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15th December 2016

Review of the FCA Crowdfunding Rules

On the 9th December 2016, the Financial Conduct Authority (FCA) published a Feedback Statement providing interim feedback on their Call for Input in relation to a post-implementation review of their Crowdfunding Rules.

FS16/13: Interim feedback to the Call for Input to the post-implementation review of the FCA’s crowdfunding rules

Whilst the FCA is continuing their ongoing research and investigatory work into the post-implementation review of loan-based and investment-base crowdfunding market – expected to be completed in the early part of next year - they have now provided an interim update following their Call for Input over the summer.

Crowdfunding Post-implementation Review

The rules governing crowdfunding (‘Crowdfunding Rules’) were first introduced in February 2014 with the aim to protect investors of loan-based and investment-based crowdfunding platforms.

The FCA’s Call for Input in July 2016 summarised the developments within the crowdfunding market since 2017 along with some of the FCA’s emerging concerns.

The feedback the FCA received from the Call for Input has since raised a number of issues for discussion, particularly concerned with risk posed to consumer detriment, which have now been laid out within the Interim Feedback Statement (FS16/13).

Changes to the Crowdfunding Rules

The regulator, having reviewed the Call for Input feedback and together with their supervision of the crowdfunding platforms actively trading, is now of the position that they need to revise various aspects of the Crowdfunding Rules.

Of particular concern to the regulator are the following findings:

Findings related to Investment-based crowdfunding:

The FCA have concerns about inadequate disclosures on investment-based crowdfunding platforms and the downplaying of risk;
The FCA found that due diligence standards vary from firm-to-firm and not all firms explain their due diligence processes on their websites;
None of the platforms the FCA reviewed provided an assessment of the valuation of a pitch, (although they did challenge the figures proposed by fundraisers);
The FCA found that not all firms aligned their business models with the possible future success of businesses raising finance (and, ultimately, the investors);
Not all firms had an effective internal control system in place in relation to the processes used for approving or communicating financial promotions; and
Not all firms satisfied the requirements to undertake an appropriateness test to assess if investors have sufficient knowledge or experience to understand any risks involved in the investment.

Finding related to loan-based crowdfunding:

The FCA found inadequate disclosures about risk and loan performance;
It was found that firms are ‘testing the boundaries’ of the regulated crowdfunding perimeter that introduces the risk of arbitrage with banking activities or investment management;
Firms have occasionally acted in a non-transparent manner due to their desire to maintain confidence in platforms. This action has thus resulted in masking true loan performance and exposing investors to risks. This has also included management intervening to influence the performance of loans (e.g. by covering arrears) or otherwise acting to support the platform (e.g. lending to provision funds);
Firms are targeting growth through new products or in new markets since they have limited scope to increase market share with their current products. The FCA find this brings about the risk of operating in unfamiliar markets without appropriate expertise, exposing longer-term investors to unforeseen lending risks;
The FCA believe that consumers may not realise they do not have the usual protections as borrowers, where agreements are non-commercial, and that firms may not be making them adequately aware of this.
Better controls are needed to mitigate risks, particularly around conflicts of interest, in cases where institutional investors are able to bring benefits for retail investors (e.g. due diligence); and
A number of platforms currently allow investment in loans formed on other platforms. This can make it harder for investors to understand the level of risk they are taking or conduct due diligence. It might be that the failure of one firm could also cause problems for other firms in the market where investors in one platform are exposed to loans on a third-party platform.

What is expected to change?

These concerns over the Crowdfunding market have resulted in the FCA looking to alter the following requirements within the rules:

Imposing additional requirements or restrictions on cross-investment to address the risks posed by crowdfunding platforms allowing investment in loans that originate on other platforms;
Strengthen the rules regarding wind-down plans to reduce the risk to investors of the plans not operating as expected;
Where the lender is not acting by way of business, extending the usual mortgage-lending standards to loan-based crowdfunding platforms; and
Putting in place more prescriptive rules on the timing and content of disclosures.

FCA Next Steps

The regulator will look to conclude their post-implementation review of the Crowdfunding Rules before determining whether they need to consult upon any further rule changes.

However, an early consultation is planned for next year to address those rules which the FCA believe are of more immediate concern.

In the meantime, the FCA will continue to conduct consumer and market research on the crowdfunding market until the completion of their review, currently timetabled for early 2017 and we can expect at least one, if not two, consultations in early 2017 on proposed changes to the Crowding Rules.