The FCA’s post-implementation review has thrown up a number of concerns over the equity crowdfunding sector, centring on disclosure, due diligence requirements and potential conflicts of interest.
The UK regulator is considering enforcing higher standards of disclosure and due diligence within the equity crowdfunding space. Investment based crowdfunders are currently subject to the same set of disclosure standards as debt-based platforms. But standards of disclosure within the two market segments are, in practice, worlds apart. In a regulatory sense, the two groups of platforms must each ensure that investors are equipped with a sufficient level of information to reasonably make investment decisions. In P2P lending, the major platforms have seized the initiative by disclosing their full loan books online. Crowdfunders, conversely, have found it tough to agree even to a standard methodology for reporting funding volumes.
But the FCA may be about to step in. Going forward, the regulator has advised that it may require platforms to change the way that fundraising campaigns are displayed. The review said that it might require firms to only display money that has been contributed by “persons unconnected with the business”. The fear is that other forms of reporting may generate a counterfeit kind of momentum for campaigns.
The FCA has also said that it might take steps to mandate the disclosure of performance data: “Based on the outcome of the review, to help potential investors better understand the risks, we could consider whether to mandate additional disclosures, for example setting out how many businesses that raised funds have since failed and how many have had successful pay-outs.” Though difficult to obtain, this kind of suggestion is wholly feasible, as made plain by the “Where are they now?” report, which was published by AltFi Data in November of last year. The report revealed that, at the time of its writing, over 80% of the companies that had raised funds through equity crowdfunding platforms between 2011 and 2013 were still trading.
The regulator’s approach to due diligence so far has been to allow investment based crowdfunders to either perform their own analysis on prospective projects, or to allow those platforms to delegate the better part of that responsibility to the crowd. The only stipulation was that the involvement of the platform in assessing the quality of a project be clearly laid out. The FCA is now concerned that this approach is not working. The review stated the following: “We are potentially concerned, however, that this approach may not be working as well as it might. It appears that some businesses that successfully raise capital fail shortly afterwards.” The review goes on to state that individual investors may be exposed to risks that “they are not well placed to assess in advance”.
In response to these concerns, the regulator intends to analyse the due diligence processes of the various platforms, and indeed to gauge what level of additional assessment is being undertaken by individuals. If the FCA deems that investors are not in a position to protect their own interests, then it “may consider the feasibility of minimum due diligence standards”. It may also consider requiring business plans to be reviewed by an appropriate third party.
Charles Owen, Founder of CoInvestor, reacted: “News that the FCA is considering tightening due diligence rules for crowdfunding and P2P platforms has to be a welcome development as the alternative finance sector continues to grow. Investors in these platforms are making their own investment decisions based on the information presented to them and it is important that what is presented is both thorough and complete.”
Also of note in the FCA’s review is the general point that equity crowdfunders have a large number of conflicts of interest to manage, including the trade off between maximising profits by chasing volume, versus maximising investor return by focusing on quality. The regulator will consider whether existing regulatory requirements address these issues adequately.
The review revealed that the regulator is planning an in-depth assessment of the appropriateness test. This mechanism is used by platforms to sort investors into either high net worth, experienced, sophisticated or restricted camps. In its review of the test, the FCA has warned: “Where we find poor consumer outcomes – e.g. clients being assessed as ‘sophisticated’ where they do not understand the risks or are unable to conduct necessary additional due diligence – we will consider taking further action with firms, either to ensure appropriate redress or to sanction the firm.”
Finally, the FCA continues to mull over whether to bring equity crowdfunding investments into the IFISA regime. Debt securities are already slated to become eligible from Autumn 2016. Equity falls outside of the scheme for now. On IFISAs, the review advised: “We are considering mandating the disclosure of required information in relation to ISA investments in non-readily realisable securities, such as in relation to the tax implications of the investment, Innovative Finance ISAs may involve greater risk than most other ISAs. For example, investors may lose their ISA allowance for a year if they hold equities in a business that goes on to fail.”
You can access the full paper here. Those interested in submitting their feedback will need to have done so by 8 September 2016. Below is a full list of the questions that were posed by the review in relation to investment-based crowdfunding.
Q16: What other market developments should we take into account in our review of the investment-based crowdfunding sector?
Q17: Do you have any comments on the management of conflicts of interest on investment-based crowdfunding platforms?
Q18: Do you have any comments on current due diligence standards for investment-based crowdfunding platforms?
Q19: What do you think of the current client assessment standards on investment-based crowdfunding platforms?
Q20: What do you think of the current standards of information disclosure on investment-based crowdfunding platforms?
Q21: Should we mandate the disclosure of risk warnings in relation to non-readily realisable securities held within Innovative Finance ISAs?
Q22: Are there any other matters we should take into account in the post-implementation review for investment-based crowdfunding?