Spotlight: Crowdfunding and fintech regulation in LAC

COVID-19 struck at a moment of rapid growth, transformation and new regulation for fintechs in Latin America and the Caribbean (LAC), including exponential growth of crowdfunding, according to the authors of a study produced by IDB and the Cambridge Centre for Alternative Finance (CCAF).

Even with the pandemic, “I think that fintechs are in a positive situation," said Tania Ziegler, head of global benchmarking at CCAF. "They’re in a position to be able to serve their clients,” she said, speaking at an online event Wednesday hosted by IDB.

“Now, this has been a huge shock based on the health crisis. It’s affecting the economy, financing, all aspects of life,” said Ziegler, an author of CCAF’s Global Alternative Finance Market Benchmarking Report and manager of the center’s alternative finance benchmarking program. 

“Most of what we’ve seen has had to do with companies that have not been able to digitize fast enough,” she said, whereas fintechs are by their very nature already digital.

The researcher said CCAF is currently conducting a new study with the World Bank and the World Economic Forum “to understand how nowadays fintechs are being affected and their market.

“Something that we’re already seeing is that consumer and business lending are changing to eKYC [electronic know your customer] and onboarding [processing for new customers],” said Ziegler, where companies are being forced to adapt as quickly as possible to the changing status of their clients. 

While they are not yet ready to state findings, she said, “we’re seeing examples of platforms reducing fees and commissions and allowing payment holidays, but we aren’t seeing default levels that are very different than the rest of the ecosystem.

“I do think that there’s going to be some short-term suffering, I do, however, believe that fintechs are in a good position for the new status quo.” 

Crowdfunding boom

Headed into the pandemic, crowdfunding and alternative finance models with fintechs were experiencing a period of rapid acceleration in the region. 

“Crowdfunding is growing,” said Sonia Vadillo, a fintech and alternative finance regulation specialist at IDB, speaking at the same event. “It’s a sector with enormous potential, and year after year volumes in our region have done nothing but go up.”

For the first time, LAC surpassed the US$1bn threshold in 2018, generating alternative finance volumes of US$1.81bn for consumers, businesses and others. 

Up 173% on the previous year’s US$663mn, the vertical’s “exponential growth” has been a consistent trend in the region since 2013, with average annual growth of 147%, according to the CCAF report.

The 2018 figure includes alternative finance volumes from 34 countries and territories, “though it is worth mentioning that 93% of the region’s volume comes from six key countries: Brazil (37%), Chile (16%), Mexico (13%), Colombia (11%), Peru (9%) and Argentina (7%),” reads the report.

New sophistication

Crowdfunding mechanics have also experienced a high level of sophistication with models now bringing in institutional lenders, who often have the option of buying loans made on the platform in part or in full, as opposed to the traditional model where the platform itself acts as the sole intermediary in a contract.

“When we started to look at this landscape a few years ago, we only saw a few types of models, but now in 2020, this taxonomy has 50 different models, and that’s not surprising,” said Ziegler. “The ecosystem is evolving, and that’s why we have to change our vocabulary, so we’re able to describe it.”

Some of the most common new models involve lending without guarantees to borrowers that are primarily SMEs. Others include property as collateral for loans. Some classes are based on peer-to-peer (P2P), and some on balance sheet, said Ziegler.

“It’s not unusual to see a company that works with one model,” Ziegler said, adding that more than 40% of P2P firms work with a balance sheet model as well, for example. 

Regulation 

Most fintech companies interviewed for the study, Ziegler said, have a positive perception of the need for regulation of these alternative financing models, largely as this would allow many to scale up.

However, she added, it is essential that regulators and legislators understand both the new models and design frameworks that are able to adapt to constant evolution.

The rapid growth of crowdfunding “could help close financing gaps that we see in sectors that have typically been traditionally excluded from financial services, especially SMEs,” said Vadillo, adding there are already several countries in the region “moving towards better regulation in order to promote crowdfunding as a source of financing for these sectors.”

Vadillo said that crowdfunding is among the most common verticals seeing regulation in the region, along with payments and remittances.

She added, “In the rest of our areas with two or three exceptions, the region is sliding quite far behind European and Asian markets.”

In the map below the darker blue countries have passed some form of fintech regulation, the middle-shaded ones are those that have regulation projects in the pipeline and the lightest blue nations are those with no clear plans to regulate.

 Source: IDB, CCAF

The next map shows where crowdfunding regulation stands in the region with the darkest orange countries having made the most significant advances.Source: IDB, CCAF

“In Mexico you have the fintech regulation law, which regulates equity crowdfunding, P2P crowdfunding as well as property crowdfunding,” said Vadillo.

“In Colombia, there is a regulation on [crowdfunding based on] securities and debt. In Brazil, the central bank and the stock exchange issued specific regulations for equity crowdfunding and debt-based crowdfunding. In Peru, there’s a very recently passed law which regulates crowdfunding platforms. And, we’re just awaiting the secondary regulation for that law.”

In Argentina, “the national securities commission issued a crowdfunding regulation, and in terms of things in the pipeline, Chile is working on a crowdfunding law, as is Uruguay.”