FCA publishes interim feedback on review of crowdfunding rules

Background

In April 2014, new rules came into force for the regulation of firms operating crowdfunding platforms under the new Article 36H regulated activity. The FCA had committed to carry out a full post-implementation review of the crowdfunding market and regulatory framework in 2016 to identify whether further changes would be required.

On 08 July 2016, the FCA published its Call for input to the post-implementation review of the FCA’s crowdfunding rules. In this paper it set out some of the recent developments across the crowdfunding sector and a number of concerns that it had identified in response.

Review findings

On 09 December 2016, the FCA published its interim feedback. According to the FCA, £2.7bn was invested on regulated P2P and crowdfunding platforms last year, up from £500m in 2013.

The FCA believes it is appropriate to modify a number of rules for the market based on a review of the feedback received, issues seen during the supervision of crowdfunding platforms currently trading, and consideration of the applications from firms seeking authorisation. In particular it wants to find out if consumers who lend and invest money on peer-to-peer and similar crowdfunding platforms understand the risks they are taking - especially as the FCA finds the industry may encourage “less experienced or knowledgeable retail investors” to invest.

Loan-based and investment-based crowdfunding

For both loan-based and investment-based crowdfunding platforms the FCA has found that:

• due to complex and often unclear product offerings it is difficult for investors to compare platforms with each other or to compare crowdfunding with other asset classes
• it is difficult for investors to assess the risks and returns of investing on a platform
• financial promotions do not always meet the “clear, fair and not misleading” requirements, and
• the complex structures of some firms introduce operational risks and/or conflicts of interest that are not being sufficiently managed.

Loan-based crowdfunding

In particular, in the loan-based crowdfunding market the FCA is concerned that:

• some of the provision funds (and other similar features) used by platforms introduce risks to investors that are not adequately disclosed and may not be sufficiently understood by investors
• despite the work done between the FCA and P2P platforms this summer over wind-down plans, the FCA remains concerned and will propose more robust rules so that in the event of a firm’s failure the wind-down plans can successfully run-off loan books to maturity. Greater capital adequacy may be required for those firms who offer products where there is a mismatch of term between borrower and lender. Alternatively, greater transparency may be required, by way of disclosure requirements, to ensure the liquidity risks are adequately explained to investors, and
• some firms need to improve their client money handling standards and CASS rules may be tightened.

Other challenges noted

• The FCA is resisting calls to cease referring to P2P lending as loan-based crowdfunding even though many in the industry argue differently often claiming that P2P involves lending while crowdfunding is an equity investment. Instead, the FCA deems P2P “loan-based crowdfunding”, arguing that it increasingly involves pooled credit risk where a number of investors lend to one borrower.

• Some platform operators are “pooling credit risk” by maintaining a shared provision fund, or similar, which is designed to protect lenders in the event of defaults. Whilst this does not amount to a Collective Investment Scheme it may amount to an Alternative Investment Fund (subject to the structure) and therefore be caught by AIFMD. The FCA raises concern that business models of this nature are similar in nature to asset management yet sit under a regulatory framework that was not designed for businesses that operate like asset managers, thus creating what it cites as “regulatory arbitrage”.

• The increasing institutional engagement in P2P platforms is creating:

  • an emerging trend of securitisation of P2P agreements, and
  • the potential risk that institutional lenders will be given preferential treatment by platform operators.

The requirement for firms to ensure they appropriately manage conflicts of interest is likely to become more prescribed.

• The FCA appears to be considering the requirement for investment-based platforms to have vetting procedures to confirm that people are high net worth or are sophisticated investors, despite the fact that this guidance has to date only been applied to pooled investment structures. This double check could be expensive for firms and put off potential investors.

• Malpractice and cyber-security are cited as two main concerns and it is clear from the general theme of the paper that the FCA has some concerns about corporate governance within firms. Given the forthcoming extension of the Senior Management Regime to financial services firms generally, it is possible that specific rules for P2P firms may be introduced to improve risk accountability in the sector.

• The number and variety of products in the P2P sector is ever increasing including P2P mortgages, pawn broking, and increasing levels of institutional lending. The latter has created a duplication of regulation with both lenders and platforms required to comply with similar provisions of the Consumer Credit Sourcebook (CONC). The FCA therefore intends to require platforms to comply with the relevant MCOB provisions where the loan is one ordinarily caught by the Mortgage Credit Directive. It also intends to review the consumer credit provisions applicable to P2P platforms as part of its wider review and reform of the remaining provisions of The Consumer Credit Act 1974. 

• The FCA is of the opinion that investors with other ISAs will not understand the risk in Innovative Finance ISAs (IFISAs), but it does not expect the IFISA to appeal to people who do not already invest through platforms. Nevertheless, risk disclosures for IFISAs will form part of the proposed new rules.

• The FCA states that it is concerned about the pace of innovation. As this is a different stance from that of Project Innovate it may be an indication that the FCA is finding supervising this relatively new market to be challenging.

New rules

The FCA’s current rules on loan-based and investment-based crowdfunding platforms came into force in April 2014. They aimed to create a proportionate regulatory framework that provided adequate investor protection whilst allowing for innovation and growth in the market.

The FCA says that it plans to consult on additional rules in a number of areas which include more prescriptive requirements on the content and timing of disclosures by both loan-based and investment-based crowdfunding platforms (which may include around due diligence processes in the case of investment-based platforms).

For loan-based crowdfunding it also intends to consult on:

• strengthening rules on wind-down plans

• additional requirements or restrictions on cross-platform investment, and

• extending mortgage-lending standards to loan-based platforms.

Next steps

The FCA has stated that it will work with firms and carry out additional research and investigatory work into the market to inform the review and that this should be completed early in 2017. At that stage, the FCA will complete the post-implementation review and determine whether further consultation on rule changes is needed. Any additional rules will come into effect in 2018.