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Crowdfunding – new FCA regulations to impose law and order, but will it be good, bad or ugly for the crowd?

Crowdfunding has been increasingly grabbing the business headlines of late, with outlaw brands such as Brewdog leading the charge in this innovative way for businesses or organisations to secure vital investment.

Pioneering new platforms have been springing up on a weekly basis, and some notable success stories have made the business world take note. Spurred on by new technology, its pace of growth had until now left the regulators in its dust.

Now, though, they’re finally catching up, and new restrictions on the fledgling industry are going to mark the coming of age of Crowdfunding. But will it be for the better?

FCA consultation paper on Crowdfunding

The Financial Conduct Authority (“FCA”) yesterday issued a consultation paper regarding crowdfunding. Many of the UK crowdfunding investment and lending platforms were keen to see some form of regulation from the FCA provided it did not over-regulate the industry and take the “crowd” out of crowdfunding. In my opinion, the proposed rules meet this desire to an extent and are helpful in creating some trust in crowdfunding platforms.

The FCA’s consultation paper distinguishes between loan-based crowdfunding and investment-based crowdfunding with the former being seen as lower risk thus meaning a slightly lighter touch approach has been adopted. Part of their rationale for this is a statistic they quote which states that most investments in start-up businesses result in a total loss of investment, while between 50% and 70% of new enterprises fail in their early years. I would say that this figure is on the high side in terms of the type of work we see but, nevertheless, investment in early-stage businesses is high risk.

The FCA proposals include the following:

• loan-based platforms must have a set minimum level of funding of at least £50,000 from 1 April 2017.  From 1 April 2014, the transitional minimum level will be £20,000;
• requirement for rules on the resolution of disputes and a maximum period of eight weeks to make an initial review of any complaint;
• more clarity on risks and ensuring that all communications are fair, clear and not misleading. Until now, many of the platforms had a lack of balance in their communications and tended to emphasise the benefits without a prominent indication of the risks;
• for investment-based platforms, investors must fall within one of the following categories:
o sophisticated or high net worth investors;
o an individual who is receiving investment advice; or
o an individual who signs a certificate saying that they will not invest more than 10% of their portfolio in unlisted shares or debt provided that an authorised firm (which could be the crowdfunding platform itself) has carried out an appropriateness test to ensure that they have the knowledge or experience to understand the risks.

Many established UK crowdfunding platforms will already follow a lot of the practices set out by the FCA however there are some areas, such as more clarity on risks etc, where the majority will need to improve the way they operate.

Some of the smaller, newer platforms will need to look at all of their procedures. With a higher degree of regulation, it may mean that some of the smaller platforms cannot survive due to the increased costs of regulation, however the overriding objective for the FCA was to protect investors who lack the knowledge, experience and resources to cope with potentially significant losses when investing through these platforms.

UKFCA chair Julia Groves says that, overall, the regulator’s proposals, put out for consultation this morning, “achieve a reasonable balance between consumer protection and access to finance and investment opportunities. They would also help ensure high standards consistently applied across the industry.”

It is worth pointing out that this paper is only a consultation paper and the FCA is inviting feedback by 19 December 2013, so the exact shape of the rules remains to be seen. However, the consultation paper is useful in understanding the FCA’s concerns about the industry.

The FCA expects to publish its final policy statement in February or March 2014.  Between now and then, crowdfunding platforms should be looking at their own procedures to ensure that they are ready to act when the rules come into force on 1 April 2014. 

If you would like to speak to anyone about anything in this note, or find out more about crowdfunding, please contact Paula Skinner on 0141 227 9271 or email paula.skinner@harpermacleod.co.uk.