In 2016 the FCA launched a post-implementation review of its regulation of the crowdfunding sector covering investment-based and loan-based crowdfunding. On 27 July 2018, the FCA published Consultation Paper 18/20 (CP18/20) which summarises its findings, and consults on proposed new rules and guidance for loan-based and investment-based crowdfunding platforms.
CP18/20 will be of particular interest to:
- peer-to-peer (P2P) platforms;
- investment-based crowdfunding platforms;
- trade bodies for the above sectors;
- consumers and businesses investing or considering investing through an online crowdfunding platform;
- consumers and businesses that have entered, or plan to enter, into loan agreements as borrowers via P2P platforms;
- intermediaries who might refer home finance customers to P2P platforms; and
- consumer organisations who might also like to consider the proposals.
In chapter 2 of CP18/20 the FCA examines the differences in the existing regulatory framework as between P2P lending and investment-based crowdfunding. The differences in business models between P2P lending and investment-based crowdfunding is examined in chapter 3, including how these differences influence the calibration of the regulatory framework. In chapter 4 the FCA examines some of the poor business practices it has observed which has led it to conclude that the regulatory framework needs updating. In chapter 5 the FCA discusses its proposed new rules. Chapters 6 and 7 cover, respectively, certain questions raised by investment-based crowdfunding platforms and P2P platforms and mortgages and home finance.
A casual chain diagram summarising the FCA’s proposals, purpose and intended impact can be found on page 52 of CP18/20.
The FCA’s proposals are grouped into the following headings:
- risk management (paras 5.5 to 5.22);
- governance (paras 5.24 to 5.42);
- marketing restrictions (paras 5.43 to 5.51);
- wind-down arrangements (para 5.52 to 5.64);
- disclosure requirements (paras 5.65 to 5.86); and
- contingency funds (paras 5.87 to 5.91).
The new requirements discussed in chapter 5 concerning the risk management include:
- for those platforms that set the price of the agreement, the FCA proposes prescriptive rules for a risk management framework, to require that, as a minimum, a platform: (i) gathers sufficient information about the borrower to be able to competently assess the borrower’s credit risk; (ii) categorises borrowers by their credit risk in a systematic and structured way (taking into account the probability of default and the loss given default); and (iii) sets the price of the agreement so it is fair and appropriate, and reflects the risk profile of the borrower;
- if a platform is offering investors a target rate of return for a P2P portfolio which it assembles or manages, it is acting as a decision maker, exercising discretion on behalf of investors. The FCA’s proposals provide that the platform should have a reasonable basis to conclude that the return it is advertising to investors can reasonably be achieved within the risk parameters originally advertised;
- where the platform chooses which loans to facilitate for an investor the platform should ensure that investors are only exposed to loans that, at the point they are allocated to an investor, meet the risk parameters advertised at the time of investment. The platform must have and use a risk management framework that is designed to achieve this;
- in models where the platform facilitates an exit for a lender before the original maturity date of the loan, it must ensure that this is done at a fair and appropriate price;
- platforms must ensure that their risk management framework is adequate at all times. In practice, this means that the expected target rate of return predicted by the framework should match the expected outcome, within a reasonable degree of confidence. To ensure that the risk management framework is sound, the FCA proposes that platforms should keep it under review by assessing outcomes against expectations, modifying it if necessary;
- the FCA expects platforms to only expose investors to services that they can adequately control and manage. Depending on the type of lending they facilitate, some platforms may find it more appropriate to simplify their business model, rather than investing in upgrades to their control environment; and
- as a minimum, platforms must re-value loans that have defaulted. However, platforms may need to consider valuations more frequently depending on their business model.
The FCA proposes to build on the existing high level requirement that platforms must have robust governance arrangements. This includes:
- P2P platforms being required to: (i) establish, implement and maintain adequate risk management policies and procedures, including effective procedures for risk assessment, which identify, manage and monitor risks relating to their activities, processes and systems; (ii) have an independent risk management function, depending on the nature, scale and complexity of its business and the nature and range of the services undertaken in the course of that business; and (iii) report to and advise the platform’s senior management on matters of risk;
- P2P platforms maintain a permanent and effective compliance function which operates independently and which: (i) monitors the adequacy and effectiveness of its policies and procedures designed to detect compliance failings, and the actions taken to address deficiencies; and (ii) advises and assists the relevant people within the platform on compliance matters;
- where appropriate and proportionate in view of the nature, scale and complexity of the platform’s business, a P2P platform will be required to establish and maintain an internal audit function; and
- that the person(s) with overall responsibility within the platform for the establishment and maintenance of a platform’s risk management framework must be a person approved for a significant influence controlled function (and under the Senior Managers and Certification Regime, a person approved for a senior manager function), such as a director.
The FCA is not proposing new rules to manage conflicts of interests. But highlights the importance of the existing rules in paras 5.37 to 5.41.
In terms of marketing restrictions the FCA’s proposals include:
- requiring P2P platforms that communicate direct offer financial promotions for P2P agreements to only communicate these promotions to the following types of investors (in the FCA Handbook ‘retail clients’): (i) those who are certified or self-certify as sophisticated investors; (ii) those who are certified as high net worth investors; (iii) those who confirm before a promotion is made that, in relation to the investment promoted, they will receive regulated investment advice or investment management services from an authorised person; or (iii) those who certify that they will not invest more than 10% of their net investible portfolio in P2P agreements; and
- where no advice is to be given to retail clients, the platforms that communicate direct offer financial promotions for PSP agreements should comply with the rules on appropriateness (COBS 10).
In terms of wind-down arrangements the FCA’s proposals include:
- further guidance explaining what platforms’ arrangements might include in practice and what they may need to consider to ensure their arrangements address the real challenges faced by a platform which may no longer be a going concern; and
- platforms to produce and keep up-to-date a manual containing information about their operations that would assist in their resolution in the event of insolvency.
Information about the role of the platform
The FCA states that the investor must be able to understand not only the nature of the investment and the risks involved, but also the service that is being provided by the platform. In particular the FCA proposes that P2P platforms must provide a description of their role including:
- the nature and extent of the due diligence it undertakes in respect of borrowers;
- whether and what role the platform will play in determining the price of a P2P agreement;
- where a platform offers a portfolio of loans to investors, what role it will play in composing that portfolio; and
- an explanation of how any tax liability for lenders arising from investment in P2P agreements would be calculated.
The FCA also proposes that platforms must explain the risks of the possibility that, in the event of its failure P2P agreements may cease to be managed and administered, that regulatory protections may be reduced or be no longer available and that future payments from an investor do not fall under the definition of client money.
The FCA’s proposals include more specific disclosure requirements to ensure that investors have a clear understanding of whether the platform achieves what it has advertised. It is also proposing that disclosures should be made to a lender in a durable form or made available on a website in good time before the platform carries on any business for that lender.
The FCA’s proposals cover: (i) information to be disclosed where the investor chooses individual P2P agreements (para 5.79); (ii) information to be disclosed where the platform allocates P2P agreements to investors (para 5.80); (iii) on-going disclosures (para 5.81); and (iv) outcomes statement (para 5.84).
The FCA’s proposals include a requirement for the platform to have a prominent standard risk warning to make it clear to investors that the operation of a fund does not guarantee payment in the event of defaults.
The deadline for responding to CP18/20 is 27 October 2018. The FCA expects to publish a Policy Statement later this year. The FCA proposes that the new rules should come into force six months from the publication of the Policy Statement.