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Fintech Act. 22 Aug 2017

The six financial risks of 'crowdfunding'

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As with all financial products, investments in P2P platforms include certain risks linked to liquidity, credit, the market itself... As an additional risk, "intermediary" platforms may not correctly assist in the selection of projects, management of information, and even in aspects of payment management. These are the six financial risks linked to crowdfunding operations..

One of the main financial risks characterizing crowdfunding platforms is that they operate in shadow banking. In fact, the less stringent regulation of this alternative market and the degree of informality with which many of the platforms operate increase the liquidity and solvency risks faced by the investors.

"The best defense against the latter risks is to ensure that the platform on which we invest providessufficient transparency in the selection of projects or loans as well as commissions, risk management, etc." says Pablo Díaz, Business Development Supervisor at the Zencap platform.

In finance, risk is associated to uncertainty. In other words when one speaks of risk he or she is speaking of the possibility that something will happen that will result in losses for participants in the financial operation, including investors. And these probabilities of uncertainty also occur in P2P financial operations.

The six main risks affecting P2P funding are the following:

Solvency risk

In P2P operations this type of risk can be increased due to greater asymmetry of information between entrepreneurs and investors, given that there is no regulation specifying what information is to be shared between them.

Liquidity risk

That one party in the financial operation might not obtain the necessary liquidity to assume its obligations is one of the main financial risks in traditional operations as well as in P2P.

Credit risk

Although this may be linked to the liquidity risk, this type of risk is based on the possibility that one of the parties in the financial operation may fail to assume all of the obligations agreed between the entrepreneur and the investor and, therefore, that a financial loss may be incurred for the other party of the agreement.

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Operational risk

This refers to the possibility of experiencing losses resulting from failures in processes, information, and internal systems of the platform as well as losses resulting from human error or the consequences of events external to the operation that affect its process, such as reputation risks for instance.

Market risk

The risk that exists because the fair value or future cash flows of a financial instrument may fluctuate as a result of price variations in the market.

Lack of coordination in regulation

Although new rules are beginning to be created to regulate P2P financial operations, a degree of uncertainty persists with respect to the application of certain local rules in the global context in which crowdfunding takes place, given that access to relevant Internet operations is international. This poor coordination between the regulators in different countries may cause a fragmented market that doesn't help in the rise ofcrowdfunding.

Specific regulations are beginning to emerge in the countries where P2P funding operations are most common, that regulate these operations in pursuit of two objectives: on one hand, to protect unqualified investors and, on the other, to make it easier to access funding for startups or small businesses, which are the ones that find it difficult to fund themselves in the conventional financial market.