Out-Law News 3 min. read

FCA seeks reforms in 2017 to some crowdfunding rules

The Financial Conduct Authority (FCA) will seek to address potential investor detriment by outlining proposed reforms to crowdfunding rules in the early part of 2017, the regulator has said.

The proposed new rules would impact on platforms that support loan-based crowdfunding, as well as platforms that facilitate investment-based crowdfunding. The FCA said it will open a consultation on reforms to "address some of the more immediate concerns" it has during the first three months of next year, with final rules scheduled to be set out in the summer.

In an interim report it published on findings observed to-date from its post-implementation review of crowdfunding rules it introduced in 2014, the FCA said it had found evidence of "inadequate disclosures about risk and loan performance" in the loan-based crowdfunding market and that it was also concerned about "inadequate disclosures … and the downplaying of risk" by investment-based crowdfunding platforms.

To address the issue in the context of loan-based crowdfunding, the FCA has said it will consult on additional provisions to disclosure requirements in a bid to "aid firms and to raise standards". It said the new rules would seek to "provide a consistent minimum basis for investor disclosures".

The FCA also confirmed that it would "consult in the first quarter of 2017 on more rules for disclosures by firms operating investment-based crowdfunding platforms". It said in this regard that it would "give further thought to requiring disclosure of information about funding sources and the ongoing responsibilities of the platform".

Other concerns the FCA raised included those about financial promotions. It said it had seen promotions on crowdfunding platforms which were not always clear, fair and not misleading. It clarified that loan-based crowdfunding should not be described as "a 'savings' product", and called on firms to align with rules on financial promotions.

"We believe detriment is possible if investors regard loan-based crowdfunding as a type of deposit as the risks, particularly to capital, are different," the FCA said. "Section 21 of [the Financial Services and Markets Act] prohibits the communication of financial promotions unless certain conditions are met. Businesses should not communicate invitations or inducements to invest unless they meet they conditions in the Act."

The FCA also confirmed it plans to toughen rules relating to the plans loan-based crowdfunding platforms have to have in place to account for the potential failure of their business.

"We are concerned that, in practice, wind-down plans may not work as expected, and may be inadequate to enable a loan book to be administered to conclusion in the event of platform failure," the FCA said. "To help guard against this, we propose to consult on strengthening the rules in this area."

In its report the FCA noted the fact that loan-based crowdfunding businesses are providing "more competition to traditional lenders" in some areas of the market, notably SME lending. However, it said evolving business models in the loan-based crowdfunding market allows some businesses to operate outside of regulatory requirements that banks are subject to. It said it would consider introducing additional rules to address "regulatory arbitrage" if it sees a likelihood of "consumer detriment".

Expert in the regulation of financial services Thomas Howard of Pinsent Masons, the law firm behind Out-Law.com, said: "Whilst the introduction of new rules may help strengthen investor protection in this area, much could be achieved by more active enforcement of the FCA’s existing rules, particularly in relation to the FCA’s high level requirements that financial promotions are clear, fair and not misleading, and that firm’s manage conflicts of interest fairly."

"It is often the case that it is FCA enforcement action which most clearly reveals the regulator’s expectations of firms, and which causes firms to pay closer attention to made rules and guidance," he said.

"The FCA has to strike a difficult balance between the growing demand for innovative finance, both from investors and borrowers/issuers, with the increased risks to consumers associated with a less heavily regulated market. At the same time, institutions under threat from the crowdfunding sector will be concerned about the effects of perceived regulatory arbitrage. Ultimately it may take a significant failure of a crowdfunding platform or crowdfunded issuer, and subsequent FCA enforcement action, to significantly raise standards," Howard said.

On investment-based crowdfunding, the FCA said it could also look to require platforms offering Innovative Finance ISAs to issue "risk warnings" to potential investors where "non-readily realisable securities" are held in such products.

The FCA confirmed its post-implementation review of its crowdfunding rules would continue into the new year. The initiative was started in July when the FCA opened a call for input. The regulator said it intends to conclude its review with a final report to be published in the middle of 2017.

Andrew Bailey, chief executive of the FCA, said: "Our focus is ensuring that investor protections are appropriate for the risks in the crowdfunding sector while continuing to promote effective competition in the interests of consumers. Based on our findings to date, we believe it is necessary to strengthen investor protection in a number of areas.”

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