Our ‘Crowd Finance 101’ series takes a look at the nuts and bolts of crowd finance. Today we take a look at the important topic of regulation in crowd finance, with a focus on the UK.
Crowd finance regulation in the UK
Whilst still small, the crowd finance market is growing rapidly.
The entire market is a tiny portion of the size of the balance sheet of any bank. The total assets of Barclays are £1.2 trillion and JP Morgan are $2.5 trillion, so the crowd finance market is about 1-2% of the balance sheet of any of the major banks. But it will grow. And this is something the UK regulator is well aware of.
There are currently over 100 crowdfunding platforms in the UK market and the Financial Conduct Authority (FCA) estimates the amount invested via crowd finance platforms has grown from £500 million in 2013 to £2.7 billion in 2015, with entrepreneurs launching new platforms that address all kinds of niches. Technological advances and white-label solutions have made it easier than ever to launch a crowd finance platform.
Can the UK regulatory framework cope with the explosive growth of crowd finance? We take a look.
The current state of regulation
Regulation of crowd finance the UK is conducted by the FCA. As a consequence of the global financial crisis, the regulator has been involved since the early days of the industry. Since the crisis, UK regulators have become more cautious and proactive. Some argue they have overcompensated for past failures in an attempt to address the long slide into deregulation that began with the “Big Bang” in the 1980s and which New Labour failed to adequately address.
In the UK, P2P lenders and equity crowdfunding platforms perform regulated activities. Donation and rewards platforms are not regulated, but they are bound by English Common Law.
Crowd finance platforms must obtain FCA authorisation before commencing regulated activity. In order to receive, hold and process money from investors or lenders, platforms must obtain client money permission from the FCA and comply with its rules and guidance.
Any communications made to potential investors or lenders by a crowd finance platform to promote an investment or lending opportunity comprises a financial promotion, regulated under FSMA, an act of parliament. Platforms need to be FCA-authorised to do this and satisfy the rules set out in the FCA’s Conduct of Business Sourcebook (COBS).
The FCA’s regulatory standards for equity crowdfunding platforms include guidance on regulatory capital minimums, know your client (KYC) checks, restrictions on member types and investment limits, disclosure and professional requirements on belief of the platform.
How did we get here?
The FCA introduced P2P regulations in March 2014, taking over from the Office of Fair Trading.
Similarly, UK equity crowdfunding was unregulated in its infancy. April 2014 saw a regulatory framework come into force. This meant platforms had to be licensed or have regulated activities managed by authorised parties. It also stipulated that platforms must screen investors to ascertain their sophistication.
The FCA reformed retail financial promotion in 2014, whereby a “direct offer financial promotion” could only be offered to retail investors for whom the investment firm considered it suitable. Guidelines surrounding financial promotions are currently under review.
The FCA conducted its latest regulatory review in 2016 and is consulting with market participants to understand how it can support the development of UK crowdfunding markets. This is another example of the UK regulator’s sensible and supportive approach.
Where are we headed?
P2P lending is headed towards a more stringent regulatory environment.
In an interim feedback statement issued in December 2016, the FCA asked whether some P2P platforms were acting more like banks or collective investment schemes and observed that it can be difficult for investors to compare platforms and assess risk.
It also raised questions regarding financial promotions and stating that provision funds – used by Zopa and RateSetter etc – need to be explained in better detail to investors.
The regulator is considering more stringent P2P lending rules to ensure retail investors are informed of the risks. These could include “setting investment limits” and extending “mortgage-lending standards” to P2P platforms.
The FCA will complete its research in 2017. New rules would come into force in 2018.
Crowd finance platforms can only benefit from bespoke regulation, increasing credibility and trust amongst investors. Regulation tends to follow market shocks and negative headlines, so it’s interesting that the UK regulator has got involved before any major negative headlines for crowd finance.
The FCA is a pro-active regulator and as such it is unique – others can be far more reactive. The FCA and its peers across the world can benefit from using the Crowdsurfer engine to get a real-time, unbiased view of the market and draft better regulation.
Those who doubt the stability and transparency of crowd finance should bear in mind that there are vast unregulated markets which much greater consequences for the general public. For example, real estate purchases and sales. Regulation appears not to be driven so much by risk, but by political exposure and media-worthiness.
P2P lending and equity crowdfunding are no longer new kids on the block – they are maturing into mainstream asset classes, so it’s only right the FCA should review its regulatory approach.
Part of this approach should involve increased transparency and disclosure of data, which is what we provide here at Crowdsurfer.