|Alternative Funding Network|
Regulating Crowdfunding 2.0 – What can we expect?
Over the summer the FCA released a consultation paper calling for input about the current crowdfunding rules (both debt and equity) that the FCA should consider improving and modifying. Following on from the AFN seminar Fox Williams hosted earlier this month and bringing to bear our own and our clients’ experiences, we have outlined the key area we think the FCA will be looking to change over the coming months.
One size doesn’t fit all
Neither loan-based, nor investment-based, crowdfunding encompasses just one model - there are a multitude of models that have emerged in the market over the last few years. On the loans-based side, there has been institutional investors sitting side by side with retail investors, secondary markets, provision funds, insured lending, and auto-bidding, to name but a few.
There is a big concern that the FCA has been applying rules in a way that was not the intention of the legislation. Article 36H was drafted to fit a market and models that already existed and yet the legislation is being interpreted narrowly by the FCA, meaning that some models fall outside the legislation. We are hopeful that Treasury and the FCA will review and amend the legislation over the coming months in order to capture the essence of what P2P platforms do (i.e. facilitate lending between lenders and borrowers and service the resulting loans) rather than focus on the technical minutiae. If this is achieved, we have no doubt that this will help further increase investor protection in the industry.
Conflict? What conflict?
The FCA has a concern that several crowdfunding platforms (particularly investment-based ones) do not appear to have an interest in investors’ exit of their investment, and so an inherent conflict arises as it may be in the interest of the platform to make available as many projects as possible (to maximise profit) - this may not be in the best interests of retail investors who may be ill-equipped to pick out winners and losers.
Although there are inherent mechanisms in place to mitigate the conflicts risk (including the operator’s vested interest in the platform and keeping their reputation intact), it is a positive step to at least encourage platform operators to think about these potential conflicts more carefully.
To mitigate the risk of the FCA proposing legislation to deal with this perceived conflict, platform operators should make greater disclosure of any potential conflicts so that investors are fully informed before they commit funds. This can include transparency on fees and rigorous disclosure of how the platform makes its money. If any inherent conflicts are properly disclosed to investors before they commit funds then they can make a considered decision as to whether this is an investment that they wish to make.
It is also important to note that, as with P2P models, equity crowdfunding is a diverse marketplace with many different business models available to consumers. Whilst some platforms specialise in curating specific projects, others simply act as marketplaces and introducers. We believe the current legislation is adequate to cater for all these models.
Due Diligence Standards
This is a difficult issue to call, for investment based platforms in particular – due diligence must be proportionate to the size of the raise, the risks, and the amount of information there is to review. Again a one size fits all approach to due diligence is not advisable, as what is appropriate for a start-up will not be appropriate for a mature company with several years trading under its belt.
However, we would therefore recommend platforms putting in place an initial standardised DD checklist which can be used as a base level for all companies, regardless of size. This would include criteria such as CRB checks on company directors.
Treating Customers (Un)Fairly?
The FCA have been concerned for a while now that institutional lenders are given preferential treatment over retail lenders. For example, we understand that some platforms allow institutional lenders access to due diligence information about borrowers that is not readily available to other lenders. In our view, institutional funding is critical to the development of the industry, and it is an unavoidable fact of a capitalist society that those with access to large amounts of funds will have increased bargaining power. However, we believe that any better terms or perceived advantages provided to institutional lenders should be prominently disclosed to other lenders in easy to digest information, and perhaps even infographics. Anything less, and platforms may be accused of allowing institutional funds to cherry-pick assets, an action which clearly goes against Principle 6 of treating customers fairly.
This review by the FCA is welcomed and we are encouraged by the way in which the FCA is looking to obtain input from within the market before bringing in any changes. What the end result will look like for both loan and equity based crowdfunding platforms will remain to be seen!
Jonathan Segal, Partner at Fox Williams LLP
Jonathan is a partner in the FinTech and Alternative Finance team at Fox Williams, a City-based Law Firm. He advises clients across the FinTech and Alternative Finance spectrum, from start-ups disrupting existing markets with innovative technology to financial institutions looking to invest in new technology.
He has particular expertise in peer-to-peer and crowdfunding platforms, drawing on his extensive experience in the banking and finance sector gained both in-house at major financial institutions and in private practice. His experience spans a variety of financial products, including loans (both corporate and consumer), real estate and development finance, asset-based lending, receivables financing, asset finance, trade finance, capital markets, derivatives and repos. A regular speaker at industry events both at home and abroad, Jonathan is also heavily involved in next generation disruptive financial products such as virtual currencies (including Bitcoin), blockchain technology and the use of Big Data in financial predictive analytics and disruptive insurance models.
Fox Williams LLP are experts at advising entrepreneurs and FinTech businesses in particular in the P2P and crowdfunding sector. For more information as to how Fox Williams can help you (including arranging a free consultation) or for further information on the issues discussed in this article, please liaise with either Jonathan Segal or Daniel Geller.