Crowdfunding continues to grow both as an industry and as an alternative source of finance for start-ups and early stage companies. We previously noted the potential of crowdfunding to disrupt the early stage lending and investment industries (see our previous update here) and this continues to hold true, as crowdfunding is beginning to enter mainstream markets. While there is currently no regulation in Ireland, the UK is getting to grips with this evolving industry and the UK rules will most likely influence Irish regulation of crowdfunding in the years ahead.
FCA Feedback Statement
The Financial Conduct Authority (the "FCA"), the body responsible for regulating crowdfunding in the UK, recently issued an interim Feedback Statement following its review of the current UK crowdfunding rules. The original rules were published in February 2014 and regulate loan and investment-based crowdfunding platforms. The aim of these rules is to ensure appropriate consumer / investor protections and to promote effective competition and growth in the crowdfunding industry. The FCA's review follows feedback received from over 90 industry stakeholders and roundtable discussions with companies, trade bodies and consumer organisations in the UK.
The Feedback Statement sounds some warning bells. The FCA is particularly concerned with loan-based crowdfunding platforms. While investment-based crowdfunding companies are fully authorised by the FCA, loan-based crowdfunding companies mostly operate under interim permissions which allow companies to trade while their application for full authorisation is being determined. As a result, the FCA considers that more issues can arise with loan-based crowdfunding.
The main issues with loan-based crowdfunding platforms identified in the Feedback Statement are:
- inadequate disclosures regarding the risks of lending and performance of loans;
- the risk of regulatory arbitrage with investment management and/or banking activities;
- management intervention with the performance of loans which in turn distort the risks and performance of loans;
- client money handling standards; and
- a lack of awareness among borrowing consumers that they may not have the usual protections afforded to borrowers in traditional banking arrangements.
The main issues with investment-based crowdfunding platforms identified in the Feedback Statement are:
- inadequate disclosures and downplaying of the risks involved in an investment;
- variations in due diligence standards between platforms and lack of information regarding the due diligence processes applied by each platform;
- lack of assessment of the valuation basis of an investment; and
- lack of "appropriateness tests" for assessing an investor's knowledge and experience in investment activities.
The Feedback Statement suggests several changes to the current rules, including:
- strengthening the wind down rules for the continued administration of loans in the event that a loan or platform fails;
- consultation on additional requirements and restrictions to be applied to cross-investments, in order to reduce the risk that failure of one platform will affect another; and
- consultation on extending mortgage lending standards to loan-based crowdfunding where the investor / lender is not acting through or by way of a business.
The Feedback Statement further suggests an amendment to both loan-based and investment-based crowdfunding platforms whereby there will be a further consultation on the introduction of more prescriptive rules relating to the content and timing of disclosures.
The objective of these changes is to adapt the current rules to match the recent developments in crowdfunding. This is a nascent and changing industry and the FCA is actively trying to ensure proper regulation, which is important in order to legitimise crowdfunding and ensure continued confidence and growth.
The FCA plans to issue a further consultation paper containing new rules later in Q1 of this year and a revised set of regulations by summer 2017.
Any further consultation papers or revised regulations will certainly be of great interest to Irish policy makers, regulators, investors and companies. Crowdfunding in Ireland is an area which will eventually be regulated once the market reaches a sufficient scale and the UK rules will most likely heavily influence the direction that the Irish law will take. To that end, it is encouraging that the FCA is conscious of promoting competition and growth while also ensuring appropriate consumer protection.