after banks, trusts, financial leases, financial guaranty insurance, money brokers etc. 104 http://business.sohu.com/20141011/n405007974.shtml 105 www.zhongchou.com 106《私募股权众筹融资管理办法（试行）（征求意见稿）》

(see below). These are the regulations that most platforms adhere to.

In August 2015, CSRC issued an Announcement to Inspections of Internet Equity Financing Activities.107 The Announcement stated that no organisation or individuals could operate equity crowdfunding activities without an appropriate licence issued by one of the securities regulatory bodies in the State Council. This implies that equity crowdfunding platforms require a licence to operate legitimately. However, no detailed guidelines on the specific licence or regulatory body have been issued. 108

Currently there is no formal licence or regulatory body for equity crowdfunding platforms; however, platforms that are in operation must report to and register with CSRC and SAC as per the ‘pilot draft’ regulations. The intention of the ‘pilot draft’ regulations was to gauge industry response; it should not be considered a decisive set of regulations. However, the industry took the publication of the ‘pilot draft’ regulations as a signal that government was actively in support of equity crowdfunding and actively developing regulations in support of the industry. This led to an explosion in the number of platforms in operation (see section 4.2).

Criteria for Platforms as detailed in the ‘pilot draft’ Regulations

Below is a summary of the criteria for platforms as detailed in the ‘pilot draft’ regulations issued by SAC in December 2014:109110

Platforms must:

- have net assets of CNY 5 million or greater - register with SAC and apply to be a member - be a legal Chinese company - perform due diligence on businesses soliciting investment and investors - keep a record of all investments and transactions for at least 10 years - ensure number of investors per project is limited to less than 200

107 证监会《关于对通过互联网开展股权融资活动的机构进行专项检查的通知》 108 http://it.sohu.com/20150810/n418496473.shtml 109 http://www.sac.net.cn/tzgg/201412/t20141218_113326.html 110 A detailed translation of the ‘pilot draft’ regulations is available at http://bop.co.uk/articles/progress-towards-equity-crowdfunding-in-china

Platforms must not:

- offer their own company or other related companies as an investment opportunity on the platform - provide guarantees or be a shareholding nominee for projects on the platform - offer shares for resale - publish investment information to unaccredited users - offer underwriting securities services, investment advice or asset management, unless the company has a relevant license - offer online P2P lending services at the same time

Criteria for Investors as detailed in the ‘pilot draft’ regulations

To qualify as an accredited investor an individual must pass one of the following criteria;

- invest at least CNY 1 million in a single project (£100k; 114 EUR) - have net assets of CNY 10 million or - have net assets of CNY 3 million and an average annual income of CNY 500,000 for the past three years.

Regulatory Review in China

Regulation of equity crowdfunding remains in a state of flux and constant review. As detailed above, while guidance and ‘draft pilot’ regulations exist, the Chinese government and regulatory bodies have yet to settle on a regulatory standard. The Chinese government’s hesitancy stems from a wish to strike a balance between encouraging new forms of financing for entrepreneurs and providing new forms of investment services to investors while avoiding the fraudulent activity that has beset the P2P industry111.

111 http://business.sohu.com/20161017/n470452730.shtml

This section details the key regulatory and legal developments, related government pronouncements and industry activity.

December 2014

- Private Equity Crowd Funding Administrative Measures (pilot draft) published by the SAC112 (see 4.7)

July 2015

- Guidance to Promote the Healthy Development of Internet Finance (‘Guidance’)113 issued July 2015 by a consortium of government ministries (see 4.1) defines ‘equity crowdfunding’ as ‘activities that raise small sums of equities publicly through the Internet’. - SAC states that equity crowdfunding platforms should register their business within one month of going into operation114.

August 2015

- The Announcement to Inspections of Internet Equity Financing Activities (‘Announcement’)115 issued August 2015 by CSRC (see 4.1) proposes three categories of ‘equity crowdfunding’: 1) public equity crowdfunding; 2) non-public equity financing through Internet; 3) private equity financing through Internet (see 4.1). The Guidance reasserts that unlicensed ‘public equity crowdfunding platform’ is illegal fund-raising but offers no guidance for existing platforms to obtain a licence.

January 2016

112 《私募股权众筹融资管理办法（试行）（征求意见稿）》 113 《关于促进互联网金融健康发展的指导意见》2015 年 7 月 18 日 114 中国证券业协会 2015 年 7 月 29 日发布并于 2015 年 9 月 1 日实施的《场外证券业务备案管理办法》第二条规定，开展’互联网非公开股权融资’业务的机构应当于首次开展应备案业务之日起一个月内进行备案. 具体备案细则由中国证券业协会明确。 115 2015 年 8 月 7 月证监会《关于对通过互联网开展股权融资活动的机构进行专项检查的通知》2015 年 8 月 7 月

- Leading P2P lending platform Ezubao’s fraud scandal, exposed in December 2015116, prompts increased government scrutiny and control of the Internet Finance sector. From January 2016, cities including Beijing, Shanghai and Shenzhen stopped registration of companies that provide finance related services online.117 Local finance regulatory departments ally with industry and commerce departments to restrict the registration of companies that provide services related to ‘exchange house (交易所), finance, assets management, fund management, investment management, wealth management, equity investment fund, internet lending, P2P, equity crowdfunding, internet insurance and payment’. The abrupt change in policy creates extreme uncertainty within the sector and negatively impacts investment activity (see 4.2).

March 2016

- China Internet Finance Association announces a draft for comment of the Internet Finance Information Disclosure Regulation 118. This regulation requires equity crowdfunding platforms to make available information and data including: number of projects, total investment raised, average investment size; and to highlight potentially fraudulent activity. This draft regulation signals government’s resolution to establish and improve information disclosure within the sector.

April 2016

- Shenzhen Internet Finance Association requires all platforms registered in Shenzhen to stop real-estate related equity crowdfunding projects. Similar policy is issued in Guangzhou at the same time. This regulation is issued in the context of government attempts to control an overheated real estate market.119

116 2015 年 12 月，易租宝事件将 P2P 行业闹得满城风雨，近百万投资人几百亿本金受损。 117 http://money.cnfol.com/licaizhoukan/20161228/24064190.shtml 118 http://www.cs.com.cn/xwzx/jr/201603/t20160311_4921841.html 119 http://money.cnfol.com/licaizhoukan/20161228/24064190.shtml

October 2016

- The State Council publishes the Implementation Plan of Special Rectification on the Risks of Internet Finance120 and the Implementation Plan of Special Rectification on the Risks of Equity Crowdfunding121. The plans are intended to clean up the Internet Finance and equity crowdfunding industries in China and ensure businesses adhere to existing regulations and law. As a result, a number of platforms have stopped operating. 122The clean-up was due to be completed and a summary published in January 2017. It is still forthcoming. - National Development and Reform Commission (NDRC) publishes the Internet Market Entry Negative List Pilot Draft for Comment. Among others, ‘non- public fund raising through the Internet’ is included in the list.123 This increases expectation of regulations specific to equity crowdfunding.

2017

- A review of the second revision of Securities Law was due to be completed by the end of December 2016 and implemented in 2017. Findings from the ‘Rectification’ plans are likely to influence this revision 124 and terms related to equity crowdfunding are expected to be included in the new Securities Law for the first time.

Chinese Polices Related to the Equity Crowdfunding Market

Internet financing is one of the pillars of the Chinese government’s ‘Internet+’ policy125, as ratified in its 2016 13th Five-Year Plan. The Internet+ finance strand

120 10 月 13 日国务院办公厅印发《互联网金融风险专项整治工作实施方案的通知》http://www.gov.cn/zhengce/content/2016-10/13/content_5118471.htm 121 http://www.cs.com.cn/xwzx/zq/201610/t20161013_5070354.html 122 http://www.jiemian.com/article/1044249.html 123 http://www.sdpc.gov.cn/gzdt/201610/t20161021_823458.html 124 http://www.zczj.com/column/2016-10-13/content_9107.html 125 互联网＋行动计划

of this policy aims to support ‘mass entrepreneurship’ 126 and enable businesses and start-ups to access new sources of funding. The government wishes to cultivate conditions that support a move away from a manufacturing-dependent economy, towards an innovation economy.

China’s going-out policy encourages businesses to participate more internationally in ‘high value added industry sectors’.

Internet + and Internet Finance

The Internet+ policy calls for ‘the integration of the Internet with economic and social sectors, making new industrial modes a main driving force of growth by 2018’.127 Besides finance, other sectors included in the Internet+ initiative are ‘manufacturing, agriculture, energy, public services, logistics, e-commerce, traffic, biology and artificial intelligence. 128

Guidance recommendation to promote healthy development of Internet Finance was published by the People’s Bank in July 2015. It encourages collaboration between traditional finance institutions and Internet companies to establish, ‘new financial service models of payment, investment and information exchange through the application of Internet and telecommunication technology’. 129

Going-out policy

Going-out policy was announced in 2007 as an extension of the policy to ‘open [China] to the outside world'.130 It seeks to overcome barriers to international trade and to encourage businesses to participate more internationally in ‘high value added industry sectors’.

Going-out policy aims to:

- improve the quality of foreign direct investment attracted to China; - expand direct investment in international markets; - encourage investors to participate actively in competition in global markets.

126 http://english.gov.cn/policies/infographics/2015/06/16/content_281475128482059.html 127 http://www.miit.gov.cn/n1146290/n4388791/c4538291/content.html 128 互联网＋行动计划 129 www.gov.cn/xinwen/2015-07/18/content_2899360.htm 130 对外开放的基本国策

National Internet Finance Association of China (NIFA)

NIFA131 is a public-private body established in March 2016 by the central bank, the People's Bank of China. The association was established as a means for the industry to self-regulate and self-police. It aims to ensure members comply with the law and regulations, to promote knowledge of internet finance to the public and strengthen international communication and cooperation.

NIFA covers all areas of internet finance; the 437 founders include 84 banks, 44 securities, funds and futures companies, 17 insurance companies, and 292 research entities and alternative finance companies - including equity crowdfunding platforms.132

131 http://www.nifa.org.cn/nifa/index.html 132 http://www.csai.cn/jijin/1141374.html?WebShieldDRSessionVerify=sAexbMBSjGYHR1EhADoO

— 5. China UK Cross-border Investment Regulations Primer In China, individual outbound cross-border transactions are highly restricted. This is a consequence of the government’s desire to control the value of the RMB, limit emigration of wealthy people and prevent money laundering.133 There are strict policies and regulations detailing restrictions on individual outbound investment.

The Chinese government supports institutional outbound investment as part of the government’s ‘going-out’ policy that encourages Chinese business to develop overseas business interests. Institutional investment is subject to institutions obtaining the appropriate licences and approval. Recently, outbound institutional investment has been subject to greater scrutiny; this has slowed down the process of executing outbound investment deals and the pace of outbound investment from China.

The Chinese government is in favour of and incentivises inbound cross-border investment by foreign businesses and individuals into certain ‘encouraged’ industries in China.

In the UK inbound investment is relatively unrestricted.

Chinese Individual Outbound Investment

Personal Foreign Currency Management Implementing Regulation 134 limits Chinese individuals to a maximum of $50,000 foreign currency exchange per annum - which includes all overseas transactions.

Overseas direct investment by individuals is not expressly prohibited in China. Rather, regulations state that individual outbound investment is subject to approval. However, regulations do not specify a dedicated approval body (PRC Regulations on Foreign Exchange Control)135. The lack of clarity makes individual

133 http://finance.qq.com/a/20170116/037052.htm 134 《个人外汇管理办法实施细则》 135 《中华人民共和国外汇管理条例》

outbound investment in China impossible under the current legal framework.

In 2015, the State Administration of Foreign Exchange (SAFE) moved to further prevent illegal outflow of foreign exchange for investment purposes and banks will not process certain transactions if they believe it is an attempt to circumvent restrictions. Restricted behaviours include (but are not limited to) 136:

- more than five different people transferring foreign currency to the same overseas account within a ‘short period’; - any individual purchasing foreign currency close to USD10,000 or equivalent at least five times within seven days from the same account; - individual foreign currency transfers to five or more immediate family members

In December 2016 the State Administration of Foreign Exchange (SAFE) reasserted the administration and reporting requirements for currency exchange. Individuals need to report and leave a detailed record of currency exchange requests and transactions with the bank. The pronouncement also reasserted that the $50,000 cap is restricted to overseas travel and educational use only, rather than overseas investment.137 At the same time the Bank of China made an announcement that Union Pay and Visa/Master Card payment systems can no longer be linked to the same bank account.138 The idea is to minimise access to domestic accounts while abroad and make it easier for the government to monitor foreign currency exchanges.

Chinese Institutional Outbound Investment

MOFCOM is the main regulatory body governing outbound investment in China and Chinese entities. Companies, state owned enterprises (SOE) and public bodies must receive an approval certificate from MOFCOM to qualify for outbound investment.

There are several types of qualified institutional investors. They include Qualified Domestic Institutional Investors (QDII); Qualified Domestic Investment Enterprises (QDIE); and Qualified Domestic Limited Partners (QDLP).139 QDII, the most established scheme, established for a decade, allows Chinese financial institutions to invest in offshore markets such as securities and bonds. QDLP allows domestic institutional investors to participate in overseas private equity

136 个人分拆结售汇行为 137 http://mt.sohu.com/20170101/n477512495.shtml 138 http://news.163.com/16/1207/13/C7MGJOLN000187VE.html 139 http://www.goingconcern.cn/article/10944

secondary markets.140

Outbound Investments Approval and Record Regulation released by the National Development and Reform Commission (NDRC)141 requires that:

- any approved entity seeking to execute an outbound investment of less than $300 million can register and record the transaction with provincial government without asking for approval from the National Development and Reform Commission - i.e., it does not require national level approval - entities seeking to execute an outbound investment exceeding $300 million must be recorded with the National Development and Reform Commission (NDRC) - i.e. at national level - investments of more than $1 billion; investments to sensitive countries (either at war with China, or without an established diplomatic relationship with China); and investments in specific sensitive industries (listed as basic telecommunications operations, cross-border water resources development, large scale land development, electricity grid systems and news media) must apply for approval from the NDRC.142

In addition to NDRC regulations, outbound investment projects also need approval from the Ministry of Commerce143 and Administration of Exchange Control144. Other relevant government bodies could also be involved: for instance, CSRC manages outbound investment for listed companies; while the State-owned Assets Supervision and Administration Commission will manage outbound investment of stated-owned enterprises.

Pilot free-trade zones, such as the Shanghai free-trade zone, aim to liberalise the requirements for outbound institutional investment. Companies within the free-trade zone do not need prior approval certificates for outbound investment activities. Instead, they need to register each proposed investment with the Shanghai Municipal Government 145 and to go through the approval procedure for foreign currency control.146

In recent months, the Chinese government started to further restrict institutional outbound investment. With an eye on China’s diminishing foreign currency reserves, the Foreign Currency Exchange Office announced that it would ‘strictly’ review proposed overseas investments.147 The Ministry of Commerce

140 http://www.sinotf.com/GB/News/1005/2016-07-20/wNMDAwMDIwNjcwNA.html 141 境外投资项目核准和管理办法 142 http://www.ndrc.gov.cn/zcfb/zcfbl/201404/W020140410560098013507.pdf 143 http://www.mofcom.gov.cn/article/b/c/201409/20140900723361.shtml 144 http://www.fdi.gov.cn/1800000121_23_72124_0_7.html 145 http://www.millercanfield.com/resources-alerts-864.html 146 http://www.gov.cn/gzdt/att/att/site1/20140218/7845c441d7d8146d006b01.pdf 147 http://finance.sina.com.cn/china/gncj/2016-12-08/doc-ifxypipt0508500.shtml?cre=sinapc&mod=g

explained in January that the objective of these restrictions is to ‘manage’ currency outflow. 148 149

Chinese Inbound Foreign Direct Investment (FDI)

The Chinese government actively ‘encourages’ and incentivises inbound FDI in certain industries and ‘limits’ and ‘prohibits’ investment in others.150 Encouraged industries include: ‘modern agriculture’, ‘advanced manufacturing technology’, ‘energy conservation and environmental protection’, ‘nuclear energy’ and ‘modern services’ 151.

Investment in certain industries may limit foreign investors’ shareholding in a business to less than a controlling stake i.e. no more that 49%.152 Most inbound FDI is structured as a joint venture or a wholly foreign-owned enterprise (WFOE) and all investments must seek government approval. The approval process varies by industry and provincial regulations.153

The Qualified Foreign Institutional Investor (QFII) program allows licensed foreign institutional investors to buy RMB-denominated class ‘A’ shares in China's mainland Shanghai and Shenzhen stock exchanges. The Qualified Foreign Limited Partner (QFLP) program allows licensed foreign institution investors to invest in the domestic private equity market.154

UK Inbound Investment

UK inbound investment is relatively unrestricted. Foreigners or foreign-controlled companies are treated the same as UK-owned businesses. However,

148 http://finance.ifeng.com/a/20170106/15127567_0.shtml 149 http://mt.sohu.com/20161219/n476352906.shtml 150 http://www.sdpc.gov.cn/xwzx/xwfb/201503/t20150313_667339.html 151 http://www.sdpc.gov.cn/xwzx/xwfb/201503/t20150313_667339.html 152 http://news.163.com/15/0328/03/ALOUMEPD00014AED.html 153 http://www.gx.xinhuanet.com/dtzx/2012-06/19/content_25414523.htm 154 http://www.sinotf.com/GB/News/1005/2016-07-20/wNMDAwMDIwNjcwNA.html

authorisation is required for investment in sensitive areas, such as defence, and regulated areas, such as banking, media and financial services.155

Note: Equity crowdfunding platforms in the UK do not offer investment opportunities to Chinese investors as individual outbound investment from China is restricted.

155 http://uk.practicallaw.com/9-502-8985

— 6. UK perspective on the Chinese market We asked a number of UK based crowdfunding platforms (including Seedrs, Sharein and Syndicate Room) about their perspective on the Chinese market, including the extent to which they were already doing work in China and their interest in doing this in the future.

The platforms’ perspectives were collected through short semi-structured interviews with each platform and a crowdfunding roundtable which took place in Guiyang, China, (November 2016), and had participation from two UK platforms, with representatives from Chinese regulators, policy makers, crowdfunding platforms and other fintech businesses.

The main feedback from platforms was that none of them are currently doing any direct work in China. However, two platforms have undertaken projects related tothe Chinese market.

- Sharein - In 2015 Sharein announced the first attempt at setting up the first cross border equity crowdfunding initiative, allowing Chinese investors to invest in a UK based company.156 - Seedrs – In January 2017 Seedrs announced a new partnership with the China Innovation and Entrepreneurship International Competition (IEIC). In London this March, Seedrs, working alongside InteBridge Capital and the Shenzhen Government, will be hosting the UK divisional round of a competition which gives UK entrepreneurs the opportunity to win £100,000. The competition is supported by the Ministry of Science and Technology of the PRC, the State Administration of Foreign Experts Affairs and the Shenzhen Government.157

However, while none of the UK platforms are operating directly in the Chinese market, they all expressed interest in doing so in the future, particularly if they could get more clarity on a number of issues and questions related to the Chinese market, demand for finance and how it is regulated. Their primary concern was around regulation of the Chinese equity crowdfunding market. There is little or no information available to UK platforms on how the Chinese equity crowdfunding market is regulated and the policy of the Chinese government when it comes to foreign platforms operating in the Chinese market. This creates a significant barrier to understanding if, how and under what terms a UK platform could operate in the Chinese Market.

156 http://www.scotsman.com/business/companies/tech/sharein-to-launch-first-chinese-uk-crowdfund-campaign-1-3925516 157 https://www.seedrs.com/learn/blog/seedrs-and-intebridge-partner-to-host-the-china-innovation-and-entrepreneurship-international-competition

Alongside a request for more clarity on regulation in general, the UK platforms identified four specific areas where they in particular would need more clarity on the Chinese government and crowdfunding regulators position regarding :

- Investment size and investor profiles: As most UK platforms were set up to enable investment from both unsophisticated and sophisticated investors there was an interest in understanding what type of investor is legally allowed to invest using an equity crowdfunding platform in China. Following on from this, platforms also wanted to understand the rules regarding size of investment per investor (what are the minimum and maximum amounts) and what the maximum amount that can be raised per crowdfunding campaign is. - What are UK platforms allowed to do? UK platforms described three scenarios for how they could operate in or with the Chinese market: 1) as a platform operating in China facilitating investment from Chinese investors into China based businesses 2) as a platform based in the China/UK facilitating investments from China into the UK and/or European businesses and/or 3) as a platform based in the UK/China facilitating investment from the UK/Europe in to businesses based in China. However, in all three of these models, platforms would need more clarity on the Chinese government’s view on Chinese based investors bringing money out of China through investing in UK/EU businesses, UK/EU investors taking ownership or a stake in Chinese businesses and a UK platform operating in the Chinese market. - Trends and demand in the Chinese market: UK platforms cover a broad range of sectors and types of campaigns. However, to be able to better understand opportunities in the Chinese market, UK platforms highlighted that they would like more insight into the demand for finance in China, which sectors in China would be most suitable and have demand for investment and whether there were particular regions or cities that the platforms should initially target. - Avoiding and dealing with fraud: Finally, platforms raised concerns about potential fraud from Chinese investors trying to access companies in the UK listed on UK platforms, and asked for more clarity on how best to engage with Chinese regulators to deal with cases of fraud.

What could regulatory and policy makers do to better support cooperation between the UK and China158

- Better guidance for UK platforms and businesses on the Chinese market and how it is regulated - Networking and introductions, bringing together policy makers, platforms, investors and businesses interested in UK / China equity crowdfunding

158 With governmental / regulatory support or financing

- Initiate a pilot programme with bespoke support from regulatory bodies to test how the different forms of UK / China cooperation (cross border investment and UK platforms operation in China).

—

7. Chinese perspective on the UK market

This section details some of the top-level findings from a series of consultations with some of the leading equity crowdfunding platforms in China. The consultations sought to understand the appetite for cross-border activities between China and the UK, how the UK equity crowdfunding market is perceived by the industry in China and the perceived barriers and opportunities for cross-border cooperation that policy makers can support.

Existing Cross-border Activities

- Some Chinese platforms have established offices in the USA and focus on facilitating China USA cross-border activity. According to one platform: ‘the US was first choice for an overseas office because laws and regulation of cross-border funding in the US are clear.’ - In addition, China and US are ‘complementary’, China offers a ‘big market’ and, ‘the US has the technology’. One platform raises funds in the USA for Chinese businesses and introduces US businesses that have raised funds to the Chinese market. - One platform remarked that Chinese investors perceive businesses overseas as being more reliable and of a ‘higher quality’ - Existing cross-border payments are managed by an unspecified ‘third party’ and one platform is developing a cross-border mechanism based on block chain technology: ‘it is important to try new methods under the framework of laws and regulations.’

Potential Areas for China-UK Cooperation

- Both countries should work together to promote the development of laws and regulation for the industry to ‘protect investors’ , ‘support companies’ and ‘overcome barriers to fundraising’. - The UK can help ‘mature’ the Chinese market by sharing knowledge on existing UK businesses models and investor education programmes. While there are many wealthy individuals in China there is not yet a mature retail investment environment. Information failures and regulatory uncertainty combine to create barriers to entry to the market: ‘Chinese investors don't have knowledge of what they can and cannot do, nor how to increase the return, or at least keep the value in their investment.’

- The UK can help bring early stage and advanced technology to China from the UK in areas such as Internet of Things, fintech ‘Intelligent Hardware’ and support businesses. The aim would be to find compatible partners across the industrial value chain, ‘where the UK partner is good at design, and China offers lower production costs and bigger market.’ - There is scope for co-financing and ‘complementary’ cooperation: ‘UK projects are interested in Chinese investors, China is interested in investment opportunities in the UK.’

Perceived Barriers to UK-China Cooperation

- Restrictions to individual outbound investment from China is unanimously perceived as the biggest problem - There is a lack of familiarity with the UK market; compared with the US market - Chinese investors do not have the capacity to do due diligence checks on international companies - Language and cultural barriers - Perceived risk that losses for investors, particularly unsophisticated and inexperienced investors, could have repercussions for the government in China. - A lack of knowledge of overseas laws and regulations, and the potential for legal repercussions

What could regulatory and policy makers do to better support cooperation between the UK and China159

- Establish ‘pilot zones’ that enable individuals to access cross-border investment opportunities. This would require support from both governments. - Develop knowledge sharing initiatives that support the development of the regulatory environment in China, including industry to industry dialogue through trade bodies and associations - Fund and support a number of pilot projects to test the feasibility of cooperation between China and the UK, including support for experimentation with new technologies such as Bitcoin / block chain

159 With governmental / regulatory support or financing

- Promote business model development (perceived as the biggest problem in the sector: how do platforms make money?) - Promote awareness of the ‘complementarity’ between the UK and China, enabling UK platforms to scale and Chinese platforms to access new ‘advanced’ / ‘high’ technology. This would support the Chinese government’s goal to develop an ‘innovation based economy’.

—

8. Appendices

— Appendix - Overview of international regulation of equity crowdfunding

European Union

The UK market is the largest crowdfunding market in Europe. However, the equity crowdfunding market is growing across continental Europe and in 2015 the total market volume was €186.29m, with an average project size €459k, and a growing real estate sector (€26.97m). Of the non-real estate offers, projects in technology, manufacturing or health and social work were the most funded sectors, with a typical project being funded by 143 investors.160

While there are EU-wide rules regarding Securities (such as MIFID/Prospectus Directive), there is no EU-wide regulation specifically targeting investment crowdfunding where offers often fall below the threshold level at which MIFD restrictions apply (which includes equity based crowdfunding, debt securities, mini bonds and convertible bonds). However, the EU is monitoring market development:161 in particular, the European Securities and Market authority (ESMA) has been looking to co-ordinate and support national regulators seeking to introduce bespoke national regulation to the sector.162,163

Canada

160 https://www.jbs.cam.ac.uk/faculty-research/centres/alternative-finance/publications/sustaining-momentum/#.V875ABQ4ZwO 161 http://ec.europa.eu/finance/general-policy/docs/crowdfunding/160428-crowdfunding-study_en.pdf 162 https://www.esma.europa.eu/sites/default/files/library/2015/11/2014-1560_advice_on_investment-based_crowdfunding.pdf 163 http://ec.europa.eu/finance/general-policy/docs/crowdfunding/160428-crowdfunding-study_en.pdf

In 2015, the Canadian equity based crowdfunding market volume was US$6m (of which US$0.8 was real-estate crowdfunding). Regulation of equity based crowdfunding in Canada is complex as there is no central regulator. This means all 13 provinces must be negotiated with when equity is offered across provincial borders. However, Canada has recently introduced two equity-based crowdfunding exemptions: the ‘Start up equity’ crowdfunding exemption and the ‘Integrated’ crowdfunding exemption.

The ‘Start up equity’ crowdfunding exemption was launched in 2015 in six provinces, which each agreed prospectus exemptions. These set a cap of CAD$500,000 on the annual amount start-up and early-stage companies can raise each year through crowdfunding portals (with no more than CAD$250,000 in one offering) and capped individual investments at CAD$1,500 per deal.164

The ‘Integrated’ crowdfunding exemption, which was launched January 2016, has set disclosure requirements and caps projects investment at CAD$1.5m per year, with no restrictions on which jurisdiction in Canada the firm can operate in. Individual investors are capped at CAD$2,500 in any one offering, up to a maximum of CAD$10,000 within a 12-month period across all equity crowdfunding issuers. Accredited investors can invest up to CAD$25,000 in any one offering, up to a maximum of CAD$50,000 in a 12-month period across all equity crowdfunding issuers165.

United States of America

Equity crowdfunding started in the US in 2011. At the time it fell under Regulation D of the Securities Act of 1933 - this was poorly suited to the model, as it meant platforms could not solicit or advertise their offering, and could only sell equity to a limited range of High Net Worth (HNW) / accredited investors.

In April 2012, the Jumpstart Our Business Startups (JOBS) act sought to boost equity crowdfunding. In September 2013, new rules implemented by the Securities and Exchange Commission (SEC) allowed firms to advertise their offering whilst continuing to limit investments to those of accredited investors.

By 2015 equity crowdfunding market volume had grown to $1bn, of which $470m was real estate crowdfunding166.

Several US states have established their own exemptions and rules for resident issuers of shares on equity-based crowdfunding websites. However, in May

164 https://www.jbs.cam.ac.uk/fileadmin/user_upload/research/centres/alternative-finance/downloads/2016-americas-alternative-finance-benchmarking-report.pdf 165 http://ncfacanada.org/equity-crowdfunding-regulations/ 166 https://www.jbs.cam.ac.uk/fileadmin/user_upload/research/centres/alternative-finance/downloads/2016-americas-alternative-finance-benchmarking-report.pdf

2016, Federal rules were updated to allow retail investors to invest up to a set amount depending on the investor’s circumstances:

- If either the investor’s annual income or net worth is less than $100,000, during any 12-month period, they can then invest up to the greater of either $2,000 or 5% of the lesser of their annual income or net worth. - If both the investors annual income and net worth are equal to or more than $100,000, during any 12-month period, they can then invest up to 10% of annual income or net worth, whichever is lesser, but not to exceed $100,000.

The deals must be offered via either an authorised broker or funding portal and, depending on the size of the deal, provide a minimum level of disclosure.167 Platforms are required to have transparent channels for public discussions for each investment opportunity, such as an open forum. However, platforms are only required to disclose annual financial statements, rather than information about performance. Investors are restricted from selling their investments within the first year.

Israel

The Israeli government only recently (January 2016) amended a law to provide an exemption from prospectus requirements for equity based crowdfunding to help the sector grow. The exemption only applies up to a threshold amount, and there is a cap on the amount investors can provide to each deal. Platforms must register with the regulators and adhere to fair conduct and reporting obligations and supervision requirements.168

—

167 https://www.sec.gov/oiea/investor-alerts-bulletins/ib_crowdfunding-.html 168 http://www.lexology.com/library/detail.aspx?g=0bc64859-7fe2-4d79-ad7b-c5b1b0bb6ffa

Appendix: UK stakeholders

See Table 1 below for an overview of the key stakeholders that make up the UK Equity crowdfunding environment.

Organisation name and Type or organisation Description of organisation Areas of responsibility related to equity acronym (industry body, policy, crowdfunding regulation) Bank of England (BoE) which Policy Non-Departmental Public Body Monitors financial services and possible causes include Prudential Regulation (NDPB) of systemic risk authority (PRA) British Business Bank (BBB) Stakeholder / promoter Non-Departmental Public Body Promotes access to finance for UK businesses (NDPB) British Chamber of Commerce Stakeholder / promoter Private membership body Represents SMEs and promotes access to (BCC) finance Department for Business Stakeholder/promoter Government department Promotes access to finance and is the leading Energy and Industrial Strategy. scheme to refer SME rejected by banks to (BEIS - formerly BiS) alternative finance providers Competitions and Markets Regulator Non-Departmental Public Body Able to perform reviews of sectors on behalf of Authority (CMA) (NDPB) consumers Financial Conduct Authority Regulator Non-Departmental Public Body UK regulator of financial services (FCA) (NDPB) Objectives to: -Promote competition -Protect consumers - Enhance market integrity Federation of Small business Stakeholder/promoter Private membership body Promote interests of Small business such as (FSB) access to finance Financial Ombudsmen’s Complaints monitor (linked to Non-Departmental Public Body Independently assess complaints made by Service (FOS) regulator) (NDPB) consumers against regulated firms

HM Treasury (HMT) Policy development Government department Controls public spending, setting the direction of the UK’s economic policy and working to achieve strong and sustainable economic growth. The HMT leads on strategic tax policy and policy development HM Revenue and Customs Policy maintenance and Government Department Manages and implement policies such as EIS, (HMRC) implementation SEIS, ISAs, tax incentives Innovative Finance Promoter /Not-for-profit Private body Promotes UK Fintech firms including equity membership association crowdfunders UK Trade and Investment Stakeholder/Promoter Government Department Promotes UK firms overseas UKCFA Trade association Private membership body Represents crowdfunding industry to policy makers and regulators (equity, donations, rewards and some Peer-to-Peer lending) Which? Consumer body Private membership body Able to issues super complaints on industries that adversely impact consumers Table 1

— Appendix: Chinese stakeholders

This section provides an overview of some of the key stakeholders that make up the Chinese Equity crowdfunding environment.

The China Securities Regulatory Commission (CSRC) is an institution of the State Council, with ministry-level authority. It is the main regulator of the securities industry in China. China's Securities Law grants CSRC, ‘authority to implement a centralized and unified regulation of the nationwide securities market to ensure their lawful operation.’

CSRC oversees China's nationwide centralized securities supervisory system, with the power to regulate and supervise securities issuers, as well as to

investigate, and impose penalties for, ‘illegal activities related to securities and futures.’169

The Securities Association of China (SAC) is the Chinese securities industry regulatory and trade body. It works under the guidance and supervision of CSRC and the Ministry of Civil Affairs of China, and works directly with its members and the industry.

Equity crowdfunding platforms are required to register with SAC.

National Internet Finance Association (NIFA) (see 4.10)

The State Administration of Foreign Exchange (SAFE) of the People's Republic of China is an administrative agency tasked with drafting rules and regulations governing foreign exchange market activities, and managing the state foreign exchange reserves.

The People's Bank of China (PBC) is the central bank of the People's Republic of China with the power to carry out monetary policy and regulate financial institutions in mainland China.

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169 Huang, C.W. ‘Company Law and the Independent Director System in Contemporary China.’ Hastings International and Comparative Law Review, Winter 2008 (Vol. 31), note 1

Appendix – Abbreviations

APPG All party political group

BaFin Bundesanstalt für Finanzdienstleistungsaufsicht (German Federal Financial Supervisory Authority)

BEIS Department of Business Energy and Industry Strategy

FCA Financial Conduct Authority

HMRC Her Majesty Revenue & Customs

HMT Her Majesty Treasury

HNW High Net Worths

IRR Internal Rate of Return

MIFID Markets in Financial Instruments Directive

P2P Peer-to-Peer

PLC Public Limited Company

SPV Special Purpose Vehicle

UK United Kingdom

UKCFA UK Crowdfunding Association

CSRC China Securities Regulatory Commission

CPI Consumer Price Index

CNY Chinese Yuan

CIB Industrial Bank of China

SAC Securities Association of China

NIFA National Internet Finance Association of China

PRC People’s Republic of China

SAFE State Administration of Foreign Exchange

QDII Qualified Domestic Institutional Investors

QDIE Qualified Domestic Investment Enterprise

QDLP Qualified Domestic Limited Partner

NDRC National Development and Reform Commission

FDI Foreign Direct Investment

WFOE Wholly owned-foreign enterprise

QFII Qualified Foreign Institutional Investor

QFLP Qualified Foreign Limited Partner