On 9 December 2016, the FCA published a feedback statement (FS16/13) setting out interim feedback to its call for input on its post-implementation review of its crowdfunding rules.
In July 2016, the FCA published a call for input on market developments in the crowdfunding sector that had occurred since the introduction of rules regulating crowdfunding platforms in March 2014. In FS16/13, the FCA sets out the feedback that it received to that call for input. The FCA now considers it necessary to modify its rules so as to strengthen consumer protections, while continuing to ensure it promotes competition. The FCA plans to consult in early 2017 on proposed rules.
The FCA intends to consult on the following areas to address its concerns with the FCA’s primary focus centred on loan-based crowdfunding platforms:
- Regulatory arbitrage – The FCA has identified a risk of regulatory arbitrage in the loan-based sector, and potential for investors to misunderstand the nature of the products offered. The FCA has said it is still worried about ‘regulatory arbitrage’, whereby firms are adopting some business models which include aspects that are the same or similar to those in the investment management and banking sectors. The FCA is therefore concerned about the risk of arbitrage in parts of the industry and expects crowdfunding firms applying for authorisation to ensure their activities fall within the scope of the permissions for which they have applied.
- Wind-down plans – The FCA intends to reduce the risks for investors concerning the administration of existing loans following the failure of a firm. The FCA are concerned that the plans some firms have for wind-down in the event of their failure are inadequate to successfully run-off loan books to maturity and adequately protect investors. Although changes to these rules have been forecast, nothing has been formally stated so far.
- Requirements or restrictions on cross-investment – This relates to scenarios where firms operating loan-based crowdfunding platforms allow investment in loans originated on other platforms. The FCA is concerned that the failure of one platform may have a direct impact on the viability of others. The main issue here is found when a platform’s products have been repackaged or bundled into products and are offered to investors by another platform. This then runs the risk of contamination between platforms. The FCA confirmed that they plan to consult on additional requirements or restrictions on cross-investment.
- Mortgage lending standards – This is regarding extending mortgage-lending standards to loan-based crowdfunding platforms where the investor or lender is not acting by way of business. The FCA intends to put some thought into implementing these standards but is wary of introducing any measures that would add burdensome administrative costs to platforms.
- Conflicts of interest – The FCA has stated its concern about conflicts of interest, in particular arising due to preferential treatment of institutional investors. The FCA states in its report that it is important that crowdfunding platforms treat those on both sides of the transactions they facilitate as clients. Once conflicts of interest have been identified, firms must seek to manage them. Avoiding a conflict is one way to manage it. Disclosure of a conflict may only be considered if the firm cannot manage it in order to avoid consumer detriment. The disclosure should make clear that the firm cannot manage the conflict and that investors are likely to suffer detriment. How these thoughts will be implemented by the FCA remain to be seen, but firms should certainly prevent institutional investors from cherry picking loans.
- Disclosure – The FCA also intends to consult on more prescriptive rules on the content and timing of disclosures relating to loan-based and investment-based crowdfunding. For loan-based crowdfunding the FCA has said it will consult on additional rules requiring a ‘consistent minimum basis for investor disclosures. With investment-based crowdfunding the FCA has said it will consult on new rules on disclosures and in particular the rules will be intended to place requirements on the content and timing of disclosures. As a general point, the FCA has said it has concerns about the quality of communications between firms and potential investors.
- Financial promotions – It is down to firms who make financial promotions to ‘believe, on reasonable grounds’ that a client is either high net worth or sophisticated. There are fears that firms are not actually undertaking proper assessments and the FCA will consider whether additional supervision of this process is required. As part of the FCA’s research to support the post-implementation review, they will survey consumers to find out if the FCA’s goals for financial promotion are being achieved. If they are not, the FCA may revisit the client assessment rules in the future.
The FCA’s aim is to publish a consultation paper in the first quarter of 2017 and to publish the final rules in the summer of 2017. The FCA is continuing its consumer and market research into crowdfunding. This should be completed early in 2017 and, depending on its outcome; the FCA may publish a second consultation paper on rule changes in mid-2017, with any rules coming into force in 2018. We will of course provide an update and opinion as and when this information is released.