FCA Publishes Sweeping Regulatory Review

The FCA has published a sweeping review of the state of regulation in the peer-to-peer lending and equity crowdfunding sectors.

The update has already provoked reaction from a number of different prominent industry voices – a couple of which are featured below. The document is studded with heaps of important information, particularly relevant to the platforms themselves.

The review kicks off with some simple definitions. In the eyes of the regulator, “crowdfunding” is a catchall term which is then split into debt-based and investment-based activities. The FCA then summarizes the rules that have been implemented thus far – rules which the majority of AltFi readers will already be familiar with, i.e. the 10% cap on retail investment in the equity space, minimum capital requirements for P2P outfits, and so on.

An overview of the size and state of the “crowdfunding” market is then conducted, leveraging data from the Nesta/University of Cambridge Report, AltFi Data and P2PMoney. An interesting layer that has been mixed into this equation by the regulator itself is the size of each market based on current and prospective operators. In the debt-based space, there are reportedly 56 platforms either already rolling or awaiting the FCA’s permission to roll. The total number of firms in the equity crowdfunding space, or seeking to enter into it, is 35.

The FCA provided guidelines as to how best to secure authorisation – pointing also to the recently launched Innovation Hub, which can help businesses to work towards regulatory approval. Broadly speaking, these pointers boil down to:

• Submitting a thorough and considered business plan.
• Possessing adequate non-financial resources.
• Possessing ample financial resources.
• Having an already up-and-running or suitably developed website in place.
• Understanding the requirements for FCA authorisation.

In terms of its oversight of the equity-based market up to now, a number of incidents were inexplicitly alluded to:

“Supervising investment-based crowdfunding platforms in 2014 included engaging with firms’ senior management, monitoring their websites and reviewing monthly management information (MI). This approach has resulted in a number of regulatory interventions that have been mainly to ensure the proper protection of consumers.”

These interventions were chalked up to making sure that the right kind of people were investing, and that promotions were clear, fair and not misleading. The regulator was generally positive about its experiences reviewing the P2P sector, praising the platforms’ comprehension of credit risk as well as their robust anti-money laundering and Know Your Customer checks.

The regulator is most keen to see that the platforms disclose information in a sensible and transparent fashion. An interesting tie-in to this point is that negative comments on some equity crowdfunding projects are occasionally deleted, a risk-masking technique upon which the FCA appears to frown.

Promotions in fact occupied an entire section of the report. The regulator identified problems in both the equity crowdfunding and peer-to-peer sectors. For equities, the primary issues were an overemphasis on the benefits of investing (of which there are in fact few tangible examples!), cherry-picking of potentially misleading information and the downplaying of important risk warnings. Most concerning to the regulator is the fact that the majority (62%) of equity crowdfunders are, according to the Nesta report, retail investors.

In the P2P sector, the main point of discomfort was the tendency of the platforms to liken peer-to-peer investments to savings accounts and/or banking. Other areas of concern included insufficient information about the taxation of investments, a lack of prominence placed upon APRs for borrowers and too little air-time being given to risk in relation to the borrower’s circumstances.

Mini-bonds were also a focus-point. Once again, promotional issues were at the heart of the FCA’s thoughts on the product-type. The illiquidity of mini-bond investments was also flagged, as was the suggestion that they may occasionally represent an incidence of venture-stage firms taking on debt. For a thorough take on the pros and cons of the mini-bond structure, journey back to AltFi Data CEO Rupert Taylor’s take on the matter.

A section of the report was also dedicated to the use of social media as a means for financial promotions. Nothing much new here since the regulator published its stance on the subject back in August. A final guidance on this matter will be published in the next couple of months.

The FCA also took a moment to praise its own work when set against an international context! The regulator pointed to the rapid growth of the UK industry – across various sub-sectors – as evidence that its regulatory approach in fact provides a favourable framework for the development of the many platforms.

The paper concluded by suggesting that the FCA sees no need to alter its regulatory approach for the time being, either in terms of consumer protections or platform requirements. But the final note was an intriguing one. The paper insinuated that if the riskiness of opportunities showcased by the P2P platforms shifted more towards risk-levels in the equity crowdfunding space, then the FCA would react by implementing equity crowdfunding-like restrictions. The restriction being referenced is, presumably, a percentage cap on retail investment via the platforms.

This might seem a strange to caution to issue to the P2P space, given that it is to be fair worlds apart from equity crowdfunding in terms of its riskiness. I expect that the warning relates to the potential danger of the peer-to-peer platforms lending to increasingly risky borrower-types in an effort to drive volume – a threat recently flagged by newly appointed LendInvest CFO Paul Jeffery. The FCA appears to be trying to nip that one in the bud.

Now for some reaction. Christine Farnish, Chair of the P2PFA, was the first to weigh in:

“The FCA’s review of the peer-to-peer lending industry and equity crowdfunding industry comes at an appropriate time. While I am encouraged to see growth and the wider benefits delivered through our sector, we must remain vigilant to the wider challenges too.

“The report is correct to highlight incidences of where companies have misled customers and the FCA is right to take a tough line as this could bring the whole sector into disrepute.

“The P2PFA sets out a strict set of rules within our own membership in order to promote high standards and consumer protection. This includes high standards of transparency by providing clear, balanced and fair information to all customers. Any member does not abide by these rules faces expulsion.”

Louise Beaumont, Head of Public Affairs at GLI Finance, welcomed the report and called for the FCA to take up an even broader remit:

“The news that the FCA is considering beefing-up the regulatory framework for crowdfunding is good news and shows that the regulator is on the ball. It also comes with little surprise – whilst the industry is growing at a staggering rate, it is vital that it is regulated and managed robustly, so that it is sustainable. It is no good if platforms simply blow-up, as the hard won confidence of retail and institutional backers will be lost.”

“We would like to see regulation extended right across the loans and debt financing sectors, including trade, invoice, supply chain and commercial finance broking, so there is consistency and existing loopholes are buttoned up. Together, this will this will provide both borrowers and investors with the assurance that the alternative finance market is a long term, sustainable and viable solution for those seeking finance, invariably SMEs requiring fuel to grow”.