With the world's economy still stabilising after the financial crisis, governments and central bankers, their hands on the tillers of the real economy, are looking for sources of growth. With this impetus, regulatory stakeholders have been relatively quick to see the potential of technology as a force for change.
Despite the real desire to unleash the potential of under-tapped forms of finance (e.g. see IMF World Economic Outlook April 2015) and permissive regulatory initiatives, the birth of the innovative finance ISA (IFISA) confirms that, in the UK at least, the regulators have consumers' backs.
Stimulating real economic growth
The UK government, in its March 2016 Budget, re-stated that it was keen to release the availability of more diverse and accessible financing for individuals and small and medium sized enterprises (SMEs) and cause more rigorous competition in retail banking services.
Steps such as those initiated in The Small Business Enterprise and Employment Act 2015, and related Small and Medium Sized Business (Finance Platforms) Regulations 2015 (which help match SMEs rejected for finance by designated banks with alternative finance providers) indicated government support for peer-to-peer (P2P), and equity crowdfunding platforms and built on announcements in the Autumn Statement 2014 (paras 1.168-1.171), when the intention to extend ISA eligibility was set out.
Resulting from technological and commercial innovation, it is easy to see why government wants crowdfunding, a catch-all for both equity-based investment and P2P lending arrangements, to be used as part of the process to fulfil its growth and technology policy goals – even if it has proven a little difficult to realise.
Following the 2016 budget, legislation quickly hit the statute books to add P2P to the range of investments that may be held within an individual savings account (ISA). The IFISA was to be, in theory at least, available from April 2016.
It seems no accident that the government wants to utilise the well-established ISA concept to capitalise on the crowdfunding sector:
- as a sector, crowdfunding has grown rapidly. Looking specifically at P2P, in his response to the Treasury Select Committee, dated 16 June 2016, Andrew Bailey (then at the Prudential Regulation Authority) indicated that gross flows of new P2P consumer lending grew by 66% in 2015; and
- ISAs, meanwhile, first came on the scene in 1999, building on earlier prototypes. These are a 'mass market' retail financial services product, benefiting from favourable taxation treatment, broadly intended to encourage longer term saving and investment.
Although popular (according to the Office of National Statistics, at the end of 2015-16, the market value of Adult ISA holdings stood at £518 billion (52% cash and 48% stocks & shares)), ISAs have been flagging, suffering from low interest rates and squeezed savers, whereas crowdfunding has a little cachet, being relatively new and 'alternative' and, as such, interesting. Policy goals, such as releasing underutilised baby-booming savings, increasing returns to savers (many of whom are income-poor pensioners) and getting investment into growth generating SMEs, looks realisable if this synergy delivers.
Shadows are cast upon the strategy by at least two factors:
- a key point about ISA offerings is that assets held within ISAs must be qualifying investments; for the IFISA, these include interest from a P2P loan. Importantly, a separate category of ISA has been created for those involved in P2P lending because the underlying asset class (unlike cash or most stocks and shares which are qualifying investments) may be illiquid (or non-readily realisable). But, also creating risk, the range of qualifying investments within the IFISA is not particularly diverse. Arguably, IFISAs have a different risk profile to a 'normal' ISA and should not be made available to many retail investors; and
- crowdfunding, although popular and well supported, is not without its issues. This warrants deeper consideration.
For regulatory purposes, P2P crowdfunding is a type of consumer credit. The FCA took over supervision of the consumer credit sector from the Office of Fair Trading (OFT) in April 2014. While the FCA's style of supervision (markedly different from the OFT) ratcheted the compliance environment up a notch or two, the FCA considered it was light touch where crowdfunding was concerned (see "A review of the regulatory regime for crowdfunding and the promotion of non-readily realisable securities by other media", February 2015).
As well as getting familiar with the FCA's tactics, the wider sector has also had to take on board an increased regulatory perimeter and related compliance requirements (for example, advising on P2P agreements has been a regulated activity since April 2016 - see RAO art s3(2) and also FCA PS 16/8).
Against these shifting sands, P2P firms have, since 2014, been in the process of moving from an operational model based on "interim permissions" to one of full FCA authorisation. That process can seem slow and laborious, intrusive even, and is an important dynamic in the development of the IFISA. To be able to register as an ISA Manager with HM Revenue and Customs, a firm needs to have a full regulatory licence; interim permissions are not sufficient and only a few firms so far have the requisite permissions to launch.
A revised framework?
Given that the IFISA is a flagship government policy, some say the FCA has been slow in authorising firms. Is there a reason behind the FCA's ponderous approach or is it merely battling volumes when assessing which firms operate at a sufficient standard for its liking? Perhaps it is relevant that the overall view of the sector appears more cloudy than a year ago.
As planned, the FCA initiated a full post-implementation review of the rules in July 2016. Obviously concerned about the enduring stability of this sector and related investor protections, perhaps prompted by Treasury Select Committee enquiries earlier in 2016, the FCA subsequently considered its light-touch approach was unlikely to be fit for purpose long-term.
In its interim feedback statement from December 2016 (FS16/13), the FCA confirmed that it will consult on refreshed rules in 2017 (although in its April policy development update (7 April 2017), the expected date was left open).
In FS16/13, crowdfunding firms received clear guidance on how the FCA is likely to develop its mandate. When the forthcoming consultation paper mutates to regulation, crowdfunding platforms can expect:
- to be required to tighten their control environment, especially around retail protections, such as due diligence, disclosures and creditworthiness assessments and cross-investment;
- requirements to plan appropriately for wind-down/insolvency and undergo related checks on client asset and client money safeguarding; and
- additional restrictions around complex business models (e.g. cross-investment) or those where regulatory arbitrage is possible.
Given that regulators are taking a close look at crowdfunding platforms, FCA communications, such as the FCA's Dear CEO letter, from 28 February 2017, need to be addressed.
With this letter, the FCA has indicated there is a chance that some P2P firms might have been accepting deposits, for which they should have had a licence. Carrying on a regulated activity without the necessary authorisations and permissions may amount to a criminal offence. An indicator of the regulatory emphasis placed on this is that firms only had a two week response window; we anticipate further output from the regulator and remedial action from some firms.
Far from the madding crowd?
While the IFISA has had a long gestation period, to be fair, the in-transit regulatory status of P2P was known at the time of the government's budget 2016 announcement.
And the FCA's decision to sharpen its regulatory approach in advance of the inevitable further growth of P2P should be no surprise; after all an inexperienced new gizmo can easily drive a flock of retail investors and lenders off a cliff. Charged with maintaining financial stability and consumer protection, the FCA would wish to navigate around avoidable risks.
While further regulation is clearly in the offing (following FS 16/3 and the Dear CEO letter), for most crowdfunding firms this should be no more than a salutary warning to approach business expansion with a modicum of care. Those found transgressing into other areas of regulatory faux pas will not be treated lightly.
Despite all this, several platforms do now have the correct permissions in place to offer IFISAs and more will be coming through the pipeline so IFISAs have started to become available in 2017. With a public keen to embrace the new offers that technology brings and a permissive governmental, fiscal and regulatory environment, IFISA could easily be a success, in keeping with the general trajectory of crowdfunding as a whole.
While taking on board all the usual risk warnings on a case by case basis, investors and lenders should feel reassured that, although the IFISA has taken time to come to fruition, the FCA has taken a thorough look at practices in this sector. There are no guarantees, of course, but certainly a rocky start alone is no reason for the IFISA not to meet stakeholder objectives longer-term. As Bathsheba and Gabriel learned, some things are worth the wait.