UK: FCA Imposes New Regulation On Crowdfunding

Last Updated: 27 May 2014
Article by Tristan Mutimer

INTRODUCTION

The Financial Conduct Authority ('FCA') published a Consultation Paper in October 2013 regarding its proposed regulatory approach to crowdfunding over the internet and the promotion of what the FCA calls "non-readily realisable securities" (i.e. an unlisted share or debt security with no, or a very limited, secondary market). The comments to the Consultation Paper have been received and, following the FCA's review of these comments, the FCA has now published the final rules on how it intends to regulate crowdfunding in Policy Paper PS14/4.

Crowdfunding generally falls within one of the following four main categories:

  • Donation or charitable crowdfunding; people donate money to charitable organisations. There is no expectation of financial return.
  • Loan-based crowdfunding; people lend money to organisations with the expectation that they will receive back the sums lent plus interest.
  • Pre-payment or rewards-based crowdfunding; people give money on the expectation that they will receive a reward, service or good in return. For instance, those who pre-purchase a book to help fund the publication of that book might be rewarded with a signed copy of the book. Those who donate money or purchase a quantity of books could, for instance, be rewarded by being given an evening with the author.
  • Investment-based crowdfunding; people invest in a business by buying shares, debt securities or units in an unregulated collective investment scheme.

The new rules affect loan-based and investment-based crowdfunding.

WHY THE NEW RULES?

Crowdfunding has brought investment opportunities and the related risks to the masses. Prior to the advent of crowdfunding, it was much more difficult to invest in or loan money to an unlisted company. The rise of crowdfunding is expected to continue and, as crowdfunding grows, the FCA is seeking to protect retail investors by redressing some of the risks involved.

The risks perceived by the FCA include:

  • The lack of understanding by the investor of the potential risks involved in investing. The FCA is concerned that investors do not realise how high the risk is when investing in early stage companies. The FCA is also concerned that investors may not, for instance, fully appreciate that there may be no secondary market in the investment and that their funds may be tied up for a long period.
  • The conflicts of interest. The FCA is concerned that the risks involved in investing might be understated by the investment or lending platform which wishes to encourage investment.
  • The potential abuse of the platform for fraud and money laundering.
  • The potential for platform failure and poor management.
  • Whether proper checks are being carried out on the borrowers and target companies.
  • The platform operators inadvertently giving unauthorised advice.

The FCA has sought to give consumers more protection by addressing some of the above risks whilst also ensuring that the new rules do not exclude investors or stunt the growth of crowdfunding.

WHAT TYPES OF CROWDFUNDING ARE NOW FCA REGULATED

The FCA does not regulate either charitable crowdfunding or rewards-based crowdfunding. As there is no financial return expected when investing in such schemes FCA regulation is considered unnecessary.

Investment-based crowdfunding was largely already regulated by the FCA as the investment activity generally amounts to a regulated activity, such as: arranging deals in a specified investment or agreeing to carry on a regulated activity. The new rules do not seek to amend these regulations and it is likely that companies operating such platforms will be required to be authorised by the FCA.

The main change in the FCA's regulatory powers is that the FCA's scope will now include "lending platforms".

THE CHANGES TO REGULATION

Loan-based crowdfunding

Previously, loan-based crowdfunding was unregulated by the FCA and came under the remit of the Office of Fair Trading ('OFT'), as the OFT regulated the provision of consumer credit. From 1 April 2014, the FCA assumed the OFT's responsibility for the consumer credit market.

The new rules have created a new regulated activity of "operating an electronic system in relation to lending". This means that where a firm uses an electronic system to operate a loan-based crowdfunding platform, in practice it is likely that it will need to be authorised by the FCA.

However, the FCA has been less stringent in its regulation of loan-based crowdfunding than it has been with investment-based crowdfunding. This is because the FCA feels that loan-based crowdfunding is less of a risk to lenders than investment-based crowdfunding. There is, therefore, an emphasis on providing lenders with the information they need to make informed decisions, rather than restricting promotion.

As a result of the FCA's Policy Paper the core FCA provisions, including the conduct of business rules, will now apply to the firms which run loan-based crowdfunding platforms. Some of the key changes are as follows:

- Capital requirements & prudential standards

The FCA has imposed a minimum capital requirement on loan-based crowdfunding platforms. The minimum capital amount will be the higher of a fixed minimum requirement and a variable volume-based requirement. The fixed capital requirement minimum is currently £20,000, rising to £50,000 from 1 April 2017.

In terms of the volume-based capital requirement, the minimum required is:

  •  £0 – £50m*: 0.2%
  •  £50m – £250m*: 0.15%
  •  £250m – £500m*: 0.1%
  • £500m+*: 0.05%

* Figures relate to the total outstanding value of funds loaned through the platform.

- Investor finance protection

The FCA has stated that loan-based crowdfunding platforms will now have to comply with certain aspects of the client money rules in relation to monies received from lenders and in respect of receipt of borrowers' repayments and the distribution of these funds to lenders.

- Administration of loans following failure

The loan-based crowdfunding platform must have appropriate arrangements in place for existing loans to continue to be administered following any failure of the platform or firm. The FCA has not, however, specified any exact requirements.

- Dispute resolution

Lenders using loan-based crowdfunding platforms will not fall within the remit of the Financial Services Compensation Scheme. The FCA feels that the mechanisms introduced by the new rules give lenders enough protection. However, loan-based platforms should have adequate complaints procedures in place to allow users first to complain to the firm before complaining to the Financial Ombudsman Service.

- Reporting/Disclosure

There is no set list of information which has to be provided by the loan-based crowdfunding platform to the client. There is a general obligation on the firm to provide information which is fair, clear and not misleading.

The FCA has, in particular, sought to ensure that there is not a general lack of information and to make sure that the information being given to investors is balanced and shows both the potential negative and positive outcomes in making a loan.

  • The types of information which is likely to be required include:
  • Expected and actual default rates.
  • Fair description of likely return.
  • Details of loan risk assessment.
  •  Details of lender protection.
  • Lender exit options.

Loan-based platforms will also be subject to reporting obligations. The firm will have to report information to the FCA including the capital requirements, accounts, client money position, complaints and information on the loans conducted over the previous quarter and any change in the total value of loans outstanding of 25% or more.

Investment-based crowdfunding

The major changes to the rules relating to investment-based crowdfunding are as follows:

- Direct-Offer Financial Promotions

The FCA has confirmed that a firm must not communicate or approve a direct-offer financial promotion relating to a non-readily realisable security unless the retail customer falls within one of the following categories:

  • Certified high-net-worth individual: annual income in excess of £100,000 or net assets (excluding primary place of residence, pensions and rights existing under certain contracts of insurance) in excess of £250,000.
  • Certified/Self-certified sophisticated investor: assessed by an authorised firm as being sufficiently knowledgeable to make accurate and reasoned investment decisions. Certain individuals can self-certify if they fall into one of the prescribed categories; such categories include those who have worked in private equity for the two years leading up to self-certification.
  • Restricted investor: An investor who will not invest more than 10% of their net assets in a non-readily realisable security.
  • Where the FCA-authorised firm will itself comply with the suitability requirements.
  • The investor has confirmed before the promotion that they are a retail client of another firm that will comply with the suitability rules in relation to the investment promoted.
  • The investor is a corporate finance contact or a venture capital contact under the FCA rules.

A useful category under which investors can self certify as sophisticated investors is the category applicable if an investor, in the two years prior to their self certification, has made more than one investment into an unlisted company.

Appropriateness

In addition, where no professional advice has been provided, an investment-based crowdfunding firm will have to consider the appropriateness of the investor and the firm must check that the investor has the knowledge and experience needed to understand the risks involved with investing. The FCA expects that firms will be able to assess the investor as part of an online registration process.

CONCLUSION

The news rules came into force on 1 April 2014 with interim provisions for certain requirements such as those in relation to capital. Those consumers and consumer organisations with an interest in investments which are offered on crowdfunding platforms, and other similar investment schemes, are urged to read the full FCA Policy Statement PS14/4  and to seek advice if they are unsure of any of its provisions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.