
The FCA has announced their regulatory approach to crowdfunding and it will have direct impact on the sector. Investors will be better protected and platforms will have to adhere to rules already commonplace within the wider financial services industry. This deliberate positioning of crowd funding within the financial services industry and not tech or social media is a good move for the sector. The fear that regulation will strangle burgeoning businesses is misplaced as most companies already work to the standards, but new entrants from the tech or social media sectors will have to structure and manage their affairs correctly.
For investors, the eligibility criteria have been expanded to include unsophisticated investors and those not classed as high net worth. Everyone can now invest as long as it is not more than 10% of his or her savings. This means friends family and fans can now support start-ups and expanding businesses, which is great news.
In its paper “The FCA’s regulatory approach to crowdfunding over the internet (http://www.fca.org.uk/news/firms/ps14-04-crowdfunding) the FCA outlines the fundamental rules to which platforms should adhere and for which investors should look out. They make a distinction between equity and loan based platforms. In regards to equity there is a new description of equity shares in non-listed companies “Non-readily realizable securities”. If a platform is managing these investments and not providing advice by a qualified advisor they must ensure the investment is only promoted to
The final group is most interesting. The FCA has provided the self-declaration questions for this group but the platform also has to ensure that investors fully understand the investment and the associated risks. This will be harder to do and it will be interesting to see if any platforms are challenged by an investor who thinks they have been mislead or not fully informed. The positive outcome of this change is that businesses can appeal to friends and family investors who are often the foundations of startups and crowdfunding was arguably invented for them.
The FCA has also provided some clarification around the wider promotion of equity crowdfunding. Simply put, a platform should promote themselves and what the platform can offer rather than specific investments. Once they capture traffic, as soon as investors self-declare as one the groups above then they can receive the specific investment details.
Loan Based Crowdfunding
The arrival of Loan Based Crowdfunding (P2P) has had a dramatic impact on the economy. The announcement in the March 18 2014 budget that it can be included in ISAs show that it is becoming an increasingly mainstream way of investing and borrowing money.
As it moves into the mainstream the FCA has to give investors protection and bring platforms into line with other financial services firms. They are doing this by making Consumer Credit Licences mandatory.
A significant part of their approach to P2P lending is how they ensure platforms have contingency in place if they collapse, as they are not and will not be covered by the Financial Services Compensation Scheme (FSCS) introduced during the banking crisis. This means that investors can potentially lose all of their investment if the platform fails, as they will not have any recourse to recoup lost funds. The protection they have introduced will subject platforms to the regulations within the Clients Assets Sourcebook. These are rules instructing them of the level of funds that must be held in reserve in the event of a platform collapse.
Platforms will also be brought closer to other financial services firms as they will have a requirement to report regularly to the FCA on their platform’s performance on “Gabriel” - the FCA portal - and using the forms as laid out in the document mentioned above. The reporting will cover platforms' prudential and financial position, loans outstanding, client money position, complaints handling and information on new loans.
The established platforms will absorb these changes easily and, one would hope, they will have no real problem providing the reporting required. New entrants from technology or non-finance sectors will find this more challenging and must identify partners to provide support.
The overriding fear for the FCA is a high profile platform failure. They are keen to have visibility of problems as they emerge, so that action can be taken. They also want to be safe in the knowledge that contingency funds are available to lessen the blow.
Hybrid platforms
They are not identified in the document but many platforms do offer both equity investment and loans. They must follow both sets of rules and there is no obvious reason why they can’t continue to prosper under the new regime. There is some ambiguity for platforms that offer more sophisticated financial instruments such as debentures. During the consultation process it was argued that they were equity investments but the FCA was keen to put them in P2P grouping. There is no direct mention within the FCA document, so they may have to adhere to all rules.
As with everything regarding the FCA, financial promotions and disruptive technologies, there are grey areas of debate. It makes sense for any platform to ensure that they have strong legal guidance and an established relationship with the FCA; and that they join and adhere to the rules and operating principals of the Peer to Peer Finance Association and the UK Crowdfunding Association. This will give both investors and those looking to raise money the reassurance they require.
As the Chancellor has indicated with his willingness to include crowdfunding investments in ISAs, crowdfunding is becoming mainstream and an established part of the UK’s alternative investment landscape; it therefore has to play in the same regulatory playground.
Image credit to: @Doug88888. http://bit.ly/SEfxGP
In its paper “The FCA’s regulatory approach to crowdfunding over the internet (http://www.fca.org.uk/news/firms/ps14-04-crowdfunding) the FCA outlines the fundamental rules to which platforms should adhere and for which investors should look out. They make a distinction between equity and loan based platforms. In regards to equity there is a new description of equity shares in non-listed companies “Non-readily realizable securities”. If a platform is managing these investments and not providing advice by a qualified advisor they must ensure the investment is only promoted to
- Professional clients;
- Retail clients classified as corporate finance contacts or venture capital contacts;
- Retail clients certified as sophisticated or high net worth; or
- Retail clients who confirm that they will not invest more than 10% of their net investible assets in these products. They are classed as 'restricted investors.'
The final group is most interesting. The FCA has provided the self-declaration questions for this group but the platform also has to ensure that investors fully understand the investment and the associated risks. This will be harder to do and it will be interesting to see if any platforms are challenged by an investor who thinks they have been mislead or not fully informed. The positive outcome of this change is that businesses can appeal to friends and family investors who are often the foundations of startups and crowdfunding was arguably invented for them.
The FCA has also provided some clarification around the wider promotion of equity crowdfunding. Simply put, a platform should promote themselves and what the platform can offer rather than specific investments. Once they capture traffic, as soon as investors self-declare as one the groups above then they can receive the specific investment details.
Loan Based Crowdfunding
The arrival of Loan Based Crowdfunding (P2P) has had a dramatic impact on the economy. The announcement in the March 18 2014 budget that it can be included in ISAs show that it is becoming an increasingly mainstream way of investing and borrowing money.
As it moves into the mainstream the FCA has to give investors protection and bring platforms into line with other financial services firms. They are doing this by making Consumer Credit Licences mandatory.
A significant part of their approach to P2P lending is how they ensure platforms have contingency in place if they collapse, as they are not and will not be covered by the Financial Services Compensation Scheme (FSCS) introduced during the banking crisis. This means that investors can potentially lose all of their investment if the platform fails, as they will not have any recourse to recoup lost funds. The protection they have introduced will subject platforms to the regulations within the Clients Assets Sourcebook. These are rules instructing them of the level of funds that must be held in reserve in the event of a platform collapse.
Platforms will also be brought closer to other financial services firms as they will have a requirement to report regularly to the FCA on their platform’s performance on “Gabriel” - the FCA portal - and using the forms as laid out in the document mentioned above. The reporting will cover platforms' prudential and financial position, loans outstanding, client money position, complaints handling and information on new loans.
The established platforms will absorb these changes easily and, one would hope, they will have no real problem providing the reporting required. New entrants from technology or non-finance sectors will find this more challenging and must identify partners to provide support.
The overriding fear for the FCA is a high profile platform failure. They are keen to have visibility of problems as they emerge, so that action can be taken. They also want to be safe in the knowledge that contingency funds are available to lessen the blow.
Hybrid platforms
They are not identified in the document but many platforms do offer both equity investment and loans. They must follow both sets of rules and there is no obvious reason why they can’t continue to prosper under the new regime. There is some ambiguity for platforms that offer more sophisticated financial instruments such as debentures. During the consultation process it was argued that they were equity investments but the FCA was keen to put them in P2P grouping. There is no direct mention within the FCA document, so they may have to adhere to all rules.
As with everything regarding the FCA, financial promotions and disruptive technologies, there are grey areas of debate. It makes sense for any platform to ensure that they have strong legal guidance and an established relationship with the FCA; and that they join and adhere to the rules and operating principals of the Peer to Peer Finance Association and the UK Crowdfunding Association. This will give both investors and those looking to raise money the reassurance they require.
As the Chancellor has indicated with his willingness to include crowdfunding investments in ISAs, crowdfunding is becoming mainstream and an established part of the UK’s alternative investment landscape; it therefore has to play in the same regulatory playground.
Image credit to: @Doug88888. http://bit.ly/SEfxGP

About the guest author - Michael McDowell
Michael has extensive knowledge and experience in crowdfunding. In 2006 he was a founding shareholder of a web based property crowdfunding platform and was recently actively involved in the UK Crowd Funding Association response to the FCA public consultation process. Michael currently works with Sapphire Capital and their crowdfunding technology partner Crowd Valley (part of the Grow VC Group) to advise clients on how to structure their crowdfunding platforms and related businesses.
Michael has extensive knowledge and experience in crowdfunding. In 2006 he was a founding shareholder of a web based property crowdfunding platform and was recently actively involved in the UK Crowd Funding Association response to the FCA public consultation process. Michael currently works with Sapphire Capital and their crowdfunding technology partner Crowd Valley (part of the Grow VC Group) to advise clients on how to structure their crowdfunding platforms and related businesses.