Financial Conduct Authority to crack down on crowdfunding

BI Intelligence

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The UK's Financial Conduct Authority (FCA) issued its first crowdfunding regulations in 2014, but gave itself two years to review those rules and determine if they remained adequate for the nascent industry.

Following a call for input in July 2016 to launch its post-implementation review, the FCA published its findings on Friday. Its general conclusion is that, given the problems it has identified in the crowdfunding sector, its rules have to be revisited and made more stringent to protect consumers and investors. 

The review, which examined both investment- and loan-based crowdfunding, identified several concerning characteristics of the current market: 

• Poor customer communication and disclosure. In both categories, the FCA found that companies do not effectively explain how their products work, making it hard for investors to assess risks and returns. Pressure to retain customers has also led several companies to conceal underperformance. 
• Conflicts of interest. A lack of internal communication has led to conflicts of interest in some companies. For example, several were found to have given preferential treatment to lucrative institutional investors at the expense of others. 
• Unauthorized risk-taking. Several companies have expanded into investment management and banking activities to remain profitable, without adequate expertise or authorization. In addition, a number of platforms allow cross-investment, i.e. investment in loans on third-party platforms, exposing themselves and investors to potential third-party failures. 
• Weak wind-down plans. Many loan-based platforms, specifically, do not have wind-down plans robust enough to enable them to continue servicing existing loans in the case of failure, which endangers both investors and borrowers. 

The FCA has outlined a number of rule amendments it will consider. These include demanding more robust wind-down plans, instituting “more prescriptive” rules on the content and frequency of company reports to increase transparency, and enacting more limits on cross-investment. In addition, the regulator will look into introducing investment caps to protect consumers and consider extending existing mortgage-lending rules to loan-based platforms. 

This crackdown is a marked departure from the UK regulator's liberal attitude toward the fintech sector. The UK government is often commended for proactiveness in introducing fintech-specific regulation, which gives fintechs more room to experiment than legacy players. Given this reputation, the FCA's proposed plans to increase stringency and extend mortgage-lender regulation to startups will likely take many fintechs by surprise.

And it is possible that a less liberal regulatory framework might at least temporarily stifle the crowdfunding sector. On the other hand, however, investors have recently shunned the sector due to concerns over weaker performance and political uncertainty, so stricter oversight might reassure both consumers and investors, helping the sector with customer acquisition and loyalty in the longer term.

Fintech regulations in the U.S. have been extremely restrictive thus far, but those in Europe have proven successful and allowed the region to become a hub of financial technology innovation. The U.S. would be wise to examine the policies in place across the pond and consider how to implement similar ones within its own borders.

The fintech industry is booming, with VC-backed fintech investment growing 106% to reach £10 billion ($13.8 billion) in 2015. But the new business models fintechs are bringing to market also need to be regulated, and the old models aren't sufficient. The approach regulators take will have a significant impact on how big fintech gets and how fast it gets there.

Sarah Kocianski, senior research analyst for BI Intelligence, Business Insider's premium research service, has compiled a detailed report on fintech regulation that explains how regulators in Europe are successfully growing fintech innovation and how it's becoming a model for regulators around the world.

Here are some of the key takeaways from the report:

• The financial technology sector is booming, and Europe is a leading region for growth. VC-backed fintech companies in Europe raised £1 billion ($1.5 billion) in funding across 125 deals in 2015.
• With this boom in funding comes a need to regulate the nascent industry. There are a variety of approaches — active, passive, and restrictive — that regulators can take. The EU and the UK, in particular, have taken an active approach, in order to encourage growth.
• The regulation that will have the most impact on the European fintech market is the Second Directive on Payments Services, known as PSD2. It will force banks to open up their systems to fintechs. This will allow fintechs to act as intermediaries between banks and their customers.
• The UK regulator is actively promoting its approach to regulation as a model for other countries to follow. Some of its innovations are already being copied by other regulators around the world.

In full, the report:

• Examines the different approaches to fintech that regulators can take
• Explains the key EU laws that will affect the European financial services industry in the next two years and beyond
• Explores the potential impact of new regulations
• Details the workings of the initiative central to the UK regulator's approach to fintech
• Highlights what can be achieved when regulators, governments, and fintech companies work together

To get your copy of this invaluable guide, choose one of these options:

1. Subscribe to an ALL-ACCESS Membership with BI Intelligence and gain immediate access to this report AND over 100 other expertly researched deep-dive reports, subscriptions to all of our daily newsletters, and much more. >> START A MEMBERSHIP
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