MICRO-INVESTING IN A DIGITAL ECONOMY: OLD LAWS MEET NEW INNOVATIONS
For the observant and industry-aware, it is a fairly widely accepted trope at this point that the future of financial services is digital. The financial services industry is currently battling rigorous digital disruption and the status quo is evolving rapidly. From digital payment services to cryptocurrency to crowdfunding, etc., agile and nimble tech startups keep slugging it out with traditional financial services providers. And the focus, it seems, has now shifted to actual investment trading – a space formerly seen as the exclusive preserve of stock exchanges, investment banks, capital market operators, etc. In recent times, there has emerged a new crop of micro-investment tech startups that enable global investing for individuals and businesses by connecting everyday people with traditionally unavailable global investment opportunities through tech platforms and partnerships with financial firms. And they are proving widely attractive in Nigeria where a unique combination of a teeming young but tech-savvy population and a volatile local economy means that there is a growing market for digitally accessible investment diversification services.
In collaboration/partnership with broker-dealers etc. registered in Nigeria, the United States (USA), and other foreign countries that they service, these tech micro-investment platforms allow average Nigerians to access and invest in local and foreign markets. Platforms like Trove, Bamboo, Chaka, Risevest, etc. enable those looking to gain access to stable returns from buying and selling stocks in foreign publicly traded companies such as Apple, Google, etc. to do so. Much like global depositary receipts (GDRs), exchange-traded funds (ETFs), mutual funds, etc., these investment platforms offer timely inflation protection, high/steady return on investment, and portfolio diversification to their users and investors – only this time at a ‘democratized’ and publicly accessible level. By ‘democratizing’ stock buying through reducing the amount of Naira needed to invest in US-listed securities, etc. (achieved through fractional shares) and offering diversification by currency and geography, it is not surprising that these platforms have been widely embraced by Nigeria’s teeming young and tech-inclined populace.
Matters Arising – SEC’s Circular and the Extant Laws
Despite the obvious benefits they are bringing to the investing public, eyebrows have been raised in various corners about the propriety/legality of this disruptive approach to stock investing. On April 8 2021, the Securities and Exchange Commission (SEC) issued a Circular titled; “Proliferation of Unregistered Online Investment and Trading Platforms Facilitating Access to Trading in Securities Listed in Foreign Markets” which declared illegal the activities and operations of these micro-investment platforms. The Commission warned the investing public to be wary of the proliferation of unregistered online investment and trading platforms facilitating access to trading in securities listed in foreign markets, stressing that, by the provisions of the extant laws and regulations in Nigeria (Sections 67 – 70 of the Investment and Securities Act, 2007 and Rules 414 & 415 of the SEC Rules and Regulations), only foreign securities listed on an Exchange registered in Nigeria may be issued or offered – for sale or subscription – to the Nigerian public.[1]
The SEC further enjoined the capital market operators (CMOs) purportedly operating in partnership with these ‘wealthtech’ platforms to desist henceforth while advising the investing public to seek clarification as may be required on investment products advertised through conventional or online mediums via the Commission’s official channels of communication.
This development is in line with the Commission’s previous stance late last year as evidenced by its obtaining from the Investment and Securities Tribunal (IST) interim orders suspending micro-investment platform, Chaka, from carrying out investment activities outside the regulatory purview of the Commission and without requisite registration.
Unstoppable Growth of Fintech and Digital Investing – Positives Only
In a recent PwC Global FinTech Survey, incumbents in the financial services industry admitted to PwC that a quarter of their business, or more, could be at risk of being lost to standalone FinTech companies within five (5) years. Having successfully disrupted the most profitable elements of the financial services value chain like payments services, retail banking, wealth management, etc., FinTech startups are now setting their sights on other institutional areas such as capital markets, insurance, etc. And with their large technology investments and innovative platforms driving unprecedented advances in efficiency, even those are only a matter of time.
In the area of micro-investing, the quest for protection of investment from loss, erosion from inflation, etc. underscores portfolio diversification and the recent global trend in cross-border securities trading as democratized by digital technology and the surge in micro-investment platforms. With the inflation rate in Nigeria in double digits, concerned investors are seeking alternative investments to provide them succour and reliable return on investment and that is exactly what these ‘wealthtechs’ provide, while also simultaneously helping to alleviate the country’s financial inclusion challenges. It is presently estimated that these platforms have, since inception, introduced over 150,000 new capital market participants in Nigeria – primarily millennials – and are contributing trading volume over Ten Billion Naira (NGN10,000,000,000) monthly. This is not the least surprising given that, buoyed by the COVID-19 pandemic, personal trading apps saw record transaction volumes globally in 2020 and it is estimated that 2021 is not about to buck the trend. As such, it has become increasingly clear that these winds of change are not transient and traditional investment services providers will need to be wary of the disruption going on in their backyard.
Besides, Nigeria is indeed experiencing an explosion in the number of fintech products hitting the market and the amount of foreign investment attracted into the country, and so must not fail to take advantage of such momentum. According to McKinsey, fintech investments in Nigeria have grown by 197% over the past three years, with the majority of investment coming from outside the country. Funding for Nigerian startups reached an all-time high in 2019[2] and, while it was always going to be a tough task to surpass those heights in 2020, according to Startuplist Africa, Nigerian startups still attracted around 17% of the over $1 billion total funds raised by African startups in 2020, with Flutterwave even recently becoming a unicorn – a tech company with $1 billion valuation – earlier this year. One thing is certain – these startups are not only innovative but will also continue to attract the necessary (financial) war chest to take on traditional financial service providers and digitally disrupt the services that they offer.[3]
According to a McKinsey report titled “Harnessing Nigeria’s Fintech Potential”, the combination of a youthful population, increasing smartphone penetration, and concerted efforts towards driving financial inclusion are factors that interplay to create the perfect recipe for a thriving fintech sector in Nigeria. This presents the country with an exciting, democratizing development, offering the tools and services needed to meet the demands of today’s modern market. Not only can the sector help to unlock economic growth by driving increased productivity, capital, and labour hours through the digitization of financial services, fintech can also support Nigeria’s human capital development by driving financial inclusion and literacy through the provision of accessible and affordable financial products that are innovative and cater to the needs of unbanked and underserved segments of the population across culture, gender, and geography.
Understandable Need for Regulation
As consumers and businesses wake up to the disruptive potential of FinTech globally, so too are governments and regulatory bodies. Regulation has emerged as the number one concern among governments as fintech becomes “the new normal”. As the SEC itself stated after earlier obtaining from the Investments and Securities Tribunal (IST) interim orders restraining micro-investment platform, Chaka, from offering foreign-listed stocks to Nigerian investors; “without proper regulation, the genuine aspirations of market innovators and investors could be subverted through the activities of unscrupulous actors who would try to exploit the growing popularity of Fintech investment options, to the detriment of the investing public.”
So, while it has become increasingly clear that the realities of modern stock trading and micro-investing enabled by fintech has surpassed the contemplation of our extant laws, it has also become clear that, if left completely unregulated, these platforms could become avenues for unreliable entities to exploit the good intentions of innovators like Risevest, Bamboo, etc., to wreak havoc on unsuspecting investors. For examples, what guarantees are in place to ensure that a trading app/platform to which investors have willingly put a large percentage of their worth may not fold up due to, for example, fraud, mismanagement, bankruptcy, etc.? At least, deposits with traditional brick and mortar banks are typically insured to protect depositors from the likelihood of harm whereas there are no such frameworks, at least as of yet, for the multitudinous fintech startups offering various digitally disrupted financial services. This is also why regulators, for example, typically require that investors – particularly retail investors – have a limit on the percentage of their net worth/assets that they can invest on these platforms e.g. the new Crowdfunding Rules.
Further, apart from protection from fraudulent schemes and market volatility shocks, fending off cyber-attacks is another issue that comes to mind as a source of worry for regulators. Automation of processes and digitization of data makes fintech systems particularly vulnerable to cyber-attacks. As a result, ensuring the right solutions and processes are in place is critical if these platforms are going to be able to protect themselves and investors funds from attack. There are also the issues of liability for not only such cyber-attacks but also the misuse of personal information and important financial data.
All these make it evident that there is indeed a pertinent need for regulation of the space and that the worries of the SEC are justified. After all, the primary purpose of the Commission itself as evinced in its establishment Act (ISA) is the regulation of the capital market to ensure the protection of investors, maintain fairness, efficiency and transparency, and reduce systemic risk.
Going Forward – A Case for Proactive Rather Than Reactive Regulation
Fintech advances swiftly ‘under the regulatory radar’ but inevitably attracts regulatory responses and supervisory scrutiny as adoption increases and associated risks surface. To effectively capitalize on the opportunities afforded by inevitable digital disruption in the coming years, regulators and innovators will need to work hand in hand, consistently forecasting, planning and preparing for ubiquitous innovations. While consumers and investors are already benefitting from both the emergence of new fintech solutions and the evolution of existing financial services, proper innovation-centric regulation will allow new business models, alternative financial intermediation channels, and a wider range of financial products and services to be delivered to the market more efficiently and more regularly.
To achieve this, the SEC, and indeed other relevant regulators, need to become proactive with their regulation in a way that encourages and promotes innovation rather than stifle it. For example, it is rather insidious that, just as Chaka only learnt about the SEC’s regulatory stance with regards to their platform and services after interim orders suspending their activities were made by the IST, there were also no prior interactions between the SEC and the concerned startups before the recent circular was released – an action which caused a fair amount of panic in the fledgeling micro-investment market. One would expect that prior stakeholder engagement should have been adopted by the SEC and a fair amount of dialogue had with concerned actors, before toeing that route, especially since there was hitherto little regulatory certainty with regards to fintech startups engaging in the securities business and how the regulators may interpret the laws while applying them to their activities.[4]
Prior progressive engagement and dialogue would have allowed the affected platforms to put their houses in order in terms of partnerships and compliance and afford them the privilege of time to assure their users of the safety of their investments whilst also signaling to the on looking public and potential investors that Nigeria is a country conducive to innovative technologies.[5] While it is the responsibility of the SEC to protect the investing public by regulating market activities, the Commission should endeavour to do so without discouraging fintech entrants or causing avoidable panic amongst consumers and investors by embracing active stakeholder engagement and direct dialogue.[6]
Nevertheless, while, as has been highlighted above, it behoves the regulators to become proactive in their regulation of innovative/disruptive technological practices so as not to stifle innovation, given that innovation is quite naturally always steps ahead of regulation, it is also incumbent on these startups and prospective financial services tech disruptors to seek and obtain cogent corporate, investment, and regulatory advisory before proceeding with setting up their (investment) platforms. Where there seems to be regulatory uncertainty, it is pertinent to approach and liaise with the relevant regulator to see where and how the rules can be relaxed or stretched to accommodate them as has been done, for example, with the new Crowdfunding Rules or where they need to be amended and replaced totally. This will give a measure of certitude not only to the tech startups themselves but also to the prospective investors with regards to the reliability of such investments.
They should also consider initiating regular interactions with regulators, even when there is no imminent cause for alarm. This will allow them to interface with regulators to keep them abreast of advancements in digital applications of modern technologies, allowing them to be proactive rather than reactive in their oversight role. In a move described by the Harvard Business Review as “co-opetition” – a mash-up of the words ‘competition’ and ‘cooperation’ which entails competitors cooperating or collaborating to achieve a common goal, it will do a lot of good for fintech startups to have an association or unified body which can interface regularly with regulators like the SEC and the Central Bank of Nigeria so as to enable them to regulate the space more proactively and to champion law reforms that embrace new technological innovations.
While Chaka has since issued a notice informing the general public that it is in discussion with the SEC to seek the relevant regulatory approval and apply for a newly created license, it remains to be seen what the exact nature of that license will be and what conditions will be attached to it. Will it be like a capital market operator (CMO) license? A capital trade point (mini-exchange) license? We will just have to wait and see!
In the meantime, there is no doubt that agility and innovation, done right, can be revolutionary. This is why it is crucial to make sure that future policies and engagements promote innovation in the investment tech space rather than create uncertainty. In an industry that constantly rides on waves of disruption, being nimble and agile in anticipating unexpected developments is crucial to successfully respond to market changes on the part of both the regulators and the ‘technopreneurs’ themselves.
Conclusion
Around the world, the middle class is projected to grow by 180% by 2040 and so financial technologies/innovation that can bring these vast number of people into the formal economy and ensure financial inclusion should be embraced rather than disapproved of. Micro-investing is a trend that has come to stay. As the ongoing digitization/democratization engendered by micro-investment platforms continues to lower barriers for entry for Africans looking to access financial markets – both locally and internationally, they should be promoted within reasonably flexible and innovation-friendly regulatory frameworks.
There is absolutely no doubt that micro-investment platforms like Chaka, Bamboo, Trove, etc. have facilitated alternative investment options and financial inclusion for average Nigerian investors and have been embraced soundly. Consequently, it is in the interest of all stakeholders that an encompassing framework is developed as soon as practicable – just as was the case recently with Crowdfunding – to regulate these platforms. This will not only bring these platforms under the purview of regulation but also provide necessary protection for consumers, boost investor confidence, and signal necessary regulatory support for innovation in the country.
The financial services industry is generally at a tipping point globally — it is a case of “either disrupt or get disrupted.” As start-ups and financial technology firms entice new customers and embrace changing terrains, Nigeria should be looking at maintaining and solidifying its position as a leading fintech hub in the Sub-Saharan region and on the African continent. Regulators are on a tight rope to be as nimble as these innovative startups and so should focus on monitoring the industry more effectively and predicting and solving potential problems instead of regulating in a way that potentially stifles innovation. We must all be prepared for a world where change is constant—and where digital comes first because, in the future, everything that can be online will be online.
***Akorede Folarin is a corporate/commercial lawyer in Lagos, Nigeria. He has a keen interest and developing expertise in Fintech, Capital Markets, Private Equity and Mergers & Acquisitions. He can be reached at akinakoredef@gmail.com
