Private equity may not fit retail, but regulated access beats a ban

CROWDFUNDING has opened the gates of private equity to retail investors, and further innovations such as collateralisation are about to widen the entrance even more.

From a risk perspective, that greater access also opens the doors to potential fraud, abuse and plain poor decision-making because unsophisticated investors are not the best equipped to properly handle the risks attached to investing in early-stage and unlisted businesses. But the greater systemic risk is that of a black market as investors find ways to get the returns that they crave. In this regard, Singapore policymakers have wisely eschewed a total ban on retail participation in private equity in favour of a framework that enables participation within certain rules.

In its latest version of proposed rules on securities crowdfunding, the Monetary Authority of Singapore (MAS) made adjustments to better define the ways in which retail investors can buy shares or lend to early-stage businesses, and closed a loophole that certain platforms had been using to reach such investors without being licensed.

It was a subtle shift from the first iteration of the proposals, which had sought to restrict such investing to accredited and wealthier investors. The change was an acknowledgement of the demand among retail investors for higher yielding investments and among issuers for retail money.

Aside from what the MAS is doing, a fund of private equity funds controlled by Singapore investment company Temasek Holdings has also been in the news for a recently priced series of bonds backed by the cash flows of private equity assets. By creating different classes of investors, the Temasek fund created an investment grade-rated product which it hopes can offer a model for a future offering to retail.

Giving retail investors greater access to private equity has not been welcomed by many in the market, including - interestingly - many players in the private equity space. Those professionals are all too aware of the risks associated with private equity and early-stage funding, and in their opinion retail investors have no business being in that space. Indeed, MAS itself notes that about seven to eight of every 10 new businesses formed in Singapore cease operations within the same year. As one private equity fund manager put it: "Maybe one guy loses S$5,000, and you don't think it's a lot, but that's his mother's hospital bill."

The criticism over suitability is appropriate, but it might be unavoidable. Demand from retail investors for private equity is real, and will persist even if a ban is in place. When interest rates remain stubbornly low for yet another year, investors in search of higher yields start looking for riskier bets. And if they cannot find an option in the regulated space, they will look to unregulated alternatives. That assertion is not hypothetical. Problematic gold buyback and land banking schemes that resulted in major retail losses in the past were operating without oversight because they found spaces that existed in the regulatory cracks.

Singapore's current strategy on regulating access to early-stage investments for retail is the better way forward. Rather than try to fight the tide, it is better to build some breakwaters or install some lifeguards along the water's edge to mitigate the dangers. Regulators will not be able to protect investors from all the risks out there, but they can at least try to limit the impact of failures.