This article explores the newly revised regulations on crowdfunding issued by the Central Bank of Bahrain for the jurisdiction of the Kingdom of Bahrain.
On 28 April 2022, the Central Bank of Bahrain (CBB) issued a new consolidated crowdfunding platform operators (CPO) module (Module CFP) under Volume 5 of the CBB Rulebook. The new module will replace the existing financing-based crowdfunding regulations stipulated in the CBB Rulebook-Volume 5, Type 7 Ancillary Service Providers’ general requirements module, and the existing regulation for equity-based crowdfunding in markets and exchanges module of the CBB Rulebook-Volume 6.
Crowdfunding is the use of small amounts of capital from many individuals to finance a new business venture. Crowdfunding utilises the accessibility of vast networks of people through social media and crowdfunding websites to bring investors and entrepreneurs together, with the potential to increase entrepreneurship by expanding the pool of investors beyond the traditional circle of owners, relatives, and venture capitalists.
The CBB recognises both conventional and sharia-compliant crowdfunding business models. Under the CBB regulations, a CPO refers to a person licensed by them to operate an online portal or other electronic media through which money is lent in one of three ways. Either people lend money to businesses (P2B), businesses lend money to other businesses (B2B) to gain a financial return in the form of interest/profit payment and repayment of credit over a pre-specified period (financing-based crowdfunding), or businesses can issue ordinary shares or other equity instruments like preferred shares (equity-based crowdfunding). The role of CPOs is restricted to arranging deals, bringing together borrowers and lenders in the case of financing-based crowdfunding, and bringing together investors and issuers in the case of equity-based crowdfunding. CPOs are strictly prohibited from providing any advice on deals. A CPO must not undertake Business to Person (B2P) or Person to Person (P2P) lending or investing. A CPO may raise funds for borrowers or issuers based in the Kingdom of Bahrain or abroad.
For the purposes of the module, equity crowdfunding offers exclude financial instruments such as SAFE agreements (Simple Agreement for Future Equity) or similar products, which has conversion features contingent on certain pre-determined conditions being met.
Reward-based or donation-based crowdfunding models are excluded from the scope of this module.
The CBB may license a person as a CPO provided that:
- The applicant can demonstrate its ability to operate an orderly, fair and transparent market concerning the transactions offered through its electronic facilities.
- The applicant appoints at least two approved persons. One of the approved persons must be a Compliance Officer who can also handle the responsibilities of the Money Laundering Reporting Officer, and the second person is the Chief Executive Officer of the CPO.
- The business rules of the CPO must make satisfactory provisions–
- For the protection of investors/lenders and public interest.
- To ensure the proper functioning of the platform.
- To promote fairness and transparency.
- To manage any conflict of interest that may arise.
- To promote fair treatment of its users or any person who subscribes to its services;
- To promote fair treatment of any person who is hosted, or applies to be hosted, on its platform.
- To ensure proper regulation and supervision of its users or any person utilising or accessing its platform, including suspension and expulsion of such persons.
CPO Offers & Disclosures
CPOs must prominently display on their website the following:
- A general risk warning.
- Details of how and by whom the operator is remunerated for its service, including fees and charges it imposes on lenders/investors and borrowers/issuers.
- For financing-based crowdfunding: the actual default rates as a percentage of loans entered on the platform and the number and the aggregate value of loans in default; and
- For equity-based crowdfunding: the failure rate of issuers who use the platform.
- The offering statement for each crowdfunding offer disclosing any conflicts of interest.
- Information on the rights of clients relating to participation in crowdfunding offers, including the right to withdraw commitments, lodge complaints, and any voting rights.
A crowdfunding offer is open from the time when it is first published on the platform and must be closed on the closing date or at the earliest of the following:
- Three months after the offer is made unless specific approval is obtained from the CBB.
- When the offer is fully subscribed (unless over-subscription is permitted).
- When the borrower/issuer making the offer withdraws the offer.
A crowdfunding offer must be withdrawn by the CPO if it has material concerns regarding the crowdfunding borrower/issuer or if it becomes aware of any information that indicates the offer is misleading, fraudulent, or deceptive.
CPOs must provide users with the following information upon onboarding:
- The process for offering loans or equity through the platform and the risks associated with lending or investing in crowdfunding offers.
- The limits on raising funds applicable to borrowers/issuers.
- The right of retail clients to withdraw their commitments within five working days from the time the commitment is made.
- The existence or non-existence of a secondary market.
- The due-diligence process of the platform for hosting a borrower/issuer.
- Whether there will be an ongoing relationship between the platform and the borrower/issuer following the closing of an offer.
- CPOs must additionally display on their website key information on how their platform operates, including:
- The eligibility criteria for borrowers/lenders and issuers/investors using the platform.
- Arrangements and safeguards for client money held or controlled by the operator, including details of any legal arrangements (such as nominee accounts) that may be used to hold client money.
- What would happen if loans sought by a borrower or funds sought by an issuer either fail to meet or exceed, the target level.
- Steps the operator will take and the rights of the relevant parties if there is a material change in a borrower’s or an issuer’s circumstances.
- How the operator will deal with overdue payments or default by a borrower or failure of an issuer.
- Which jurisdiction’s laws will govern the financing agreement.
Upon on-boarding retail clients, CPOs must undertake a suitability and appropriateness assessment to gauge the client’s knowledge, experience, financial situation (including the client’s ability to bear losses), and the client’s understanding of risks associated with crowdfunding by seeking information from the lender/investor.
CPOs must ensure that each retail client completes a self-declaration form before the client is allowed to use the platform, which must include the following acknowledgments:
- that the client understands the risks involved in crowdfunding.
- that the client will only commit money that the client can afford to lose.
- that the client understands the potential to lose part or all of his investment made on the platform.
- that the client may face difficulties in exiting his investments made on the platform.
- that the client is aware that the crowdfunding offer has neither been reviewed nor approved by the CBB.
CPOs must provide retail clients unconditional right to withdraw their commitment to lend or invest in a crowdfunding offer within five working days from the time the commitment is made. No fee or penalty must be charged to such persons if a commitment is withdrawn.
A crowdfunding borrower/issuer is subject to the following limits in respect of crowdfunding:
- Financing-based crowdfunding offers must be less than or equal to BHD 500,000 in aggregate, per borrower, within a twelve-month period, except where the funding raised is to be used for a Government of Bahrain led initiative/project. Additionally, the tenor of loans must not exceed five years.
- Equity-based crowdfunding offers must be less than or equal to BHD 250,000 per issuer (or BHD 500,000 in respect of equity crowdfunding issuers who qualify as entities engaged in real estate projects) within 12 months.
In any event, the minimum subscription to be received in a crowdfunding offering must not be less than 80% of the crowdfunding offer size.
Conflicts of Interest
CPOs must not participate in any crowdfunding offer hosted on their platform.
CPOs must maintain and operate effective internal rules to prevent conflicts of interest. Licensees must take appropriate steps to prevent, identify, and manage conflicts of interest between their shareholders, managers, employees, or any natural or legal person linked to them by control and their clients, or between their clients. Licensees must disclose to their clients the general nature and sources of conflicts of interest and the steps taken to mitigate them.
CPOs must not accept the following persons as borrowers/issuers on their crowdfunding platform:
- Shareholders that hold 20% or more of share capital or voting rights of the platform.
- Managers or employees of the platform.
- Any natural or legal persons linked to those shareholders, managers, or employees by control.
CPOs must not provide direct or indirect financial assistance to lenders/investors to lend or invest in a crowdfunding borrower/issuer hosted on its platform.
CPOs must not provide advice on the crowdfunding offers hosted on their platform.
CPOs must conduct due diligence on crowdfunding borrowers/issuers.
CPOs must hold client money, securities, or other client assets separate from their own and are not subject to any lien or other restrictions. Client money must be kept in a client bank account with a retail bank in the Kingdom of Bahrain. Licensees must designate a separate bank account (or sub-account) for each crowdfunding offer. Licensees must establish systems and controls for handling securities, money, or other assets, including maintaining up-to-date records of client assets held.
Funds raised must be released to the issuer within one business day of registering the shares in the share register. In case the of financing-based crowdfunding, the money must be released to the borrower within one business day of the completion of fundraising. In all cases, client money may only be released if the criteria for raising funds have been met, i.e., the minimum amount required in the offering statements has been met, and there has not been any material adverse change to the crowdfunding offer.
CPOs must have mechanisms in place to refund the money to lenders/investors within seven working days if:
- due to any reason, the crowdfunding offer is withdrawn by the platform.
- the subscription amount is less than the minimum required in accordance with the offering statement.
- the offer is oversubscribed, and the platform does not allow oversubscription.
Restrictions apply to who is allowed to fund a new business and how much they are allowed to contribute.
- Crowdfunding allows investors and lenders to select from hundreds of projects.
- Crowdfunding sites generate revenue from a percentage of the funds raised.
- The CBB regulates financing-based and equity-based crowdfunding ventures in the Kingdom of Bahrain.
These regulations apply to who can fund a new business and how much they are allowed to contribute. These regulations are supposed to protect unsophisticated or non-wealthy investors from putting too much of their savings at risk. Since so many new businesses fail, investors face a high risk of losing their principal.
Crowdfunding has created the opportunity for entrepreneurs to raise millions of dollars from anyone with money to invest. Crowdfunding provides a forum for anyone with an idea to pitch it in front of waiting investors.
This regulation establishes a harmonised legal framework for CPOs operating a public digital platform in order to facilitate the matching of prospective investors or lenders with businesses that seek funding by way of loans (financing-based crowdfunding) or acquisition of transferable securities (equity-based crowdfunding).
The CBB has again acted proactively in ensuring that there is a prudent regulatory environment for a viable alternative source of funding for new businesses and start-ups. They also recognise the impact that this will have on the FinTech industry, which has shown exponential growth in Bahrain. This industry has the potential to enhance capital flows to the economy of Bahrain.
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