A set of new consumer protections are due to come into force on 01 April 2014. New restrictions will apply to two types of crowdfunding - loan-based (lending to individuals or businesses in exchange for interest payment and capital repayment) and investment (equity) based (typically in companies in exchange for shares, debt securities or other “non-readily realisable assets”). The new rules will not apply to reward or donation-based crowdfunding.
Loan-based Crowdfunding - what happens to the lender’s money if a platform fails?
The recent focus on consumer protection is a by-product of the drastic expansion of loan based crowdfunding (especially P2P lending). Last year approximately £480 million was lent- representing a jump of approximately 150% on the previous year. The new rules introduce not only minimum capital standards but also a requirement for firms running loan-based crowdfunding platforms to have arrangements in place to enable loan repayments to continue to be collected in the event that the platform fails. From 1 April 2014, loan-based crowdfunding platforms will be required to hold regulatory capital of at least £20,000. This will increase to £50,000 in April 2017. The new requirements should provide comfort to lenders, as they will still be unable to claim through the Financial Services Compensation Scheme.
Investment (equity) based Crowdfunding and other similar activities
The rules aim to ensure that consumers have access to fair and accurate information and are equipped to make informed decision about investments.
The new rules will affect direct offer financial promotions. For clarity’s sake- a direct offer is a promotion that contains an offer, or an invitation that specifies the manner of response, or includes a form, by which a response may be made.
If the promotion does not specify how to respond to it, then it is not caught by the new restrictions. However, if the communication provides marketing information about a specified investment, then the restriction will apply and, as usual (unless an exception applies), one will also need to ensure the communication complies with the other relevant financial promotion rules. A few tweaks may be required to direct offer financial promotion material whether in hard copy format or online and promoters may wish to consider removing downloadable forms - or make these accessible only to certain types of investors, as detailed below.
The new rules will place limitations on the types of investors to which equity based crowdfunding platforms may send direct financial promotions. Direct offer financial promotions can now only be targeted at professional clients and certain specific categories of retail clients whether sophisticated, high net worth investors, or retail clients who certify that they will not invest more than 10% of their net investible financial assets in unlisted equity and debt securities.
Is it appropriate?
In addition, crowdfunding platforms will need to consider an appropriateness test in cases where no professional advice was provided. It is a requirement that all firms must check that clients have the knowledge and experience needed to understand the risks involved before being invited to respond to an offer. This new appropriateness test will be in line with the rules in the Conduct of Business Sourcebook (COB). Firms operating equity-based crowdfunding platforms may also need to gather certain data on potential investors in order to undertake the appropriateness test.
Whilst the rules on direct offer financial promotions will come into force on 01 April 2014, the transitional arrangements provide that it will be acceptable for firms to continue to comply with the existing rules for another six months.