In 2014 the FCA published new rules to protect investors on loan-based and investment-based crowdfunding platforms which generally, subject to certain transitional provisions, came into force on 1 April 2014. When the new rules were introduced the FCA said that it would conduct an interim review after one year and a full post-implementation review in 2016. The FCA is currently conducting such a review and earlier this year published a call for input asking for views on possible risks that may be emerging for investors and the market.
The call for input closed on 8 September 2016. The FCA has now published Feedback Statement 16/13: Interim feedback to the call for input to the post-implementation review of the FCA’s crowdfunding rules (FS16/13). In FS16/13 the FCA summarises the feedback it received and sets out plans for further work.
In terms of analysis of market developments, the FCA has put in place certain work-streams:
- the FCA is conducting a review of the business models and practices at some firms to collect evidence on potential risks and address any knowledge gaps;
- to assist with its monitoring of the sector, the FCA is analysing third-party market data alongside other information sources; and
- the FCA is also drawing from its work on authorising and supervising firms in this sector.
Initial results from the FCA’s work on loan-based crowdfunding are:
- the regulator has found inadequate disclosures about risk and loan performance;
- firms are testing the boundaries of the regulated crowdfunding perimeter, which introduces the risk of arbitrage with investment management or banking activities;
- firms’ desire to maintain confidence in platforms has occasionally led to firms acting in a non-transparent manner, masking true loan performance and exposing investors to risks. This has included management intervening to influence the performance of loans (e.g. by covering arrears) or otherwise acting to support the platform (e.g. lending to provision funds);
- firms have limited scope to increase market share with their current products and are instead targeting growth through new products or in new markets. This brings the risk of operating in unfamiliar markets without appropriate expertise, exposing longer-term investors to unforeseen lending risks;
- consumers may not realise they do not have the usual protections as borrowers, where agreements are non-commercial, and firms may not make them aware of this;
- institutional investors could bring benefits for retail investors (e.g. due diligence) but better controls are needed to mitigate the risks – particularly around conflicts of interest; and
- some platforms allow investment in loans formed on other platforms, which can make it harder for investors to conduct due diligence or to understand the level of risk they are taking. Failure of one firm could also cause problems for other firms in the market where investors in one platform are exposed to loans on a third-party platform.
Interim results from the FCA’s work on investment-based crowdfunding include:
- concerns about inadequate disclosures on investment-based crowdfunding platforms and the downplaying of risk;
- due diligence standards vary from firm-to-firm and not all firms explain their due diligence processes on their websites;
- none of the platforms the FCA reviewed provided an assessment of the valuation of a pitch, although they did challenge the figures proposed by fundraisers;
- not all firms aligned their business models with the possible future success of businesses raising finance (and, ultimately, the investors);
- not all firms had an effective internal control system in place with regards to the processes used for approving or communicating financial promotions; and
- not all firms satisfied the requirements to conduct an appropriateness test to assess whether investors have the knowledge or experience to understand the risks involved in the investment.
In light of the following specific concerns the FCA is planning to consult on the following areas:
- the FCA’s experience suggests that firms’ wind-down plans could be improved to reduce the risks to investors of the plans not operating as expected. The FCA proposes to strengthen the rules and plans to consult on additional requirements;
- where firms operating loan-based crowdfunding platforms allow investment in loans originated on other platforms there may be a risk to investors as the failure of one platform may have a direct impact on the viability of others. The FCA plans to consult on additional requirements or restrictions on cross-investment;
- in the call for input, the FCA discussed plans to consult on extending the usual mortgage-lending standards to loan-based crowdfunding platforms where the investor/lender is not acting by way of business. The FCA states that this was received positively by respondents and it will proceed with consultation; and
- the FCA remains concerned that the standards of disclosure do not meet its expectations. As well as on-going supervision of existing rules, the FCA plans to consult on more prescriptive rules on the content and timing of disclosures it expects to see.
The FCA intends to consult in Q1 2017 and publish final rules in the summer of 2017.