Crowdfunding and the New FCA Regulations

The growth of crowdfunding over recent years has boosted entrepreneurship in the UK. Using online platforms such as Crowdcube, small investors have helped to finance all kinds of startup businesses. Up until recently, regulation of the industry has been fairly light. However, on 1st April 2014, new rules for loan-based and investment-based crowdfunding came into effect. They were drawn up by the Financial Conduct Authority (FCA), which has replaced the Office of Fair Trading as industry regulator.

Under the new rules, investments must be ring-fenced from the platform’s finances. That way, investors’ cash is protected in case the platform gets into trouble. The platforms are also required to have a third party in place to take over in the event of financial difficulties. The idea is that the takeover will be seamless so the investor doesn’t experience any inconvenience.

Platforms also need to have ring-fenced capital reserves to provide a cushion for investors from any defaults. From October 2014 platforms need to hold £20,000, and from April 2017 the required amount rises to £50,000.

The platforms are also required to highlight clearly any risks involved to investors, and marketing must be fair and not at all misleading. Investors are not covered by the £85,000 Financial Services Compensation scheme, but they are given a 14-day cooling-off period in case they change their mind on their investment. They will also have access to a financial services ombudsman should they have any complaints.

There are also rules on who is allowed to invest in crowdfunding schemes. Those wishing to invest must confirm they fall into one of the categories of permitted investors, including: retail clients who confirm they will not invest more than 10% of their net investible assets (i.e. not their house, life insurance or pension); retail clients who are advised; retail clients classified as corporate finance contacts or venture capital contacts; and retail clients certified as sophisticated or high net worth. Investors must also confirm they are aware of the risks.

Platforms in operation before 1st April 2014 have until 1st October to put the necessary systems and processes in place.

However, it’s important to note that these regulations only apply to investment-based crowdfunding platforms and peer-to-peer lending. They don’t affect donation-based or reward-based platforms.

The new regulations were met with a mixed response within the industry. Barry James, founder of The Crowdfunding Centre, was especially dismayed at the rules limiting investors. He wrote on his blog: “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.”

However, Ayan Mitra, CEO of UK equity-based crowdfunding platform CrowdBnk, took the opposite view, commenting: “We are pleased to see that the FCA has kept the ‘crowd’ in crowdfunding, by allowing anyone to invest up to 10% of their available assets. This ensures crowdfunding remains available to all types of investor and, on the whole, we think the approach strikes the right balance between consumer protection and access to investment opportunities.

Mitra added: “In an era where even established SMEs with strong track records are struggling to obtain funding from banks, crowdfunding provides an important alternative route to finance and makes it easier for all suitable investors to find and invest in quality businesses.”