The Financial Conduct Authority this week published a paper titled “A review of the regulatory regime for crowdfunding and the promotion of non-readily realisable securities by other media”.
This isn’t a consultation paper and doesn’t invite responses; it is a review of some aspects of crowdfunding regulation and of the growth of the crowdfunding market. Of particular interest in the paper are discussions of:
- the FCA’s supervision of the market;
- website and financial promotion reviews;
- social media;
- mini-bonds; and
- changes to the market.
The FCA paper focuses on loan-based and investment-based crowdfunding, as those are the two types of crowdfunding which the FCA is responsible for regulating.
The FCA’s supervision of the market: disclosure of relevant information, and platform comments
The FCA reports that it has made “a number” of regulatory interventions in connection with investment-based crowdfunding platforms. Examples given in the paper are interventions to ensure that:
- only appropriate types of customers were allowed to invest; and
- financial promotions are clear, fair and not misleading, with regard to both the nature and performance of the assets invested in and exit opportunities for investors.
In addition, the FCA adds, “there have been a small number of reactive prudential events where firms were not meeting the expected capital requirements”.
On loan-based platforms, the FCA was “encouraged by what we found during our visits, including a good understanding of credit risk and robust anti-money laundering and Know Your Customer checks”.
The FCA says that in its regulatory visits it was “particularly looking to see that platforms are disclosing all relevant information to enable potential investors to make informed decisions on whether or not to invest”. A specific example it gives of areas where information could be misleading are claims that shares offered on the platform are the same as shares held by venture capitalists. In the FCA’s words, these could be significant if:
“…venture capitalists are able to profit from successful investment opportunities but crowdfunding investors find, where an investment succeeds, that equity dilution means they do not share in the profits to the same extent.”
Some platforms allow investors to comment on investment opportunities. Here, the FCA observes that:
“Some market intelligence suggests that negative comments are being deleted from these forums on some sites, which may lead to situations where relevant risks are overlooked.”
Website and financial promotion reviews
The FCA has been “proactively” focusing on crowdfunding financial promotions, and between April and October 2014 it reviewed 25 websites against the relevant rules. With regard to investment-based platforms, the FCA identified issues such as:
- a lack of balance, with benefits emphasised over risks;
- insufficient, omitted or cherry-picked information; and
- the downplaying of important information – such as risk warnings being diminished by claims that no capital had ever been lost.
On loan-based platforms, similar issues were identified, and also:
- promotions incorrectly comparing crowdfunding investing to savings accounts and banking;
- insufficient information about taxation;
- omission of the APR; and
- lack of balance between benefits and risks.
In August 2014, the FCA published a consultation on financial promotions in social media. On that, see our note here. The FCA’s approach is that its rules are intended to be media-neutral “to ensure that consumers are presented with certain minimum information, in a fair and balanced way, at the outset of firms’ interaction with them”.
The FCA recognises that an issue of particular concern to the crowdfunding sector is the extent to which the use of social media amounts to making a “financial promotion”. Here, the FCA adopts its usual position that what is or is not a financial promotion is “a matter of interpretation of the legislation, not of our rules”.
However, the regulator points out that a key aspect to consider is whether the communication is made “in the course of business”, and references its guidance at Chapter 8.5 of its Perimeter Guidance Manual. And specifically, PERG 8.5.3G with regard to start-ups.
There has been an increase in the number of small companies issuing mini-bonds on crowdfunding platforms. Mini-bonds are unlisted and hence illiquid. The FCA has various concerns about the promotion of mini-bonds – both on platforms and through direct marketing – including:
- failure to make clear that capital is at risk and that these products are not in the deposit protection scheme;
- promotions that lack balance between rewards and risk;
- misleading comparisons to listed retail bonds; and
- approval of financial promotions that do not comply with the FCA’s rules.
The growth of the crowdfunding market
The FCA’s paper has a long section discussing “market information”. Much of the information in this section is drawn from a single source – a 2014 study by Nesta and the University of Cambridge (which is here). With that caveat, here are some highlights as extracted by the FCA: (Figures relate to 2014.)
- For the first time, business loans (£749 million) accounted for a greater proportion of the market than loans on consumer-lending platforms (£547 million);
- the average consumer loan in 2014 was £5,471;
- the average rejection rate for consumer borrowers is as high as 90%; the average default rate is less than 1%;
- the average loan for business purposes was £73,222; and 33% of borrowers said it was unlikely or very unlikely that they would have secured funding from other sources; and
- investors in consumer loans have an average age of 49; in business loans, investors are primarily aged 55 or over.
- The amount raised on these platforms in 2014 is expected to be £84 million;
- equity-based crowdfunding grew by 201%; and 95% of funded deals were eligible for EIS or SEIS; and
- the average age of investors is 40 and the average portfolio size is £5,414.