In March 2014 the FCA issued it's Policy Statement, entitled 'The FCA's regulatory approach to crowdfunding over the internet, and the promotion of non-readily realisable securities by other media'.
"Non-Readily Realisable Security": unlisted share or unlisted debt security.
In this article we aim to give a very brief overview of some of the final rules, which came into force on 1 April 2014.
The rules apply to:
> Firms operating peer-to-peer or peer-to-business lending platforms (loan-based crowdfunding platforms) on which consumers can invest in loan agreements
> Firms operating investment-based crowdfunding platforms on which consumers can buy investments, such as equity or debt securities that are not listed or traded on a recognised exchange, or units in an unregulated collective investment scheme
> Firms that use offline media to communicate direct offer financial promotions for non-readily realisable equity or debt securities to retail clients, and firms that approve such promotions.
The new rules are relevant to the marketing of retail mini-bonds and other similar investment offers.
Where retail clients receive regulated advice or investment management services in relation to non-readily realisable securities, or are corporate finance contacts or venture capital contacts, the policy statement is not relevant.
The new regime focuses on these main areas in particular:
1) New minimum capital requirement in place for firms operating the online platforms;
2) Firms operating loan-based platforms are required to have arrangement in place so that existing loans continue to be administered in the event of platform failure; and
3) Marketing restrictions to Ordinary Retail Investors (and appropriateness testing).
1) Capital Requirements
The regulated activity of operating an electronic system in relation to lending sees new client money protection rules imposed in relation to loan-based crowdfunding platforms. For those covered by this new system, the new volume-based financial resources calibration requirement will be:
> 0.20% of the first £50 million of the total value of loaned funds outstanding;
> 0.15% of the next £200 million of the total value of loaned funds outstanding;
> 0.10% of the next £250 million of the total value of loaned funds outstanding; and
> 0.05% of any remaining balance of the total value of loaned funds outstanding above £500 million.
Loan-based crowdfunding is a type of investment activity, so should be subject to the rules for investment purposes. Where a firm operates a 'pledging model' the firm will still need the FCA permission to hold client money, even if it is only held for a short time before passing it on to the borrower.
The FCA is also introducing reporting requirements for firms running loan-based crowdfunding platforms from 1st October 2014.
2) Firms operating loan-based platforms are required to have arrangements in place so that existing loans continue to be administered in the event of platform failure
If the firm operating a platform fails, to avoid difficulty for investors, existing loans must still be administered. With some platforms, some investors do not know the identity of the borrowers they have lent money to and an investor's stake in a particular loan may be small, so it may not be economic to chase missing payments. These factors may encourage borrowers to default on loans leading to investor losses. It is therefore proposed that firms have arrangements in place to ensure that loans continue to be administered if the firm running the platform goes out of business.
3) Marketing Restrictions
For investment-based crowdfunding, the FCA aims to provide ordinary retail investors, who may lack the knowledge, experience and resources to understand and cope with the risks, with both the freedom to invest and proportionate protection when they are invited to invest in non-readily realisable securities that involve potential for significant capital losses.
The aim of the new rules is to mitigate the liquidity risk that investors face when investing in the equity or debt securities of small and medium enterprises which are difficult to price and for which there is no, or only a limited, secondary market.
Direct offer financial promotions should only be promoted to certain types of investor:
> Professional clients; or
> 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; or
> Retail clients who are venture capital contacts or corporate finance contacts; or
> Retails clients who are certified or who self-certify as sophisticated investors; or
> Retail clients who are certified as high net worth investors; or
> Retail clients who certify that they will not invest more than 10% of their net investible financial assets in unlisted equity and debt securities.
In relation to loan-based crowdfunding, the Regulated Activities Order and Financial Promotion Order have been amended to include Article 36H agreements within the scope of the rules; so the websites and details of loans will be considered to be financial promotions subject to the FCA rules.
Note that as an established regime already applies to packaged products, and legislative and regulatory restrictions already apply to promotions for non-mainstream pooled investments (NMPIs), including unregulated collective investment schemes (UCISs). Therefore, there is no need for the definition for non-readily realisable securities to include such products.
In line with MiFID provisions, before arranging deals in certain complex financial instruments for retail clients who do not receive advice, firms are required to assess whether the client has the necessary experience and knowledge to understand the risk involved.
The proposed rule allows this to be carried out either by the firm which promotes the investment or by the firm arranging the sale, and either before promotion or before sale.
You may also be interested in reading:
Mini-bonds - An alternative funding solution
Pure FS Support will manage and coordinate your financial promotion process ensuring that you adhere to the rules imposed by the FCA. See more about our financial promotions services and we
look forward to discussing your requirements with you. Our contact details can be found here.