In October 2013, the Financial Conduct Authority published a consultation paper setting out its proposed approach to the regulation of crowdfunding platforms. Having analysed the feedback it received, on 6 March 2014 the FCA published a Policy Statement detailing its response to this feedback and, most importantly, setting out the rules that will apply from 1 April 2014.
What is crowdfunding?
The FCA’s description is as follows:
‘Crowdfunding is a way in which people, organisations and businesses, including business start-ups, can raise money through online portals (crowdfunding platforms) to finance or re-finance their activities.’
The FCA goes onto say that ‘Some crowdfunding activity is unregulated, some is regulated and some is exempt from regulation’.
Crowdfunding is an increasingly important part of business finance in the UK. The financial crisis meant that traditional sources of business finance became harder to access, while technological innovation allowed alternative options to enter the market. Crowdfunding has grown quickly. In the feedback to its recent consultation, the FCA was given notice of the following figures:
- Loan-based crowdfunding platforms raised £480 million in 2013, of which:
- £287 million was loaned to individuals, an increase of 126% compared to 2012
- £193 million was loaned to businesses, an increase of 211% compared to 2012, and
- Investment-based crowdfunding platforms raised £28 million in 2013, an increase of 618% compared to 2012 (see The Rise of Future Finance, The UK Alternative Finance Benchmarking Report, National Endowment for Science Technology and the Arts (Nesta), University of California, Berkeley, and Cambridge University, December 2013).
However, important though crowdfunding now is, financial regulation was not drawn up with crowdfunding in mind. Given this, there has sometimes been an element of ‘square pegs in round holes’ about the way that crowdfunding fits into the UK’s regulatory system. The FCA has been working hard to clarify the situation. Following consultation, the FCA has now set out its plans.
Loan-based crowdfunding
This type of crowdfunding will see the biggest change. From 1 April 2014 there will be a new regulated activity of operating an electronic system in relation to lending. There will be a number of aspects to this activity and various exclusions. Those operating or dealing with loan-based crowdfunding platforms would be well-advised to see whether their business model is caught by this new activity.
The FCA has been consulting on how the various aspects of the FCA Handbook should apply to those loan-based crowdfunding platforms which it regulates. The FCA has confirmed its intention that loan-based crowdfunding platforms should have to abide by the bulk of FCA provisions relating to:
- conduct of business rules (in particular, around disclosure and promotions),
- client money protection rules,
- dispute resolution rules and
- the requirement for firms to take reasonable steps to ensure existing loans continue to be administered if the firm goes out of business
However, the FCA noted the widespread view that existing capital requirements might be excessive in some instances. They have therefore amended their approach and agreed that there should be lower capital requirements for some loan-based crowdfunding platforms. In summary, for those firms covered by the new system, the new volume-based financial resources requirement calibration will be the higher of £50,000 and the sum of:
- 0.2% of the first £50 million of total value of loaned funds outstanding,
- 0.15% of the next £200 million of total value of loaned funds outstanding;
- 0.1% of the next £250 million of total value of loaned funds outstanding, and
- 0.05% of any remaining balance of total value of loaned funds outstanding above £500 million.
Investment-based crowdfunding
The FCA’s concern here is clear. Many of the businesses seeking investment via an investment-based crowdfunding platform will be risky propositions. The securities that they offer may be hard to value and may prove difficult for investors to sell on a secondary market. The FCA has taken the view that the risks likely to be involved in investing via an investment-based crowdfunding platform are such that, in general terms, direct offer financial promotions relating such investments should only be communicated to:
- professional clients,
- retail clients who confirm that, in relation to the investment promoted, they will receive regulated investment advice or investment management services from an authorised person, or
- retail clients who are venture capital contacts or corporate finance contacts, or
- retail clients who are certified or self-certify as sophisticated investors, or
- retail clients who are certified as high net worth investors, or
- retail clients who certify that they will not invest more than 10% of their net investible financial assets in unlisted equity and debt securities (ie they certify that they will only invest money that does not affect their primary residence, pensions and life cover).
In response to feedback that it has received the FCA have also clarified that if securities are:
- admitted or about to be admitted to an official listing; or
- traded, or soon to be traded, on a recognised investment exchange or designated investment exchange,
then the FCA would consider that there is an acceptable secondary market and the securities are ‘readily realisable’. The FCA therefore intends to refer to ‘non-readily realisable securities’ rather than to ‘unlisted shares’ and ‘unlisted debt securities’. This clarification will be welcome.
The regulation of crowdfunding is emerging from a period of some uncertainty and firms involved in crowdfunding would be well-advised to study the FCA’s recent publication.
Sharon Ayres is a partner at Wragge & Co LLP: sharon_ayres@wragge.com
Richard Goold is a partner at Wragge & Co LLP: richard_goold@wragge.com
Penny Sanders is a director at Wragge & Co LLP: penny_sanders@wragge.com
Richard Ellis is a solicitor at Wragge & Co LLP: richard_ellis@wragge.com
