FCA will look to ensure consumer protection and support for fintech innovation in crowdfunding review, says expert

Out-Law News | 11 Jul 2016 | 3:10 pm | 3 min. read

The Financial Conduct Authority (FCA) will look to ensure that consumers are sufficiently protected against the risks inherent in crowdfunding while supporting innovation in the growing market in a forthcoming review of its regulation of the industry, an expert has said.

The UK regulator has opened a call for input (31-page / 829KB PDF) on a post-implementation review of crowdfunding rules it introduced in 2014 in which it said it is considering applying new standards of disclosure in the crowdfunding market and placing new regulatory duties on platforms that facilitate peer-to-peer loans or investments.

"The FCA is looking to balance two competing objectives in reviewing, and potentially amending, its rules in relation to crowdfunding," expert in financial regulation Thomas Howard of Pinsent Masons, the law firm behind Out-Law.com, said. "On the one hand the FCA is keen to ensure that customers are appropriately protected – which may lead to more prescriptive rules and guidance regarding the degree of disclosure which crowdfunded platforms are required to provide, and the amount of verification or vetting they are expected to undertake. On the other hand, the FCA will not wish to be seen as cutting off a growing source of investment for innovative companies and start-ups who would otherwise struggle to access mainstream finance."

"In the wake of a number of recent high-profile equity crowdfunding failures it seems likely that investment-based crowdfunding platforms will end up shouldering a greater burden of responsibility when it comes to ensuring that investors have sufficient information to form a reasonable judgement on the relative merits of a particular investment, and that the investment opportunities they host are presented in a way that is clear, fair and not misleading," he said.

Howard was commenting ahead of London Fintech Week, during which Pinsent Masons, co-sponsors of the event, will be hosting a legal workshop on crowdfunding on 22 July.

Investment-based and loan-based crowdfunding platforms are subject to different FCA regulations, although the same disclosure requirements currently apply to each of the regulated activities.

In its call for input paper the FCA said it has plans to "review disclosure standards" in relation to loan-based crowdfunding after highlighting "potential concerns about how firms are presenting information to investors".

"It is, for example, quite difficult to find clear information on default rates on platform websites or to understand how the likelihood of default differs depending on when a loan was originated (i.e default rates by vintage)," the FCA said. "Such disclosures could make trends in underwriting standards more transparent to investors."

The regulator said that it could "mandate in detail the disclosures we expect and the time that those disclosures must be provided" and has asked for feedback from industry on the standards of disclosure on loan-based crowdfunding platforms.

On disclosure standards for investment-based crowdfunding the FCA said it would also carry out a review.

"Should we find that the current rules are not delivering adequate standards of consumer protection, we will consider a full range of options, including taking supervisory or enforcement action with specific firms or changing the rules to introduce additional requirements and, potentially, mandatory disclosures of information and risk warnings," the FCA said.

"Based on the outcome of the review, to help potential investors better understand the risks, we could consider whether to mandate additional disclosures, for example setting out how many businesses that raised funds have since failed and how many have had successful pay-outs. We could also consider requiring firms, when setting out the money raised so far on a pitch, only to include money contributed on the platform from persons unconnected to the business. If firms quote money raised from other sources, there is a concern that this can lead investors to believe there is more interest in an investment than is the case," it said.

In its paper the FCA also suggested that it might place investment-based crowdfunding platforms subject to new due diligence standards. It said it wants to ensure investors have sufficient protection against the risk of losing their money when businesses seeking funding through platforms fail and that financial crime risks are also being sufficiently mitigated.

"It appears that some businesses that successfully raise capital fail shortly afterwards," the FCA said. "While such failures are likely for the young businesses raising capital on the platforms, we are concerned about the potential for investors to be exposed to risks they are not well placed to assess in advance."

"As part of the post-implementation review, we will further analyse the due diligence processes employed by platforms and the additional analysis undertaken by investors. If we find that investors are not in a position to protect their own interests, we may consider the feasibility of minimum due diligence standards. For example, we could consider requiring business plans to be reviewed by, an appropriate third party."

According to FCA figures, approximately £2.7billion was invested on regulated crowdfunding platforms in 2015, up from £500 million in 2013. There are now more than 100 platforms either operating in the crowdfunding market or seeking authorisation, it said.