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Thoughts on Regulating Crowd-funding

At present, there is no dedicated legislation for the regulation of crowd-funding in Hong Kong, nor is there a designated government department responsible for regulating such activities. There have been calls in the community requesting the Government to review the situation and formulate appropriate legislation and regulatory arrangements, so that legitimate crowd-funding activities can be conducted in accordance with the law while unlawful acts can be tackled. A number of Legislative Council Members have shared with me their views on the matter and I strongly concur with them. In February this year, I mentioned in the Legislative Council that the Government was conducting a preliminary study on legislation related to crowd-funding. In particular, I consider that we need to focus on preventing and combating the unlawful acts of raising funds through crowd-funding for planning activities that endanger national security. We need to establish an appropriate regulatory system for stamping out attempts by individuals or organisations to raise funds directly or indirectly through crowd-funding for activities that endanger national security, and for breaking the crowd-funding capital chains of those lawbreakers (who have fled abroad) in Hong Kong. The Government has come up with some initial ideas on the regulatory approach. I would like to give a brief introduction below.

Four Major Types of Crowd-funding Activities

Generally speaking, crowd-funding refers to an appeal made by a fundraiser to a large number of individuals or organisations for raising funds to take forward a project, fund a business plan or a personal loan, or serve other purposes. The following are the four common types of crowd-funding activities:

1. Equity crowd-funding: Investors invest in a project or a business in return for equities or debts issued by a company, or profits or income of a collective investment scheme;

2. Peer-to-peer lending: Unsecured loans are provided to individuals or projects through online platforms that match lenders with borrowers;

3. Donation-based crowd-funding: Funds are raised for making donations to charitable activities or other causes (e.g. political activities); and

4. Reward/pre-sale-based crowd-funding: Fundraisers provide goods or services in return for funds provided by contributors.

Major Risks Arising from Crowd-funding

The above four major types of crowd-funding activities may be subject to regulation under the existing legislations depending on individual circumstances. For instance, equity crowd-funding activities that are considered as offers made to the public by inviting them to invest in securities shall be regulated by the relevant ordinances such as the Securities and Futures Ordinance and the Companies (Winding Up and Miscellaneous Provisions) Ordinance, and must be authorised by the Securities and Futures Commission. The participating organisations must also comply with the relevant requirements and obligations in respect of anti-money laundering and counter-terrorist financing. As regards collection of money or sale of badges, tokens or similar articles in public places for charitable and any other purposes, permits issued by the Director of Social Welfare and the Secretary for Home Affairs under the Summary Offences Ordinance must be obtained in advance. However, the legislative intent of the ordinance is to prevent obstruction and nuisance caused by fundraising activities in public places rather than to regulate these activities themselves. Also, the coverage of the ordinance is not capable of handling online crowd-funding activities, which have become popular in recent years.

To put it simply, at present, individual crowd-funding activities, depending on their purpose and nature, may be subject to regulation under various relevant legislations. That said, it is indeed the case that Hong Kong has no dedicated legislation for regulating crowd-funding. Regarding crowd-funding for donation and charitable causes, there is currently no legislation and government department responsible for regulating such activities. This may incur the following risks:

1. Platform risks: Crowd-funding platforms, which match fundraisers with contributors, may suddenly cease operation for a variety of reasons, such as insolvency. Fundraisers and contributors may not be able to recover their funds.

As operators of crowd-funding platforms have no obligation to exercise due diligence and perform continuous monitoring for projects for which funds have been raised on their platforms, the funds so raised may not eventually be used for the committed purposes.

In the process of crowd-funding, contributors may need to provide various kinds of personal data, which could be subject to abuse in the absence of regulation.

2. Information asymmetry risks: For equity crowd-funding and reward/pre sale-based crowd-funding, contributors have to rely on the information disclosed by fundraisers, such as the project purpose, use for funds, financial data as well as the descriptions of goods and services in making decisions on contributions. If such disclosures and descriptions is not accurate, the discrepancies involved may result in losses for which the contributors may not get adequate protection.

3. Risks of violating the law: In the absence of regulation, funds raised through crowd-funding may be used for various kinds of unlawful acts such as planning activities that endanger national security or supporting terrorist activities. Also, the funds involved may have come from illegal activities and are intended for money laundering through crowd-funding.

Initial Ideas on the Regulatory Approach

To address the risks stated above, the Government has come up with the following initial ideas on formulating appropriate and dedicated legislation as well as regulatory arrangements for crowd-funding, which may be worthy for further consideration:

1. Should all crowd-funding platforms operating in Hong Kong be required to obtain a licence or registration? Should these platforms exercise due diligence for projects for which funds have been raised on their platforms?

2. Before conducting crowd-funding activities, should fundraisers be required to get registered or authorized? Should they be required to make clear, accurate and fair disclosure and reporting to contributors?

3. How should we implement a reporting system to identify and report suspicious transaction, in order to guard against any risks arising from different kinds of unlawful acts, such as those that endanger national security and those that involve money laundering and terrorist-financing?

We will consult the public

The formulation of appropriate and dedicated legislation for regulating crowd-funding involves complicated policy and enforcement considerations, such as the scope of regulated activities, the issue of whether a threshold for funds should be set and the agencies responsible for regulation and enforcement. In view of this, a public consultation exercise is expected to be conducted this year to gauge opinions on the matter with a view to taking forward the next step of the specific legislative work. Many common law countries around the world have already put in place dedicated legislation for regulating crowd-funding. The Government will draw on these examples in the study process. For legitimate crowd-funding activities, the dedicated legislation and regulatory arrangements will help develop a code of best practices and enhance participants’ confidence, thereby facilitating the orderly conduct of lawful and rule-compliant crowd-funding activities in Hong Kong. Also, we will be able to prevent more effectively the flow of illicit funds within, into and out of Hong Kong by way of crowd-funding for the purpose of planning other illegal activities such as those that endanger national security or support terrorist activities.

14 April 2022