The FCA recently released CP13/13 – it’s long awaited Consultation Paper on crowdfunding.
This isn’t the only pertinent consultation process taking place at the moment. The regulator has also issued CP13/10 which outlines its proposed consumer credit regime and touches upon crowdfunding from the borrower’s perspective.
In addition, CP13/5 proposes changes to the CASS client money rules that will now be relevant for some platforms if these new regulations come into force. The EU and the US are also currently preparing their regulatory response to the growth of crowdfunding.
CP13/13 What’s right with it?
Well, firstly it is right that the crowdfunding sector should be regulated. It’s small, but growing in popularity and gets a lot of media coverage. It’s also incredibly easy to access and invest – there are far fewer barriers than there would be for traditional investments. And many of the investments are high risk.
So it couldn’t be ignored any longer and the FCA is right to step in. Hopefully one benefit on regulation will also be increased consumer confidence.
I also think the FCA has got the broad thrust of its proposals right. Minimum prudential standards, rules on holding client money, rules on the resolution of disputes, reporting pertinent information to the FCA, rules around disclosure of information and a stipulation that a process must be in place to ensure that client’s investments will continue to be managed in the event of a platform failure all make sense. These proposals will ensure best practice is followed across the crowdfunding sector and bring it into line with the rest of the saving and investment industry.
It was also great to see the FCA recognise the value of advice in CP13/13 as one of it’s key proposals.
CP13/13 What’s wrong with it?
All of that said, I do think there is something of an inconsistent approach from the FCA here. It seems there is an inbuilt bias that favours mainstream, listed investments in the public markets – despite evidence that these can sometimes be poor value and poor performers.
For example, in Annex 1 paragraph 32 of CP13/13, the FCA is implying that irrational investor behaviour might lead to sub optimal investment decisions – surely something that applies to any investment market.
The three irrational biases they highlight (overconfidence, anchoring and herding) occur all the time in many, many decisions we make (not just investment based decisions).
CP13/13 also suggests that approximately 5 per cent of funds are ‘mis-invested’ on crowdfunding platforms. I would be very interested to know what the equivalent figure would be for stock market or fund based investments – I’m sure a much higher percentage of funds are mis-invested by people following the latest flavour of the month or suffering from one of the behavioural biases highlighted above.
CP13/13 also picks out platforms for improved disclosure of information to clients on their websites. Of course this right and a positive step.
But taking platforms to task for quoting levels of return without including the impact of charges or taxes again seems a little inconsistent – many fund based investments will quote performance gross of fees and tax. So it’s a good step – but let’s apply it to the whole investment and saving industry.
CP13/13: When is advice needed?
This is a little unclear due to the wording of CP13/13. In the summary of their proposals, they state that the direct offer financial promotion of unlisted shares or debt securities (investment based crowdfunding) will be restricted to 4 categories of clients including:
- Retail clients who confirm that, in relation to the investment promoted, they will receive regulated investment advice or investment management services from an authorised person
However, in the detail of the proposals (para 4.16) they change this to:
- Retail clients who confirm before a promotion is made that, in relation to the investment promoted, they will receive regulated investment advice or investment management services from an authorised person
It’s only a subtle difference, but it could have an impact. As CP13/13 states, crowdfunding platform websites are classed as direct offer financial promotions. Therefore, if the second wording of the client category applies, crowdfunding platforms may need to introduce a step on their website to qualify clients and assess their appropriateness before they start researching the information on the site.
How practical this will be is debatable and it may be one of the elements that puts up a barrier to the ‘crowd’ who want to be involved in crowdfunding.
CP13/13 is a step in the right direction and a significant milestone for the crowding industry.
The FCA deserves praise for recognising the need to allow this sector to develop, reach its full potential and hopefully provide a healthy challenge to the incumbent intermediaries, rather than over-regulating and shutting the crowd out of crowdfunding. However, there is still work to do.
Daniel Kiernan is director at Intelligent Partnership Daniel will be speaking at the Alternative Investment Summit on 27 November