Having introduced its crowdfunding rules in 2014, the Financial Conduct Authority (the “FCA”) commenced a post-implementation review of its regulation of the sector in July 2016. Two years later, the FCA is finalising its consultation paper which summarises its findings and consults on proposed new rules and guidance for both loan-based and investment-based platforms.
Loan-based platforms
Broadly, loan-based crowdfunding software platforms facilitate the loan of capital by investors to recipients on a peer-to-peer basis, meaning through online services that help to match funders with borrowers. Interest is repayable on the capital in the usual manner, providing a return for the funders. The platform provider itself may typically charge commission on the total amount raised and on occasion an additional fixed price set-up fee.
A key concern of the FCA has been on the marketing of these types of platform. Focusing on the protection of potentially unsuitable investors, the FCA has proposed that marketing of loan-based platforms should be restricted so that they may only communicate certain financial promotions to the following investor categories:
- Certified, or self-certified, sophisticated investors;
- Certified high net worth investors;
- Investors who have confirmed that they have taken regulated or authorised investment advice; or
- Investors who certify that they will not invest more than 10% of their net investible portfolio in loan-based agreements.
The consultation paper also proposes rules relating to compliance, risk and audit, as well as a requirement for loan-based platforms to have a ‘Risk Management Framework’ (with director-level responsibility). In addition, the FCA would like to see a significant increase in the disclosure obligations placed on loan-based platforms in respect of the loans that they facilitate so as to enable more informed investment decisions. Each of these proposed changes are intended to reduce the number of investors placing funds in “unsuitable instruments” and to bring the relevant rates of return more in line with the underlying risk of payment default.
Investment-based platforms
Investment-based crowdfunding platforms facilitate investment in either new or established businesses. In exchange for their investment, investors typically receive shares, although other less traditional (or tangible) approaches may be taken (e.g. access to exclusive products launched by the relevant business).
In its consultation paper, the FCA has admitted that whilst it is “largely content” with its regulation of investment-based platforms, it does have concerns in respect of poor business practices in this sector resulting in potential harm to investors.
Amongst observations, the FCA highlighted the need for investment-based platforms to provide clearer and more accurate information to investors as to the various risks involved in making an investment. Amongst the FCA’s proposals is an increased obligation on investment-based platforms to ensure that they have in place adequate systems and processes in order to support good initial and ongoing disclosure of information to investors. In order for this to be achieved, platforms must be required to collect sufficient information and conduct adequate due diligence of businesses and individuals seeking investment from an early stage, which should be disclosed to prospective investors accordingly.
Conclusion
It is evident from the tone of the FCA’s consultation paper that its proposed changes are designed to protect crowdfunding investors, which in turn sits well with the FCA’s wider effort to make investment via crowdfunding platforms a more transparent and informed process.
Attention now turns to whether the FCA will consider it necessary to make any amendments to its proposals in light of the responses received during the consultation period and in due course, when the details of the final rules changes will be published and come into force.
Charles Maurice