Crowdfunding in Singapore – new concept, but same old risks?
8 years have now passed since the Great Financial Crisis, but global interest rates continue to languish at low levels. It is no surprise, therefore, that investors remain on the constant lookout for higher yielding investments.
This is one reason why in the last couple of years, crowdfunding and peer-to-peer (P2P) lending, has enjoyed increasing popularity in Singapore. P2P platforms, especially, allow easy access to attractive returns for relatively small amounts of money from individual investors.
Given that crowdfunding has only recently come to Singapore, there were initially no clear regulations governing the industry. In fact, there was little recognition that the industry existed.
However, in June this year, following a one year consultation period, the Monetary Authority of Singapore (MAS) established a licensing regime for the first time.
Mr Lee Boon Ngiap, Assistant Managing Director, Capital Markets, MAS said, “Securities-based crowdfunding (SCF) is a useful addition to our financing landscape. At the same time, SCF investments can be quite risky. The measures we are implementing seek to strike the right balance between improving access to SCF for start-ups and SMEs and protecting investor interests."
Crowdfunding players have also said that this will help to lend credibility to the sector while safeguarding investors.
What has changed with MAS's new regime:
1. SCF Platforms
2. Investor Requirements
What is crowdfunding?
Crowdfunding is the practice of funding a venture via an online platform which puts borrowers in touch with a lender or groups of lenders. Crowdfunding started in the US with sites such as Kickstarter and Indiegogo which enabled individual donors to contribute small sums towards funding a new project. In exchange for the donation, donors would be rewarded with new products or free services.
This is known as donation crowdfunding. But in the last few years, P2P has been further commercialized and monetised to become more of a lending platform to aid various types of financing.
In Singapore, the available crowdfunding platforms include: 1) debt-based crowdfunding, which involves investors lending money to small businesses and receiving interest on the loan, 2) property-based crowdfunding, which involves investors funding property development projects via the platform and earning rental income, 3) equity-based crowdfunding, in which investors buy equity or ownership in a company with the expectation that they will receive dividends and capital appreciation.
The appeal of crowdfunding is fairly obvious. Lenders can choose exactly how much they want to invest, and can achieve reasonably high returns. For borrowers, especially small companies that face difficulty in getting funding from banks, the platforms provide a much simpler and easier route compared to bank borrowing for obtaining funds they need to run their businesses.
What are the risks of crowdfunding?
1. Counterparty or default risk
When you decide to lend money to someone, it is because you trust or are fairly certain that the person will earn enough money in the future to repay you. If you are applying for a credit card, the bank or other financial institution will always check your credit history before issuing you with a credit card.
The same principles apply when lending via a crowdfunding platform. In other words, an investor or lender will always be exposed to counterparty or default risk of the borrower. A lender using the platform needs to understand that the platform operators will not accept any liability, and in the worst case scenario, a lender can stand to lose all his or her invested capital.
Moreover, the majority of borrowers are SMEs, and it is not always possible to carry out rigorous background checks. Financial data on non-listed SMEs can be very limited. This is why the returns offered via the platform are relatively high. It is in order to compensate for the potential risk of default.
2. Deceptive advertised returns
One of the keys to the success of crowdfunding in Singapore is the returns which are advertised. It is not unusual for some platforms to dangle a carrot of “20% per annum return”. But stated interest rates may be amortised, simple, or effective, all of which differ markedly, and may well differ from the actual returns.
So any investor considering lending on a P2P platform because of the advertised returns, must read the fine print. There is usually an asterisk next to the promised interest rate which will explain in detail the underlying calculation.
If there is no explanation available for the calculation method used for returns, do not bother to read any further – the platform is unlikely to be safe.
And you must still do your due diligence on the actual borrower even assuming the explanation for the expected return is on the website. You need to understand precisely for what purpose the money is being raised, you need to check the financial accounts of the borrower, and you must accept that even after all this, you are still exposed to risk.
Additionally, it is worth noting that quite a number of crowdfunding platforms in Singapore have ‘disappeared’ over the last few years. While crowdfunding or P2P lending is quite a new concept in finance, the same risks that have always existed for lenders have not gone away.