corporate finance 25
Crowdfunding – under new regulation
Crowdfunding – the online activity of group-based fundraising – has become a premier player in the game of corporate finance in recent years. Originally pioneered by platforms such as Kickstarter and Indiegogo to support unprofitable or high-risk endeavours, crowdfunding found its voice in the depths of the 2008 financial crisis, when the banks’ appetite for extending credit to entrepreneurs suddenly dried up. Since then, the activity has exploded. Anuj Goyal and Matthew Lee, trainee solicitors, Pitmans, take a closer look
In 2013, in the UK alone, £28 million was raised through crowdfunding sites for investments in return for equity; £480m was loaned through peer-to-peer lending – in total, a trifold increase on the previous year.
Equity-based investments and peer lending represent two types of crowdfunding activities; others include donations and pre-payments (for rewards, services or products). However, it was the explosion in these first two activities that caught the scrutiny of the regulators, the Financial Conduct Authority (FCA). Key issues for the FCA included the lack of any regulation for the activity of peer-to-peer lending, and the lack of clarity surrounding the application of current FSMA and FSA rules to investment-based crowdfunding. Given the high-risk nature of the projects to be invested in, and of conducting any such financial activity online, investor-protection was a cause for concern for the regulator and industry stakeholders alike.
In October 2013, in a move to protect investors, and regulate the flow of cash from small savers, the FCA launched a consultation paper with a number of proposals, which it sent to key stakeholders including crowdfunding platform operators, consumer organisations, individual consumers, trade bodies, and other third party businesses. The paper proposed regulations around a number of areas: financial promotions; dispute resolution; certain contingencies should a platform go insolvent; minimum capital requirements; and client money protection rules.
The industry responded voluminously and variously to the proposals, from which the FCA crafted a new regulatory framework. On April 1, 2014, this new framework came into force.
From this date, there is a new regulated activity, that of operating an electronic platform in relation to lending. Operators of loan-based platforms will now have duties, primarily to provide transparent information about the potential borrower to help investors assess the risk profile of the opportunity, and to ensure back-up plans are in place for business continuity should a platform become insolvent; capital requirements will also be phased in to protect operators from financial volatility in the markets.
THE BUSINESS MAGAZINE – THAMES VALLEY – JUNE 2014
These regulations have been met with widespread industry approval, as they have generally been formulated to ensure good housekeeping practices in relation to consumers’ money.
However, the new rules surrounding equity- crowdfunding, which already benefited from some, if unclear, FCA regulation, are now more stringent. There is further protection that prevents investors without specialist knowledge from investing more than 10% of their assets; investors who do have this experience, or seek professional advice, are allowed to invest more.
This has already been dubbed the “infamous 10% rule” in certain quarters, where it has generated some anger. Barry James, founder of The Crowdfunding Centre, said the rule would lock small savers investors out. "Make no mistake, the infamous 10% rule, however it's dressed up, takes the crowd out of equity crowdfunding. Over the centuries Britain has led the world with inventions and innovations – and then thrown away that lead."
The FCA was always going to stoke controversy by seeking to regulate this online activity, which many believe should remain free for consumers to choose. However, the regulator believes it has struck the right balance between opportunity for small businesses and protection for investors. In any event, the FCA is looking to review the implementation of the new rules by the end of 2014, and conduct a full post-implementation review of the crowdfunding market and regulatory framework in 2016 to identify if other changes are required.
Presently though, the industry is obliged to operate within the new regime. Peer-to-peer lending platforms can comply with the new regulations in one of three ways: being authorised by the FCA, exempt from the regulation, or hold an interim permission to carry out the regulated activity of operating an electronic platform in relation to lending (which must be converted to full FCA authorisation within two years). For equity-based crowdfunding, there is no such grace period; platforms are required to comply with the existing and new rules by October 2014.
Crowdfunding generates £1,700 an hour for small
www.businessmag.co.uk Matthew Lee
businesses and projects in the UK alone. Only time will tell whether the FCA has struck the right balance, or has stemmed this flow.
Details:
Anuj Goyal
agoyal@pitmans.com
Matthew Lee
mlee@pitmans.com www.pitmans.com
Anuj Goyal
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