Financial Services analysis: How is the Financial Conduct Authority (FCA) approaching the regulation of crowdfunding? Tony Watts, a consultant solicitor at Keystone Law, discusses what firms need to do to comply with the FCA’s regulatory approach.
What is the background to this latest policy statement?
In recent years (particularly since the credit crunch) alternative finance models have emerged. Primarily internet-based and loosely referred to as crowdfunding, these new models have challenged traditional lending and corporate finance businesses, offering very accessible ways of lending and borrowing for individuals and of raising capital for businesses. Those most important for regulatory purposes are:
- loan-based crowdfunding (also known as peer-to-peer (P2P) lending platforms) arranging loans between lenders and borrowers–borrowing can be by individuals or businesses, and can be secured or unsecured
- investment-based crowdfunding where typically SMEs raise capital through issuing shares or debt securities
Loan-based crowdfunding was commonly considered to fall outside much of the scope of traditional regulation. Investment-based crowdfunding was thought to be covered by the existing Financial Services and Markets Act 2000 (FSMA 2000) and FCA Rules to some extent, but their application was unclear and they were not easily adaptable to new models and increased technological innovation.
There was widespread support for these new models, including in official and government circles. There was, however, concern as to the lack of clarity of regulation. The situation was unusual because many players in the industry called for greater regulation because of concern for minimum standards to maintain the reputation of the industry. There was, then, widespread support for a system of clear regulation (this has been mirrored by similar developments in the US under the JOBS Act).
The first step was the FCA’s Consultation Paper 13/13 (LNB News 24/10/2013 106). Many of the same rules and requirements have been confirmed in this latest policy statement.
Who does it affect?
It affects operators of P2P platforms because of the new (with effect from 1 April) regulated activity of operating an electronic platform in relation to lending. This will apply to those who facilitate lending by electronic means subject to certain conditions including if either borrower or lenders are individuals. It does not necessarily affect those carrying on similar activities by non-electronic means (though these may be within the scope of existing regulation covering consumer credit or domestic mortgage activities).
It also affects those who arrange or promote investment in unlisted shares or unlisted debt securities which are not readily realisable–the investment-based crowdfunding regime. This regime does, however, have a wider application than internet-based crowdfunding since it also applies to firms who communicate direct of-fer financial promotions (and these can include anything which provides a means of accepting paper application forms for investments such as minibonds).
What are the key changes from the original consultation paper?
There are not many changes from the consultation paper. The capital regime for P2P platforms has been softened as have the transitional provisions–though to benefit from the transitional provisions firms must have held a relevant Consumer Credit Act 1974 licence as at 31 March 2014 and have registered an interim permission with the FCA. There are no real changes as regards investment-based crowdfunding other than to make it clear that the regime is not intended to apply to some readily realisable securities (such as those tradable on AIM).
What type of investors can firms promote investment-based crowdfunding to?
Firms can communicate direct offer financial promotions of unlisted securities which are non-readily realisable securities to investors who are being advised by, or whose investment is being managed by, an appropriately FCA-authorised firm when that firm has confirmed the investment is suitable. They can also be promoted to professional clients and venture capital or corporate finance contacts, though in practice the FCA regards these categories as narrow.
In practical terms, the most important categories to whom such investments can be promoted will be:
- those appropriately certified as being high net worth or sophisticated investors within FCA Rules, and
- those certifying that they are investing no more than 10% of their investible assets
In both these cases, however, the firm must additionally assess that the investor has sufficient knowledge and experience to understand the risks–an appropriateness test.
Will the new rules affect how firms market over the internet?
For P2P platforms, the main impact will be those who operate on the internet–unless they are within existing regulation on (for example) consumer credit or domestic mortgages, those not operating an electronic platform won’t be affected.
For investment-based crowdfunding, the impact may be wider (though in practice most relevant operators will be internet-based). The rules are media neutral and apply to direct offer financial promotions of unlisted securities which are not readily realisable in any form. They may therefore apply to non-internet offers of minibonds if they involve a direct offer financial promotion (ie one which provides a means of acceptance).
What do firms need to do to comply with the new rules?
P2P lending platforms need to be authorised or exempt for the new regulated activity of operating an electronic platform in relation to lending by 1 April 2014 or must hold an interim permission covering this activity. They may be exempt for certain activities by becoming an appointed representative of an FCA-authorised firm with appropriate permissions. They will have an interim permission if they hold an appropriate CCA licence at 31 March 2014 and have registered their interim permission with the FCA.
Firms with an interim permission will have an easier initial ride as far as FCA requirements are concerned but must obtain full FCA authorisation within a period of two-years and face increasingly tough regulatory requirements through the transitional period and on obtaining full authorisation (some rules will apply from 1 April 2014).
Those without an interim permission must obtain full FCA authorisation (or exemption as an appointed representative where applicable) and will be subject to most FCA requirements when authorised (there will be some relaxation of capital rules until April 2016). The FCA regime for this activity will be similar (though less rigorous) than that applying to investments with rules on disclosure and financial promotions–recourse to the Financial Ombudsman Service (though not the Financial Services Compensation Scheme), prudential rules and rules as to clients’ money.
For investment-based crowdfunding there is an option to comply with existing rules by October 2014, though in practice this is a very limited concession. There is no transitional regime for authorisation because the FCA regard these activities as already covered by existing legislation (at least under the activity of arranging deals in investments and the regime relating to financial promotions)–though there remain views that some investment-based crowdfunding platforms are outside the scope of regulation on various statutory grounds.
Tony Watts is a financial services and banking specialist. He has held senior legal positions at a range of household names including Barclays Wealth where he was co-head of legal. Since 2007 he has been in private practice, specialising in financial services law and FSMA 2000 regulation.
This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.