The British regulator, the FCA, has concluded after a public consultation that its proposed regulation of crowdfunding is mostly good to go. The new regulation focuses only on financial return crowdfunding, not on rewards or on donations. The British crowdfunding market is maturing with regard to lending-based platforms, or Peer-to-Peer Funding, and has also seen significant growth with regard to equity and project finance, but we do not yet see an established and stable industry. With the increased visibility of the crowdfunding sector, concerns have risen.
To create adequate safe guards to investors and investees alike, while at the same time still allowing sufficient room for innovation in the crowdfunding sector is not an easy task. The FCA rightfully hopes to strike a balance between on one hand making sure consumers are properly informed and on the other hand, making sure crowdfunding is open to businesses and individuals.
The FCA will monitor progress of its regulation in 2016, which the European Crowdfunding Network considers too long a period. The crowdfunding industry has grown exponentially in the past two years. We believe that an ongoing review process is more adequate in order to quickly react and adjust to the fast pace of the sector.
From 1 April 2014 a new regulated activity of “operating an electronic system in relation to lending” will be introduced and applicable to lending-based crowdfunding. The FCA confirms that loan-based crowdfunding platforms will fall under the majority of FCA provisions relating to:
- conduct of business rules (disclosure and promotions),
- client money protection rules,
- dispute resolution rules,
- the requirement to take reasonable steps to ensure existing loans portfolios are administered if the firm goes out of business
However, the FCA introduced lower capital requirements for some loan-based crowdfunding platforms, where volume-based requirements will be in excess of £50,000 plus a percentage of the total outstanding loan value.
The European Crowdfunding Network believes that the proposed regulatory safeguards are a good step to ensure customer protection and that it will help the industry to establish a more professional framework. However, the hurdles for new market entries are high, considering lending-based crowdfunding remains an immature low margin business with no substantial competitive market yet established. These hurdles might well reduce competition and lead to a decrease in innovation.
The FCA’s believes investments via an equity-based crowdfunding platform are risky, difficult to value and illiquid. The FCA argues that the risks are such that, in general terms, direct investment offers 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 authorized person,
- retail clients who are venture capital contacts or corporate finance contacts,
- retail clients who are certified or self-certify as sophisticated investors,
- retail clients who are certified as high net worth investors,
- retail clients certifying that they will not invest more than 10% of their net investible financial assets in unlisted equity and debt securities
However, if the securities are:
- officially listed or about to be listed;
- traded, or soon to be traded, on an offical investment exchange,
then this might be considered an acceptable secondary market providing liquidity.
The European Crowdfunding Network welcomes the increased customer protection in equity crowdfunding, however, we are not convinced of the overall approach and do not fully share the believe that professional or sophisticated investors are more likely to make better investment decisions compared to so called retail investors, as they are not able to perform their usual due diligence, cannot run their standard comparisons, and cannot engage as closely with the entrepreneur prior to investment as they might be used to. Indeed, this might be counter-intuitive to the idea of crowdfunding to a certain degree.
We are also not convinced yet that self assertion of retail investors will reduce any risk nor that the 10% rule can be reinforced meaningfully (or that 10% is a meaningful benchmark). We therefore remain very cautious to see if the new legislation will indeed be able to protect investors while at the same time increase asset allocation to crowdfunding. Still, we are hopeful that the approach does not discourage retail investors to engage in crowdfunding.
Overall, the European Crowdfunding Network is missing collaboration between national regulators, something we have been asking since 2012. We have already intervened with a large number of regulators, including the FCA, in national discussions but also through special work groups within the European Securities and Markets Authority (ESMA) and Financial Industry Regulatory Authority (FIRNA) in the USA.
We remain concerned that regulation by national regulators will increase fragmentation of the European market if these are not aligned. The timing of the UK regulation is uninspiring, as the European Commission, after more than one year intensive research and open discourse is about to announce its standpoint on crowdfunding on 19th of March. Something the FCA is surely aware of. We believe the FCA has not assumed its responsibility with the European Union and missed a great opportunity to ensure that the UK crowdfunding sector will emerge ahead of its European counterparts.