The FCA published Policy Statement PS14/4 relating to new rules to protect investors on loan-based and investment-based crowdfunding platforms in February 2014, which generally came into force on 1 April 2014. Loan-based crowdfunding platforms are those through which people and institutions lend money in the expectation of a financial return through interest payments and repayment of capital over time. Investment-based crowdfunding platforms are those through which people invest in non-readily realisable shares or debt securities issued by businesses.
When the FCA first introduced the rules, they said they would conduct an interim review of the rules after one year and a full post-implementation review of the regime in 2016. The post-implementation review is still ongoing. The FCA has published interim feedback following a call for input to the post-implementation review of the rules for crowdfunding on 9 December 2016. The call for input closed on 8 September 2016 and the published feedback summarises the feedback the FCA received and sets out plans for further work.
This article will look at the key points and next steps to emerge from the FCA published interim feedback.
Initial findings
Loan-based and Investment-based crowdfunding
In relation to investment-based crowdfunding platforms, the FCA has found that, for example:
- it can be 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 and there are concerns about inadequate disclosures and the downplaying of risk;
- financial promotions do not always meet the FCA requirement to be ‘clear, fair and not misleading’ as not all firms have an effective internal control system;
- as a consequence of the complex structures some firms have, operational risks and/or conflicts of interest are not being managed sufficiently; and
- not all firms align their business models with the possible future success of businesses raising finance (and, ultimately, the investors).
Loan-based crowdfunding
In relation to the loan-based crowdfunding market the FCA has found that, for example:
- inadequate disclosures about risk and loan performance occur;
- wind-down plans in the event of a firm’s failure are inadequate to successfully run-off loan books to maturity resulting in risks to investors of the wind-down plans not operating as expected;
- 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; and
- there has been a need for the FCA to challenge some firms to improve their client money handling standards.
Summary
The market has grown and evolved rapidly, particularly over the last two years, increasing the risk that firms’ infrastructure, systems and controls may not be adequate. Changes are therefore required to protect both investors and firms from the following risks:
- there may be too many firms in the market, leading to a potential for consolidation in the future and a need for firm wind-down plans to be fit for purpose;
- commercial pressure and conflicts of interest may lead firms to relax creditworthiness and underwriting standards, leading to increasing credit risk;
- inadequate controls in some firms may lead to inadequate due diligence or poor quality financial promotions;
- firms’ operating platforms are generally young operations and they are inexperienced in matters such as risk management, consequently, cyber-attacks on platforms are possible; and
- insider trading or market abuse is possible, particularly where firms operate secondary markets.
However, some respondents suggest that too much regulation could be damaging to the market, particularly in relation to prudential requirement, as this could be a barrier to entry and may add unnecessary costs. Loan-based crowdfunding can be an important form of competition to mainstream lenders and therefore it is suggested that this should not be made subject to the same regulatory standards as the risks are different. This feedback, together with all other feedback will be taken into account by the FCA.
Next steps
The FCA plan to consult on additional rules in a number of areas. For both loan-based and investment-based crowdfunding platforms these include more prescriptive requirements on the content and timing of disclosures.
In addition, for loan-based crowdfunding the FCA intends to consult on:
- the standards of disclosure as the FCA is concerned that these do not meet its expectations – there will be on-going supervision of existing rules;
- strengthening and improving the rules on wind-down plans and determine additional requirements;
- the potential risks to investors if one platforms fails and this impacts on the viability of others in circumstances where firms have allowed investment in loans originated from other platforms; and
- extending mortgage-lending standards to loan-based platforms where the investor or lender is not acting by way of business.
The FCA intends to consult in Q1 2017 and publish final rules in the summer of 2017.
To access the published FCA feedback please click here.
For any further information or advice on this topic, Cleveland & Co, your External In-House Counsel, are here to help.
