Vedanvi ltd cp13 13 response


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Response to Consultation on Crowdfunding Regulation in UK

Its worth highlighting to significant unintended consequences if the crowd funding regulations go ahead in its current form:
1. The proposed regulations require institutional investors who invest in the normal cause of business in loan based investments, will be required to comply with the same rules that crowd funding platforms need to abide by. This will dissuade them from the market. Institutional investors, such as insurers and pension funds could inject huge amounts of liquidity in the peer-to-peer lending sector, making much needed loan funding available to entrepreneurs and SMEs.

2. For equity based crowd funding the FCA is restricting such investments to sophisticated and high net worth investors. For ordinary "unsophisticated" investors, they will be restricted to only investing 10% of their portfolio. Platforms will also be burdened with an appropriateness test which will require them to assess the knowledge and skill of the unsophisticated investor in invest in equity based crowd funding before allowing them to invest.

This will take the crowd out of crowd funding.

This topic was hotly debated in Parliament on 18th of December 2013, and Members of Parliament agreed that this industry has huge potential and should not be restricted by regulation.

Interested in your views. Feel free to email me on to discuss or share your views.

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Vedanvi ltd cp13 13 response

  1. 1. 1       18  December  2013           Sent  By  Email  to     Jason  Pope  and  Susan  Cooper   Policy,  Risk  &  Research  Division   Financial  Conduct  Authority   25  The  North  Colonnade   Canary  Wharf   London     E14  5HS     Dear  Jason  and  Susan     Response  to  Consultation  Paper  13/13  (“CP13/13)”   FCA’s  Approach  to  Crowdfunding  (and  similar  activities)     I  set  out  below  our  formal  response  to  CP13/13  in  the  capacity  as  a  representative  of  a  professional   services   firm   Vedanvi   Ltd,   which   provide   management   consultancy   services   in   the   areas   of   governance,  risk  and  compliance.     We  welcome  the  regulation  of  the  wider  consumer  credit  industry.    The  supervision  and  regulation  of   this   fast   growing   industry   will   deliver   better   outcomes   for   consumers,   especially   within   certain   sectors.         To  put  our  response  into  context,  we  would  like  to  bring  to  your  attention,  timely  research  recently   carried   out   by   a   team   from   Nesta,   Berkeley   University   and   University   of   Cambridge   on   the   crowdfunding  industry  (“The  rise  of  future  finance:    The  UK  Alternative  Finance  Benchmarking  Report”   by   Liam   Collins   (Nesta),   Richard   Swart   (University   of   California,   Berkeley)   and   Bryan   Zhang   (University   of  Cambridge)).    Key  findings  include:       • UK’s   alternative   finance   market   grew   by   91%   from   £492   million   in   2012   to   £939   million   in   2013   • Cumulatively,  the  average  growth  rate  over  the  last  three  years  has  been  75%,  contributing   £1.74  billion  of  personal,  business  and  charitable  financing  to  the  UK  economy.   • A  particularly  significant  finding  is  that  collectively,  this  alternative  finance  market  in  the  UK   provided  £463  million  worth  of  early  stage  growth  and  working  capital  to  over  5,000  start-­‐ ups  and  SMEs  between  2011  and  2013,  of  which  a  staggering  £332  million  was  accumulated   in   2013   alone.     This   is   funding   that   was   previously   unavailable   to   SMEs   because   of   banks’   reluctance  of  lending  to  this  segment  of  the  economy.   • The  market  is  predicted  to  grow  to  £1.6  billion  in  2014  and  provide  £840  million  of  business   finance  to  start-­‐ups.   • In   2013,   peer-­‐to-­‐peer   lending   market   took   in   £287   million,   and   peer-­‐to-­‐business   lending,   £193  million.    The  equity  crowdfunding  market  registered  £28  million,  but  growth  rate  was  a   massive   618%   from   2012   to   2013.   Compared   with   a   growth   rate   of   126%   for   peer-­‐to-­‐peer   lending.     Clearly  this  is  an  industry  in  its  infancy  and  is  rapidly  growing.    UK  is  the  eminent  leader  of  this  market,   and   current   regulatory   initiatives   are   at   the   forefront   of   innovation.     We   understand   the   FCA’s   predicament   in   trying   to   regulate   such   an   industry.     Balancing   consumer   interests   against   financial   innovation,   market   disruption   and   competitiveness   poses   a   significant   challenge   at   this   stage   in  the   evolution  of  the  crowdfunding  industry.     Anecdotally   this  process  could  be  described  as   “building  the     Registered  in  England  &  Wales,  Registration  Number  07936886   45  King  William  Street,  London  EC4R  9AN   Tel:  +44  (0)  203  102  6750       enquiries@vedanvi.Com   1  
  2. 2. 2     plane  while  flying”  and  certainly  major  changes  and  further  fine-­‐tuning  may  well  be  necessary  along   the  way  until  the  market  matures.       General  observations   1. Consultation  period  -­‐  Given  the  infancy  and  transitory  nature  of  the  industry,  as  well  as  the  fact   that  very  little  research  is  actually  available,  we  believe  that  stakeholders  would  have  preferred   more   time   to   consider   and   respond   to   the   proposed   regulations.     By   the   FCA’s   own   admission,   this   consultation   period   is   shorter   than   is   usually   the   case.     Ideally,   the   consultation   process   should  be  extended  to  allow  for  more  research  and  dialogues.     2. Simple   Categorisation   -­‐   Despite   it   newness,   this   industry   is   diverse.   There   are   several   types   of   platforms  emerging,  each  with  their  own  unique  business  models  and  risk  profiles:   a. Peer-­‐to-­‐peer  lending   b. Peer-­‐to-­‐business  lending   c. Invoice  trading  (firms  sell  their  invoices  to  a  pool  of  investors)   d. Equity  based  crowdfunding   e. Debt  based  securities  (lenders  receive  a  non-­‐collateralised  debt  obligation  typically  paid   back  over  an  extended  period  of  time  –  similar  to  a  bond)   f. Revenue/profit  sharing  crowdfunding   g. Microfinance/community  based  shares   We  question  whether  the  two  categories,  loan  and  investment  based  crowdfunding  adequately   capture  this  diversity,  especially  given  low  risk  treatment  of  the  former  and  high  risk  treatment   of   the   latter.     Practical   implementation   challenges   are   bound   to   arise.     How   would   the   FCA   treat   platforms  offering  hybrid  loan  and  investment  based  securities,  for  example?    How  are  invoice   trading   platforms   treated?     How   would   financial   promotions   be   policed   for   loan   investment   exhibiting  equity  like  characteristics?     3. High   Risk   vs.   Low   Risk  –  Currently  there  are  no  restrictions  on  the  type  of  investors  that  could   receive  financial  promotions  or  actually  investment  in  loan  based  crowdfunding.    High  yields  have   attracted  investors  relying  solely  on  their  pensions  for  day-­‐to-­‐day  living  expenses  to  loan  based   platforms,   exposing   them   to   higher   risk   of   default.     Even   a   small   percentage   default   rate   could   have  a  material  impact  on  monthly  income.      Recipients  of  the  loan  based  funding  are  most  likely   to   have   the   same   risk   profile   as   businesses   raising   equity   based   finance.       We   would   therefore   question   whether   such   a   bipolar   approach   between   the   regulatory   treatment   of   the   two   platforms   is   appropriate.     The   proposed   regulations   provide   more   of   an   incentive   for   investors   to   choose   loan-­‐based   crowdfunding   at   the   expense   of   investment-­‐based   crowdfunding,   hence   stifling  the  growth  of    the  latter  market.     4. Sophisticated   vs.   unsophisticated   Investors  -­‐  We  appreciate  that  the  FCA  is  constrained  by  the   Financial   Services   Markets   Act   of   2000   (FSMA)   and   the   2012   in   terms   of   the   definition   of   sophisticated  vs  unsophisticated  investors.    We  think  that  a  strict  interpretation  may  give  rise  to   unintended   consequences,   as   the   traditional   definition   may   be   inappropriate   for   this   new   industry.   Social   networking   is   the   pillar   upon   which   this   industry   has   been   built.     Typically   founders   are   most  likely  to  be  funded  by  friends  and  family  through  the  platforms,  especially  in  the  first  round   of  fundraising.    In  such  an  instance,  the  investors  know  the  business,  the  management  team  and   would   have   a   keen   appreciation   of   associated   risks.     Despite   them   being   classified   as   unsophisticated,  are  they  really?       Registered  in  England  &  Wales,  Registration  Number  07936886   45  King  William  Street,  London  EC4R  9AN   Tel:  +44  (0)  203  102  6750       enquiries@vedanvi.Com   2  
  3. 3. 3     Lets   take   another   example.     This   industry   is   most   likely   to   attract   non-­‐traditional   and   so   called   “unsophisticated”  investors  who  may  have  a  deeper  understanding  of  new  age  business  models   or  technology  in  which  they  are  willing  to  invest.    In  fact  their  understanding  of  such  investments   may   be   much   better   than   investors   traditionally   classed   as   sophisticated   or   high   net   worth.     Restricting   such   savvy   but   “unsophisticated”   investors   could   unnecessarily   limit   potentially   lucrative  investment  opportunities  to  this  segment  of  the  population.           At  a  high  level,  we  agree  with  the  general  direction  of  the  proposed  rules.    The  devil  is  clearly  in  the   detail  and  unintended  consequences  will  only  become  evident  during  implementation.    We  highlight   below   specific   areas   of   concern,   which   we   believe   could   have   the   most   significant   impact   on   the   future  development  of  the  industry.     Loan  Based  Crowdfunding   1. The   consultation   identifies   five   types   of   crowdfunding.     Invoice   based   crowd   funding   is   not   explicitly  mentioned.    The  joint  research  found  that  invoice  trading  stood  at  £97  million  in  2013,   in  comparison  to  equity  based  crowdfunding,  which  stood  at  £28  million.       One   can   assume   that   invoice   based   investments   could   fall   under   loan-­‐based   crowdfunding,   however   it   is   open   to   interpretation   and   many   such   platforms   may   be   forgiven   for   assuming   that   they   fall   outside   the   scope   of   the   regulations.     Certainly   there   are   invoice-­‐based   platforms   that   explicitly  restrict  investment  to  self-­‐certified  and  high  net  worth  retail  investors.    However  many   others  don’t,  and  may  unknowingly  be  promoting  such  investment  to  unsophisticated  investors.   High  yields  will  attract  unsophisticated  investors  to  these  platforms,  exposing  them  to  a  different   type  of  risk  profile  associated  with  such  investments.    If  their  regulatory  treatment  is  not  made   explicit,   there   is   a   danger   of   creating   unleveled   playing   fields   between   the   different   types   of   crowdfunding.     Investing  money  via  loan  based  crowdfunding  platform  in  the  course  of  business   2. The   FCA   regard   loan   based   crowd   funding   as   an   investment.     However,   as   far   as   institutional   investors   are   concerned,   they   regard   this   activity   as   a   lending,   and   hence   apply   the   requirements   of  the  Consumer  Credit  Directive.    Clearly,  there  are  inconsistencies.     3. Such   institutional   investors   will   themselves   have   to   comply   with   crowfunding   regulations,     despite   never   dealing   directly   with   investors   in   the   same   way   that   platforms   do.     FCA   and   PRA   already   regulate   such   firms   under   a   separate   regime,   and   surely   their   clients   would   already   be   protected  through  those  regulations.         4. We   don’t   believe   such   a   dual   regulatory   framework   was   intended.     Furthermore,   the   proposals   would   raise   significant   practical   challenges.     How   would   such   institutional   investors   implement   the  regulations,  especially  around  financial  promotions?    What  are  the  roles  and  responsibilities   of  the  platforms  and  those  of  the  institutional  investors?       5. Of   significant   concern   is   the   fact   that   this   proposal   would   deter   institutional   investors   from   entering   this   market   (given   the   added   compliance   burden).     Their   absence   would   significantly   diminish   the   much-­‐needed   pool   of   funding   available   to   SMEs.     Institutional   investors   are   increasing  looking  to  alternate  investment  in  this  low  yield  environment.    Even  if  such  institutions   only   invest   a   tiny   fraction   of   their   portfolio   to   test   the   market,   it   nevertheless   would   give   this   sector  a  huge  boost.       Registered  in  England  &  Wales,  Registration  Number  07936886   45  King  William  Street,  London  EC4R  9AN   Tel:  +44  (0)  203  102  6750       enquiries@vedanvi.Com   3  
  4. 4. 4     Investment  Based  Crowdfunding   6. Crowdfunding   is   set   to   grow   significantly,   and   its   clear   from   the   research   highlighted   above.     Any   restrictions   on   investors   entering   this   market   have   to   be   done   with   great   care,   ensuring   that   regulations  don’t  unintentionally  stifle  innovation  and  growth.     7. We   would   like   to   bring   to   emphasise   one   of   the   consumer   protection   objectives   in   the   2012   Financial   Services   Markets   Act,   which   stipulates   that   consumers   should   take   responsibility   for   their  own  decision.    Provided  consumers  are  well  informed,  and  treated  with  care,  they  should  be   allowed  to  make  their  own  decisions  without  the  need  for  protecting  them  from  themselves.       8. Crowdfunding  also  opens  a  whole  new  possibility  for  ordinary  investors  to  take  a  stake  in  future   high  growth  business  (with  full  knowledge  of  the  risks  involved).    This  opportunity  was  previously   only   available   to   sophisticated   angel   investors,   venture   capitalists   and   private   equity   firms.     Now,   with  innovation  in  financial  markets,  an  ordinary  investor  could  take  a  stake  in  a  future  Google,   Facebook   or   Instagram,   for   example,   right   at   the   very   early   stages.     This   is   a   major   shift   that   shouldn’t  be  underestimated.     9. We   remain   concerned   about   the   following   key   areas   that   restrict   financial   promotions   to   unsophisticated  investors  under  the  proposed  rules:   • Advice   may   be   unavailable   or   prohibitively   expensive   for   unsophisticated   low   net   worth   investors.    In  this  case,  they  will  be  restricted  to  investing  10%  of  their  investible  portfolio.   • The   FCA   is   already   aware   that   the   term   “net   investible   portfolio”   is   unclear   and   poses   practical   challenges   for   implementation.     Many   so   called   unsophisticated   investors   won’t   have  a  portfolio  and  if  they  did,  most  investors  (let  alone  unsophisticated  investors)  would   find   it   challenging   to   determine   the   exact   value   of   this   portfolio   just   before   placing   their   investment.     • It’s   not   uncommon   for   investors   to   invest   small   sums   of   money   on   a   platform.     Assuming   someone   is   investing   £50,   the   hurdles   they   would   need   to   cross   seems   disproportionate   given  the  insignificant   risk.     Such  investors   will   want   to   avoid   the   additional   burden  and  may   just  stay  away.       With  the  appropriateness  test,  platforms  themselves  will  be  less  keen  to  take  on  such  small   investors  weighting  processing  costs  against  commercial  benefits  .    Hopefully  this  is  not  what   the  FCA  intended?    If  the  rules  go  ahead  in  their  current  form,  such  small  investors  will  be   opted  out  of  this  market.   • Investors  diversify  their  risks  by  investing  small  amounts  on  many  platforms.    How  would  the   10%  rule  be  policed  under  such  circumstances?     10. Over   recent   weeks   there   has   been   much   debate   about   whether   the   proposed   regulations   take   the   “crowd   out   of   crowdfunding”.     The   point   about   not   restrictions   on   gambling   has   also   been   well   made   publically.     On   balance,   taking   all   things   into   consideration,   we   believe   there   is   a   danger  of  the  proposed  regulations,  in  their  current  form,  excluding  the  crowd  from  this  market.     11. As  a  first  prize,  we  believe  the  10%  restriction  should  be  lifted  during  a  transition  period  while  the   FCA   closely   monitors   the   development   of   the   market   and   any   consumer   detriment.     A   better-­‐ informed  cap  can  be  put  in  place  if  justified  by  the  evidence  after  the  transitional  period.    In  this   way,  the  industry  would  be  allowed  to  develop  without  any  artificial  or  unnecessary  restrictions   being  imposed.      Its  worth  bearing  in  mind  however  that  the  appropriateness  test  in  such  a  case   may  still  deter  platforms  from  accepting  certain  types  of  retail  investors,  based  on  the  risk  that   they  would  themselves  be  expose  to.     Registered  in  England  &  Wales,  Registration  Number  07936886   45  King  William  Street,  London  EC4R  9AN   Tel:  +44  (0)  203  102  6750       enquiries@vedanvi.Com   4  
  5. 5. 5       12. A  second  alternative  could  look  something  like  this:   • By   gathering   market   data,   the   FCA   could   quickly   determine   the   average   value   of   an   investment  on  a  single  platform,  by  retail  investors.    Such  evidence  will  exist  on  loan-­‐based   platforms  as  well  as  rewards  based  funding  platforms.   • Based  on  the  findings,  an  appropriate  de  minimis  amount  could  be  set.   • Anything   under   the   de   minimis   amount   should   have   no   restriction   nor   should   the   appropriateness   test   apply.     Practically,   this   would   mean   that   platforms   could   allow   such   investors   to   invest   without   confirming   the   10%   rule,   nor   would   they   need   to   apply   the   appropriateness   test.     As   far   as   financial   promotions   are   concerned,   such   clients   are   more   likely  to  find  their  way  onto  platforms  out  of  their  own  initiatives  rather  than  being  solicited   by  platforms.   • Such   a   solution,   in   our   view,   would   preserve   the   essence   on   which   the   industry   was   developed   (i.e.   small   amounts   by   ordinary   investors)   and   leave   the   “crowd   in   crowdfunding”   –     • Like  entrepreneurs  that  use  platforms  to  test  concepts  or  “fail  fast”,  the  FCA  could  test  this   proposal   during   a   12   to   18   month   transition   period   and   fine-­‐tune   the   regulation   based   on   more  concrete  information  at  a  later  date.     The  UK  Government  has  shown  great  foresight  and  leadership  in  recognizing  the  economic  benefits  of   developing   the   crowdfunding   industry.     The   FCA   was   courageous   enough   to   allow   equity-­‐based   crowdfunding  on  a  case-­‐by-­‐case  basis,  when  the  USA  had  totally  restricted  such  a  form  of  investment.     Restricting  the  industry  would  in  our  view,  significantly  change  the  shape  of  the  industry  and  restrict   innovation   and   rapid   growth,   especially   at   a   time   when   alternative   finance   is   so   essential   for   the   economy.     We  therefore  hope  that  the  FCA  will  adopt  a  more  open  approach  to  allow  this  fledgling  industry  to   blossom  and  grow.     Please  contact  us  if  you  would  like  to  discuss  any  of  the  above  in  more  detail.         Yours  sincerely       Jay  Tikam   Director   Vedanvi  Ltd     Registered  in  England  &  Wales,  Registration  Number  07936886   45  King  William  Street,  London  EC4R  9AN   Tel:  +44  (0)  203  102  6750       enquiries@vedanvi.Com   5