It's been almost two and a half years since the FCA's regime for crowdfunding platforms came into being and now the regulator is starting its review of how well the regime is working. BWB has been very involved with the crowdfunding industry since 2012 and we've given the regulator our feedback. We've worked with 37 investment-based and loan-based platforms and also provide support to the UK Crowdfunding Association.
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Response to Call for Input on Crowdfunding: BWB Compliance
1. BWB Compliance
Bates Wells Braithwaite
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London EC4R 1BE
Tel: +44 (0)20 7551 7777
Fax: +44 (0)20 7551 7800
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Bates Wells & Braithwaite London LLP is a Limited Liability Partnership. Registered in London OC325522.
Authorised and regulated by the Solicitors Regulation Authority and the Financial Conduct Authority.
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Jason Pope
Retail Conduct Policy
Financial Conduct Authority
25 The North Colonnade
London
E14 5HS
8 September 2016
By email: crowdfundingcfi@fca.org.uk
Dear Jason
RE: Call for Input to the post-implementation review of the FCA’s crowdfunding rules
I am writing on behalf of BWB Compliance, a regulatory consultancy formed within Bates Wells
Braithwaite, a professional services firm offering legal and consultancy services.
The FCA has asked for input on the regulatory regime for both investment-based and loan-based
crowdfunding platforms since Policy Statement 14/4 was released. Our team has worked with 37
platforms since that time, from start-ups entering the market to well-established platforms operating
as business as usual.
We help crowdfunding platforms through the full regulatory lifecycle and this includes everything from
designing the platform’s user journey, reviewing financial promotions, and ensuring the right client
money controls are in place. We advise, support and train individual platforms on how the regulatory
rules apply both, to their current business models and to new products and services that they are
contemplating.
As you are aware from our recent meetings, we also provide advice and support to the UK
Crowdfunding Association (UKCFA). BWB has worked with the UKCFA since its establishment in
2012 which represents both regulated (loan-based and investment-based) and unregulated
(donations-based and reward-based) platforms.
This response represents the views of BWB Compliance. Our views are the result of an in-depth
knowledge of the sector generally and of a wide range of individual platforms.
Overarching comments
We wholeheartedly welcome the post-implementation review of the two regulated crowdfunding
regimes. For both investment-based and loan-based crowdfunding, regulatory policy that is well-
informed is in the interests of consumers and the industry alike.
The industry has matured and developed considerably since Policy Statement 14/4 was released.
We will comment on the specific questions raised below, but feel it is worth highlighting that in such a
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fast-paced, evolving industry, principles-based regulation, supported by supervision and enforcement,
is more future proof than prescriptive rules.
We have concerns that some commentators of the market are not able to easily distinguish between
regulated and unregulated crowdfunding and consider that in the output of your review the FCA’s
position on this be reiterated or clarify to help aid understanding.
Investment-based
Regulation for investment-based platforms already existed and did not alter significantly as a result of
Policy Statement 14/4 being released. The only change was the introduction of the concept of non-
readily realisable securities and the associated financial promotions and appropriateness rules that
were connected to that. That has made for a fairly clear regime, with a wealth of precedents and
comparable scenarios offered up by existing offline industries, such as corporate finance, asset
management and venture capital.
The key risks and challenges are the same faced by most retail facing businesses – on boarding,
financial promotions, clarity and completeness of information, treating customers fairly. While these
are occasionally complicated by the online delivery of the service, overall the regime seems well-
understood and implemented.
Our feedback on the investment-based crowdfunding can be found below.
Loan-based
The situation was and remains entirely different for loan-based crowdfunding. Policy Statement 14/4
created a brand new regime for peer-to-peer lending, an activity that had never been regulated
before. The FCA aimed to take a proportionate approach to regulation in order to allow the industry to
flourish and was able to do so because, broadly, such lending was not covered by European
regulation. The prescriptive elements of the regime surrounded client money and capital resources in
order to safeguard against investors losing money. For the most part the remaining rules were
disclosure-based, allowing platforms to make their own decisions on how to run the platform but
emphasising a need for transparency.
After publication of PS 14/4, loan-based platforms were given windows of time in which to approach
FCA to become fully authorised. The earliest of these opened roughly in November 2014. The vast
majority of platforms have still not been authorised. We can see that there are challenges with
implementing the regime. Both market developments and imperfect legislation and regulation have
created a scenario where standards and policy appear to be being created through the authorisations
process.
Sadly, the net impact of this is that the loan-based regime is suffering detriment while many platforms
are unable to launch, and others cannot launch the much anticipated Innovative Finance ISA. We
would ask the FCA to consider whether interim policies and other tools are at its disposal, could help
to tackle the challenges in a way that is fairer to the market, while also protecting the ability of the
FCA to supervise effectively.
Our feedback on the loan-based crowdfunding can be found below.
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Summary
We look forward to seeing the output of the call for input. This review of the market, to our mind, can
only be valuable to the industry, consumers and the regulator.
We would caution against changing rules unless there is real risk of consumer detriment. Guidance
and supervision should help to achieve good standards across the industry.
If there is anything we can do to assist with the review that follows this call for input, please don’t
hesitate to let us know.
Yours sincerely
Gillian Roche-Saunders
Partner, Bates Wells Braithwaite
For and on behalf of BWB Compliance
D: (0)20 7551 7876
T: (0)20 7551 7777
g.roche-saunders@bwbllp.com
4. 215658/0000/001421995/Ver.01 4
Annex: response to the questions within the Call for Input
Loan-based crowdfunding
Q1: Do you consider that there is the potential for regulatory arbitrage with banking business?
If so, what measures should be considered to address it?
It is certainly true that the market has developed and that the business models present are often more
involved than simply one lender directly lending to one borrower, but we have no evidence of
regulatory arbitrage. If anything, Policy Statement 14/4 brought into the regulatory sphere much
activity that would have been entirely unregulated previously.
Where a platform is deposit taking, operating a collective investment scheme or managing an AIF,
and assuming no legitimate exemption applies, we consider that the regime relevant to those
activities should apply. However this can already be achieved through the existing perimeter.
We have heard market commentators question how relaxed the existing regime is. No doubt there
are areas where tightening up could be valuable, to both the platforms and consumers, the regime is
far from light touch.
After the transition period, capital requirements for a loan-based platform will be at a similar level (or
higher) than BIPRU firms and small authorised alternative investment fund managers. The same
client money rules apply as to an asset manager or other custodian of client funds. Equally financial
crime, financial promotions and corporate governance rules all remain in place. Certain provisions,
such as the requirement for a living will, in fact go far further than the requirements on an asset
manager.
In addition to this, the current authorisation process is setting standards far higher than would be
required of most other financial services firms. The timeframe, the volume of questions and level of
interaction is far higher than we presently see for any other part of the investments or consumer credit
industry.
Q2: Do you have any concerns about, or evidence of, differences in the treatment between
retail and institutional investors?
It is always worth reminding firms of their obligation to manage conflicts properly and to keep the retail
customers interest at the heart of the business model. This absolutely should be part of the FCA’s
review. However, we don’t see the risks in this sector being higher than for other parts of the market.
Particularly, as loan-based crowdfunding platforms are already required, by Principle 6 and the
concept of treating customers fairly, to ensure that there is no disadvantage to retail lenders if they
take on institutional lenders also.
There has been an upsurge in institutional funding of loans and this has helped platforms to scale,
meet seasonal demand and compete for the quality loans. It can also improve liquidity for other
lenders and, arguably, benefits the platform’s governance. Conflicts need to be properly managed,
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but once this is done, we see no reason why the entry of institutional investors will necessarily cause
detriment to retail customers.
Our team has seen a range of factors utilised by platforms to manage potential conflicts and
particularly the ability of institutional lenders to cherry pick investments. These include controls
around the level and timing of information provided about loans, and what proportion of any given
deal is made available to an institutional investor within the initial period of the loan being “live”.
Further steps may need to be taken where there is an auto-bid or auto-diversification feature. In these
cases the potential for cherry picking and conflicts rise as the investor takes less of a role in actively
managing their portfolio and choosing particular deals.
Where higher returns are paid to lenders willing (and able) to take higher risk or provide increased
commitments to make lending possible in the first place, we think this arrangements should be
prominently disclosed to all lenders.
Q3: Have you seen any initial evidence that the ISA wrapper has led to consumers not fully
appreciating the risks involved in Innovative Finance ISA investments?
Due to the delays with authorisations, there are very few Innovative Finance ISAs (IFISA) in the
market. As such it is hard to comment on how consumers have reacted.
We would expect disclosure and financial promotions responsibilities to require ISA managers to
reflect the risk of the IFISA, the key difference being liquidity and FSCS cover.
Q4: Are there differences in borrower protection between commercial and non-commercial
agreements that would be best addressed by applying additional rules to P2P platforms, or are
the existing rules adequate?
We have not seen instances of borrowers being disadvantaged because the arrangement is classed
as a non-commercial agreement, and therefore sections 76, 77, 77A, 78, 87 and 98 of the Consumer
Credit Act do not apply.
Having said that, we do not see the logic in applying different standards of borrower protection based
on who is lending to them. It adds unnecessary complexity that cannot be helpful for consumer
understanding.
Q5: Do you agree with our analysis of the key developments in the loan-based crowdfunding
sector over the last two years?
There have indeed been significant developments in the sector, although we understand that the key
developments, such as provision funds, institutional investors and autobid arrangements were present
in the models when article 36H was drafted.
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Q6: Are you aware of current or emerging risks that firms’ current infrastructure, systems and
controls might not be adequate to deal with?
Having a regulatory regime dedicated to loan-based crowdfunding puts the UK at a distinct advantage
in terms of infrastructure, systems and controls.
We have heard some concerns that the limited access to bank facilities is resulting in an over-reliance
on a small number of payment services companies. If the FCA is reviewing the sector as a whole it
may be worth considering that.
At present there seems to be significant scrutiny over systems and controls through the authorisation
process, more than we see for any other part of the industry in fact, or for loan-based platforms
authorised prior to 2016. We therefore envisage that there will be few SYSC risks going forward for
those firms that the FCA authorises from this point onwards.
Q7: Do you have any comments on our concerns over the development of new loan-based
crowdfunding business models? Have there been other specific developments that are
relevant to the high-level standards summarised above?
This is a fast paced and innovative environment. As set out in our cover letter, we think that principles
based regulation, rather than prescriptive rules, will be key to creating a regime that can keep up with
developments.
Q8: Do you have any comments on the standards of disclosure on loan-based crowdfunding
platforms?
It would be useful to have further guidance on the FCA’s expectations in respect of disclosure. The
variety of business models means that mandating prescriptive standards would be challenging if not
meaningless but more details of good and bad practice would help the industry.
We would also not object to a requirement that platforms consistently display key metrics in a
prominent position on their website to aid customer assessment and comparison.
Q9: Are our current financial promotion rules for loan-based crowdfunding promotions
proportionate? If not, can you please provide examples?
We think CONC could be updated to make it clear to platforms that they also need to apply COBS 4
when considering financial promotions. Firms without advisors, or who are new to the market, may
well miss this.
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Q10: Is our approach to online and social media promotions proportionate? Do you have any
suggestions as to how to improve our rules or approach on promotions?
We consider online promotions to be an area in need of new thinking as part of the FCA’s
commitment to competition and innovation in financial services. With consideration given to how
investors behave online, we think real improvements could be made without consumer detriment.
A review of how standalone compliance is interpreted in limited character forums like Twitter would be
of particular value.
However, the problems with promotions via social media are true across the whole of the financial
services market. While we would welcome a review of the rules, any improvement should be
available to all businesses communicating with consumers online.
Q11: Should we require loan-based crowdfunding platforms to assess investor knowledge or
experience of the risks involved? What would a proportionate requirement look like?
We have taken a number of investment-based firms through the process of implementing an
appropriateness test. Despite initial concern from those firms when the obligation was brought in,
overall they have found the presence of a test to be a positive.
There is no doubt, that in the world of ecommerce, every click that an investor is asked to make is
likely to deter them from moving to the next stage in a user journey, but there is also added comfort of
having asked investors to prove that they understand the risks.
It is our view that appropriateness could be useful for some of the more complex loan-based
crowdfunding models, but we would also highlight that there is no need for this to be an onerous step
in the user journey and, particularly as the FCA is not constrained by MiFID, it would be useful for the
FCA to confirm that the step should be proportionate to the risk of the lending model.
Q12: What effect do you think loan-based crowdfunding has had on competition in lending and
investment/savings markets?
The report from NESTA and the University of Cambridge highlights how much improvement there has
been in access to finance as a result of the sector. As this is still a small proportion of overall lending
activity but is serving a valuable purpose, we hope that the position of the regulator after the review is
that the industry should continue to be supported.
Q13: Where do you think regulations could be amended to increase confidence in loan-based
crowdfunding markets, encourage the development of the markets in the interest of
consumers or increase competition by removing uneven playing fields?
The most uneven playing field is currently being created by the authorisation process. At present
there are a few players able to operate the Innovative Finance ISA because of the delays. Equally,
firms with interim permission are less hampered by the delays, particularly if they are well-capitalised,
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while firms who did not obtain interim permission are unable to operate until the FCA processes the
application.
We need a clear view from the FCA on the following things:
Provision funds – does the consumer benefit of putting these in place outweigh the risk of
consumers believing their funds are protected. If it does, or if this risk can be properly
managed, will the FCA take a view that running a provision fund amounts to an additional
regulatory activity, in which case firms may be put off from providing them.
Living will – do the rules around the living will work sufficiently well in practice or now that the
complexities are fully realised, does the FCA need to review whether the policy is actually
proportionate now that the complexities are fully realised,. Any question of proportionality
should bear in mind how little is asked of other financial institutions, above and beyond
holding the right capital requirements.
Auto-lending / auto-diversification – can the FCA get sufficiently comfortable of the benefit
that the test provides in helping investors to spread their risk and in what circumstances does
the FCA consider that such a service requires additional regulatory activities.
Pre-funding – we need HM Treasury to revise the wording in article 36H so that the FCA can
get comfortable that loans which are pre-funded and then reassigned are P2P loans.
Q14: Do you have any comments on the resolution plans of firms operating loan-based
crowdfunding platforms?
This is topical as the FCA authorisation process is currently looking in great detail at Living Wills.
Greater guidance on what is acceptable is urgently required.
The complexities in balancing regulatory requirements and insolvency law may not have been
foreseen when the requirements in SYSC 4.1.8 were drafted. It is incredibly difficult at present for
firms to work out what is an acceptable resolution plan, and feedback from the FCA’s authorisation
team is insufficiently precise for firms to be able to find a solution.
Some of the feedback also does not stem from the rules and seems flawed. For example
suggestions that a living will provider needs to have article 36H permissions or to have capital
resources commensurate with those of a loan-based crowdfunding platform operator. While there are
alternatives to a living will provider set out in SYSC, we understand that it is hard to implement these
in a way that is consistent with insolvency law.
We feel very strongly that the living wills rules should not be used as a barrier to market entry while
the FCA works out a workable policy. This is a protection that is unique to loan-based crowdfunding,
and consumers will not be losing protections they are accustomed to having in any period whilst firms
operate under procedures the FCA is not fully happy with.
Q15: Are there any other matters we should take into account in the post-implementation
review of loan-based crowdfunding?
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It has been particularly disheartening to watch platforms stuck in the authorisation process, receiving
mixed messages about when they will be authorised and being subject to more and more rounds of
questions as the FCA picks on new themes.
We understand the need for the FCA to properly vet applicants, but it must take a proportionate view
and remember that it can continue to assess firms once they have been authorised. Essentially policy
and supervisory work is being done through the process, while firms are held back from conducting
any business or being able to fully launch.
Given the length of time that has passed, it is understandable that platforms’ business models have
changed with time, adapting to changes in the market generally.
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Investment-based crowdfunding
Q16: What other market developments should we take into account in our review of the
investment-based crowdfunding sector?
The offerings on crowdfunding platforms are no longer just idea-stage and early–stage businesses.
More mature businesses, and even listed assets, are choosing crowdfunding, now the regime and its
benefits are more established. In addition, there has been a significant growth in the property
investing through crowdfunding.
There have already been some noteworthy exits, although given the nature of venture capital
investing, we would expect exits to be the exception for another year or two.
The increasing participation of venture capital firms and business angels indicates that there are
quality investments available through crowdfunding platforms.
We have observed instances where financial promotions and other rules are not being met by a small
number of players, and are concerned that this taints the rest of the sector. Prompt action using the
FCA’s general supervisory or product intervention powers would be welcomed, as a way to both
protect consumers and the reputation of the industry.
Q17: Do you have any comments on the management of conflicts of interest on investment-
based crowdfunding platforms?
The duty to manage these conflicts already applies through SYSC, COBS and PRIN and, to date, we
have seen no evidence that investment-based platforms are failing to meet these existing obligations.
We agree, however, that it is a positive step to raise awareness of the conflicts amongst platforms.
There are a variety of mechanisms used by the industry to mitigate this risk including the use of fee
deferrals, contractual provisions and co-investment to align interests more closely. We are not aware
of any evidence of increased volumes leading to lower due diligence standards or the mishandling of
conflicts.
Q18: Do you have any comments on current due diligence standards for investment-based
crowdfunding platforms?
In terms of due diligence, consumers currently have the choice between highly curated platforms,
platforms that take on a purely intermediary role and many in between. As long as the role of the
platform is made clear to investors, we see no regulatory issue with this.
The fact that there have been some business failures does not mean that due diligence (DD) is poor.
Venture capital investing carries risk and this is why the on boarding processes that we have been
involved with have crafted appropriateness test that require investors to prove that they understand
what is involved.
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Due diligence will vary from platform to platform, and deal to deal. Mandating standards of due
diligence would be challenging indeed, and are unlikely to be effective in practice. That is why
transparency and investor understanding are key areas for platforms to focus on.
We also note a link between DD standards and financial crime. All platforms are subject to the same
anti-money laundering and counter terrorist financing rules as any other investment firm. Certainly
the financial crime training and processes we use with crowdfunding platforms, is at the same level as
for the venture capital and corporate finance industries, with changes mainly reflecting the online
nature of the business.
Q19: What do you think of the current client assessment standards on investment-based
crowdfunding platforms?
The standards we see are high. We get a lot of comfort from how tailored appropriateness tests are
to the risk of the investments shown on a platform and the fact that the investor is essentially proving,
rather than declaring, that they understand the risk. Between this and the user friendly way platforms
communicate risk to their clients, we think there are some fantastic examples of good practice in the
investment-based crowdfunding industry.
PS 14/4 did not require policing of self-certificates and in fact the verbal message we received from
the FCA at the time of the new rules being implemented was that it was not necessary. Instead the
emphasis was placed on devising a meaningful appropriateness test and a user journey that was
compliant at every stage. In our view this arrangement is the most valuable in ensuring that products
end up in the right hands.
Q20: What do you think of the current standards of information disclosure on investment-
based crowdfunding platforms?
We are unaware of any consumer complaints or other indications of poor practice when it comes to
disclosure. The combination of the disclosure, financial promotions and the appropriateness rules,
seem to deliver the result where people understand the risk they are taking on when crowdfunding.
Q21: Should we mandate the disclosure of risk warnings in relation to non-readily realisable
securities held within Innovative Finance ISAs?
We consider that if risk warnings are to be applied, they should apply at the point of establishing the
wrapper rather than the underlying investments and it should be applied to all IFISAs to avoid
consumer confusion. The risk warnings should be determined by the ISA provider based on the
investments they are allowed to put within the wrapper.