The Financial Conduct Authority (FCA) has released their much anticipated interim report on debt and equity crowdfunding. The document addresses both peer to peer lending and investment crowdfunding platforms and the current state of operations as the new approach to capital formation evolves.
Andrew Bailey, Chief Executive of the FCA, released a statement on the report indicating his agency was working to balancing both risk and reward for consumers and businesses. Bailey stated additional rules were necessary to enforce investor protection;
“Our focus is ensuring that investor protections are appropriate for the risks in the crowdfunding sector while continuing to promote effective competition in the interests of consumers. Based on our findings to date, we believe it is necessary to strengthen investor protection in a number of areas. We plan to consult next year on new rules to address the issues we have identified.”
An earlier review was provided by the FCA in February of 2015. At that time, the FCA stated there was “no need to change.”
So what is different since the last report? Bailey assumed his role at the FCA in January of 2016. Meanwhile the industry has grown dramatically, evolved, and added new products and strategies for raising capital online.
The FCA wants to provide “more prescriptive requirements” on the content and timing of disclosures by both loan-based and investment-based crowdfunding platforms. A consultation on proposals will be forthcoming in Q1 of 2017.
According to the FCA’s initial findings, the “modifications” necessary for loan based and investment based crowdfunding include:
Investment based crowdfunding
- It is difficult for investors to compare platforms with each other or to compare crowdfunding with other asset classes due to complex and often unclear product offerings
- It is difficult for investors to assess the risks and returns of investing on a platform
- Financial promotions do not always meet our requirement to be ‘clear, fair and not misleading’ and
- The complex structures of some firms introduce operational risks and/or conflicts of interest that are not being managed sufficiently
Loan-based crowdfunding
- Certain features, such as some of the provision funds used by platforms, introduce risks to investors that are not adequately disclosed and may not be sufficiently understood by investors
- The plans some firms have for wind-down in the event of their failure are inadequate to successfully run-off loan books to maturity
- We have challenged some firms to improve their client money handling standards.
The FCA’s findings have lead them to consult on strengthening several rules for both investment based and loan based crowdfunding.
For loan based, the FCA wants proposes:
- Strengthening rules on wind-down plans
- Additional requirements or restrictions on cross-platform investment
- Extending mortgage-lending standards to loan-based platforms
The FCA has also recently entered into a unique and encouraging partnership with the Cambridge Centre for Alternative Finance (CCAF). The partnership has the CCAF compiling data and completing research on behalf of the FCA regarding alternative finance regulation. Bryan Zhang, a Director of the CCAF, shared with Crowdfund Insider a comment on the report;
“We are aware that the FCA has published an interim statement on its post-implementation review of crowdfunding regulation. The review is still ongoing and as stated in 5.8 of the interim statement, the Cambridge Centre for Alternative Finance is currently working with the FCA to carry out research with the investors and fundraisers on crowdfunding platforms. This research involves collecting and analysing survey and transactional data, as well as conducting qualitative interviews. We believe that this research will provide more empirical data and help broaden the evidence base for the crowdfunding regulatory review.”
The UK Peer to Peer Finance Association (P2PFA) was quick to respond to the initial findings. The Association “welcomed” the FCA’s recognition that the sector remains “relatively small” and that any regulations need to be “proportionate and risk based.”
Christine Farnish, CBE, Chair of the P2PFA, stated;
“In any dynamic market regulators need to keep the regulatory regime under close review. We are pleased, therefore, that the FCA has undertaken this sector-wide review at this time. The critical test for any review of this sort is whether the sector is, overall, delivering beneficial outcomes for investors and borrowers. It is not easy for a regulator to grapple with new market entrants, especially when they are disrupting traditional business models and challenging powerful incumbents. We trust that the critical consumer outcomes test – based on a balanced and evidence-based assessment of benefits and risks – will be applied as the Review moves forward’.
The P2PFA stated it was looking forward to working closely with the FCA to develop standardized disclosures on the benefits and risk of P2P lending.
The UK Crowdfunding Association (UKCFA) stated that the issues raised in the FCA’s interim feedback statement are a question of better enforcement of existing rules by the regulator, as opposed to the creation of new rules.
“The UK’s approach to the regulation of crowdfunding is widely admired around the world and we want to maintain our leadership position globally in shaping the future of this important and growing part of the financial services industry.”
The UKCFA said they had long been seeking “clarification of the rules defining loan crowdfunding.” Similar to the P2PFA, the crowdfunding association said they look forward to working with the regulators on any new rules. The UKCFA cautioned the governmental entity;
“…we feel the FCA should acknowledge the success of the existing rules in investment crowdfunding both in ensuring investors understand the risks and the way new investors are given additional protections through the appropriateness test and restricted retail investor status compared to traditional models of retail investment.”
The UKFCA is of the opinion that their industry approach to investor protection would better serve the broader financial industry.
“Rather than seeing crowdfunding as the ‘new kids on the block’ we believe we can teach the old dogs from the traditional sectors some new tricks in the way they educate and inform their investors. We look forward to working constructively with the regulator to find ways to make sure best practices are spread more widely across the sector and we continue the process of innovating the way businesses raise money and ordinary people invest for their future.”
The UK has been widely acknowledged as a global leader in alternative finance. This achievement has been accomplished by their “light-touch” regulatory approach setting a gold standard of competition based rules. Both the investment based and loan based crowdfunding markets have grown rapidly in the UK providing better access to capital for both consumers and smaller firms. The challenge of the FCA is to address their concerns without dampening innovation. While the FCA’s past regulatory approach has been emulated around the world, emerging regional competitors are seeking to challenge the UK as the world leader in Fintech innovation.
The FCA stated their investigatory work should be completed early in 2017. At that time, the FCA will complete the post-implementation review and determine whether further consultation on rule changes is needed.