NCFA Canada | March 15, 2018

On Tuesday, March 13, 2018, the National Crowdfunding & Fintech Association participated on a call with Finance Canada in Ottawa to discuss it's latest submission calling for an urgent need for regulatory changes and government support to ensure the Canadian fintech sector is not being held back and remains competitive with international comparators such as in the UK and US.  Below are the highlights of the submission that can be viewed/downloaded in full at the bottom of this post.

We'd like to thank Robin Ford, NCFA Advisor, Regulations and Governance for leading a group effort by the following participating NCFA members (in alphabetical order):

Alan Wunsche, Blockchain Canada
Alixe Cormick, Venture Law Corp
Amar Nijjar, R2 Capital / Investments
Beverly Brooks, Brooks Communications
Brad Kerr, FundingNomad
Cato Pastoll, LendingLoop
Craig Asano, Founder/Director, NCFA
Daryl Hatton, FundRazr / Director, NCFA
Douglas Cumming, Finance Professor, York University
Hitesh Rathod, NexusCrowd
Jason Saltzman, Gowling Canada LLP
Marcel Schroder, Managing Director, Vaultcircle (Lendified)
Marcus New, InvestX
Marty Gunderson, Director, NCFA
Peter-Paul Van Hoeken, FrontFundr
Richard Remillard, RCG Group / Director, NCFA
Robin Ford, former Head of Dept UK FSA, former Executive Commissioner BCSC, Consultant
Rubsun Ho/Sandy Hershaw, Crowdmatrix

1. OVERVIEW: Crowdfunding & Fintech are being held back in Canada

Canada’s crowdfunding and fintech “ecosystem” should be competitive, be in line with global trends, and enable early stage entrepreneurs to access smaller amounts of capital (ie, < $5 million) at a reasonable cost. Unfortunately it is not. There is a‘funding gap’ in the market as many smaller companies find it very challenging to raise debt or equity financing in Canada. This means fewer innovative start-ups, fewer opportunities for investors, and constraints on economic growth (and jobs).

The National Crowdfunding & Fintech Association of Canada (NCFA) has conducted numerous stakeholder consultations which overwhelmingly tell us that the regulatory requirements are overly prescriptive, complex, and burdensome (costly). The capital markets regulators in Canada have attempted to address the market problems within their jurisdictions, but so far without much success.

Canada is falling behind international comparators such as the United Kingdom and the United States. Entrepreneurs are reluctant to start up in Canada due to the high costs (relative to a small financing), and significant ongoing regulatory burdens. Investors are inhibited by eg caps on investment and limited education about  the  benefits  and  downside  risks  of  crowdfunding  and  other  exempt financings. This pushes many talented entrepreneurs and investors to overseas jurisdictions that better understand (and support) innovation and the economic potential of start-ups and small businesses.

The NCFA is very concerned about this and has strongly encouraged the BCSC and OSC to work smarter (and harder) to streamline regulation across the country, and to reduce undue burdens (that are not justified by the risks).

The NCFA now asks the federal government to work with the provinces and regulators to provide the required strategic direction and leadership needed to enhance Canada’s competitiveness.

2. BENEFITS OF CROWDFUNDING & FINTECH

The benefits of crowdfunding are broadly accepted and frequently described, eg - https://www.forbes.com/sites/tanyaprive/2012/10/12/top-10-benefits-of- crowdfunding-2/#3fd5ab4c2c5e.

The same is true of fintech, eg -    https://blogs.imf.org/2017/06/20/fintech- capturing-the-benefits-avoiding-the-risks/.

If the NCFA recommendations in this submission were to be implemented, the experience of other jurisdictions makes clear that more capital would be raised, especially for under-serviced sectors (eg, women and minority groups, including First Nations and rural areas). Investors would also have increased confidence and more freedom to invest as they choose.

We have a lot of tech and innovation talent in Canada. As the Competition Bureau has pointed out (Dec 2017 - http://www.competitionbureau.gc.ca/eic/site/cb-bc.nsf/eng/04322.html), a more flexible approach to regulation and adequate government support would provide significant economic benefits by freeing entrepreneurship. It would also help to keep our entrepreneurs in Canada (along with the related jobs), boost GDP (especially by improving productivity), and encourage the commercialization of new products and services generally.

3. CHALLENGES IN THE CURRENT ENVIRONMENT

As the leading and only dedicated crowdfunding and fintech association in Canada, the NCFA has consulted numerous registrants, industry experts, and practitioners in the sector about the most pressing challenges.  They say:

1. Investment-based crowdfunding requirements are far from internationally competitive with respect to raising non-bank funding.
2. Regulatory requirements are overly prescriptive with a one size fits all approach (versus risk-based) that is not working.
3. Regulatory regimes in Canada are not harmonized and are overly complex which adds significantly to the costs of start-up and ongoing compliance.
4. Lack of co-ordinated governmental incentives and support for innovation and for education and awareness puts Canada at a disadvantage that our competitors are happy to exploit.

A. Overly prescriptive requirements

Many entrepreneurs been discouraged by high legal fees, onerous reporting requirements, and other burdens. While entry into the market may be possible, entrepreneurs are also inhibited by ongoing costs of compliance and high hurdles for future financings that will limit their ability to scale up.

For example, only a small number of issuers have used online platforms to raise capital under the Accredited Investor or Offering Memorandum Exemptions in Ontario. While the Offering Memorandum Exemption is gaining some traction and is used by several NCFA member portals, it is primarily aimed at companies wishing to raise at least $250,000 (due to the costs, for example, of preparing the necessary legal and financial documentation).  Most early stage companies seeking to  raise  smaller  amounts  of  capital  cannot  realistically  use  the  OM  (or  the Integrated Crowdfunding Exemption MI 45-108 due to similarly high costs).

These exemptions are also inadequate for most marketplace lending platforms. For example, they do not allow the multi-party participation of public, private and government blended funding models which have developed in the UK and elsewhere, or membership marketplace lending models. (See Appendix 10:  P2P Lending.)

BC and some other jurisdictions have a ‘lighter’ set of crowdfunding requirements (eg, the ‘Start-up Crowdfunding Registration and Prospectus Exemptions MN 45-316 that allow small firms to raise up to $250,000 per offering (twice a year), with participation from other provinces). If there is not be a move towards a risk based approach, then the NCFA supports BC’s regime and proposes that other jurisdictions at least allow BC offers to be distributed across Canada under a mutual   recognition   system.   (NCFA   was   pleased   to   see   BCSC’s   recent announcement   of   changes   to   the   Startup   Exemptions   (BCI   45-535)   - http://bcsc.bc.ca/News/News_Releases/2017/72_Changes_to_start- up_crowdfunding_exemption_will_increase_access_to_capital_for_B_C    issuers)

For more recommendations to streamline regulation see Appendix 11.

The NCFA encourages regulators not only to adopt a more risk-based approach, but also to improve the measurement of the cost of a proposed regulatory solution against its benefits. Detailed or prescriptive controls should only be imposed when clearly justified. Market problems should not be “resolved” by additional requirements unless demonstrated benefits exceed costs. (See Appendices 5 and 6

‘Prohibitions on Advertising and Solicitation’ and ‘Frequency of Reporting Requirements’ for a high-level analysis of two requirements where we conclude that the costs far outweighs any benefit, and Appendix 7 ‘Regulatory approach’.)

B. Regulation is not harmonized and is overly complex

There  are  currently  three  versions  of  crowdfunding  specific  requirements  in Canada that form a patchwork that varies with respect to offering documentation, ongoing   disclosure   requirements,   capital   raising   and   investor   limits,   and advertising. These differences make it more costly for early stage companies, most of whom want to raise funds and do business in more than one jurisdiction (with additional costs for issuers of approximately $5,000 - $20,000 in legal fees alone).

The differences among the regulatory systems are outlined in Appendix 1. The table illustrates how complex and varied the requirements are, causing confusion and frustration for all market participants. Appendix 2 shows that differences exist even among jurisdictions participating in the same instrument, in this case MI 45-108.

C. Lack of incentives and support for education and innovation

Introducing new requirements/exemptions without a robust ongoing educational program is like asking new drivers to follow a road that contains no ‘signs’, without maps.  To increase the use of the new financing tools, in addition to the regulatory changes the NCFA proposes in this submission, many more businesses and individuals need to be educated about the opportunities and threats for both entrepreneurs and investors.

We have selected some insights from the NCFA’s annual 2017 Alternative Finance Crowdfunding survey of 170 responders (Jun-Jul 2017) including investment platforms, companies seeking capital, and a wide range of investors (including VC/PE and institutional investors):   (See: Appendix 3  NCFA Selected Survey Results Charts)

• When asked ‘What do you think is needed to attract more investors to the Canadian  alternative  finance  crowdfunding  markets?”    The  number  one (70% of the responders) answer was “More education”.
• When  issuers  were  asked  “Has  your  company  ever  raised  capital  via alternative finance crowdfunding markets before?” the overwhelming majority (approximately 90%) responded ‘No’.
• When asked why not, issuers’ number one reason (over 55%) was that they were ‘Unaware of how it works’.

While regulators have provided dedicated web pages to help potential investors and issuers better understand the capital markets, the information is limited. According  to  a  recently  published  Ernst  &  Young  “Fintech  Adoption  Index” survey, Canada has one of the lowest fintech adoption rates in the world and a central reason for this is lack of awareness. Over 70% of the respondents thought that more education was required to attract more investors to crowdfunding and that the regulators should publish more market analyses.

Data collection and analysis is poor in Canada. In contrast, the Securities and Exchange Commission (SEC) recently published an extensive whitepaper on Title III Regulation crowdfunding activity titled ‘U.S. Securities-based Crowdfunding under Title III of the JOBS Act’ that reviews offering activity, characteristics, geographic distribution and regulated platforms performance, characteristics and compensation rates.

It is crucial that data collection and analysis be improved in Canada (in collaboration with the private sector) so that we can better understand the markets and pinpoint problem areas (to enable evidence-based decisions).

Finally, we were pleased to see the announcement of the new federal program Innovative Solutions Canada as well as the support in Budget 2018, building on Budget 2017. These are steps in the right direction (and we are aware of some older federal programs). But Canada still needs a comprehensive innovation strategy and an integrated program of incentives and support. Governments, regulators, and the private sector need to work together more strategically. Other jurisdictions like the UK, Singapore, and Hong Kong are well ahead of us.

4. A CHANGE OF APPROACH

A. Work harder to harmonize and reduce unjustified regulatory burden

Prescriptive and complex regulation is simply inappropriate in a highly innovative and fast paced  digital  space.  Moreover,  businesses  cannot  be  as  nimble  and responsive to market demand.

We acknowledge that a change to a more risk based and principles based approach is not easy. Indeed it would require a profound change in regulatory culture and a significant and long term commitment from Ministers and regulatory boards and senior management. But short of that, there is much that can be done. The NCFA has made specific recommendations for regulatory change. (See Appendix 11.) (Regtech must also be part of a change of approach, but we do not discuss that here.)

B. Governments to support regulatory change

The  NCFA  strongly  supports  CSA  initiatives  such  as  “sandboxes” and  cross- border agreements (such as the recently announced agreement between some Canadian  regulators  and  the  French  AMF  FinTech,  Innovation  and Competitiveness Division). But it is not enough. (In the UK, the FCA is now pushing for sandbox improvements globally.)

There is a crucial role here for governments, especially the federal government, to champion innovation, to agree a fintech or innovation strategy with the provinces, to use already proven tax and other incentives, and to work with the private sector to ensure adequate data collection and analysis. The profound change in regulatory approach in the UK starting in 1997 could not have happened without the strategic planning and leadership of Number 10.

More government resources and support for innovation and education

While educational conferences are in high demand and markets are slowly gaining traction in Canada, the sector needs more government support to encourage and enable more portals  and  participants  to  start-up,  ‘scale  up’,  and  operate  more efficiently.    There  is  a  large  knowledge  gap  due  to  the  real  (or  perceived) complexities and burdens involved in putting together an online financing round. Businesses and investors need to be better educated about the options and the available  support  facilities  and  incentives.  Education  is  an  investment  by governments,  working  with  the  private  sector,  that  will  generate  more  capital investment and jobs, as well as making potential investors more risk aware.  (See Appendix   4:       Private-public   growth   model   for   the   alternative   finance crowdfunding industry.)

5. CONCLUSION AND TAKE-AWAYS

Governments play an essential role in facilitating and encouraging innovation and entrepreneurship. While one might now add to it, a wide ranging 2010 paper by PWC provides a good overview of how this can be done - https://www.pwc.com/gx/en/technology/pdf/how-governments-foster-innovation-2010.pdf.   The   report   concludes:   “Countries  that   understand   their   particular economic profile, and design the right strategy to suit that profile, stand to raise the odds of success in fostering innovation.”

The NCFA urges the federal and provincial governments, as well as the provincial and territorial securities regulators, to work together:

• to reduce regulatory burden, to champion innovation,
• to make good use of proven tax and other incentives, and
• to work with the private sector to ensure adequate data collection and analysis, as well as education and awareness.

If not, we will fall further behind.