Overdue Reform of the UK Consumer Credit Act

The Treasury is consulting on a long overdue overhaul of the Consumer Credit Act 1974 (CCA) which covers the UK’s £200bn non-mortgage consumer credit industry, including personal loans, credit cards, hire purchase and pawn-broking. I'm waiting on publication of a longer note summarising the detail, and will post a link to that here. You have until 17 March 2023 to respond. Let me know if I can help you in understanding the proposals and likely impact. 

Brexit

As previously mentioned, the current consultation was actually proposed in June, just prior to the European Commission proposal for a new Consumer Credit Directive (CCD2).  Extensive changes were made to the CCA in 2010 to implement CCD1, which had considerable input from the UK. 

Supervision of the CCA transferred from the Office of Fair Trading to the Financial Conduct Authority  in 2014 under the Financial Services and Markets Act 2000 (FSMA). This meant adding consumer credit and hire agreements, and related activities, to the FSMA (Regulated Activities) Order 20012 (RAO); and transferring some CCA regulations to the FCA’s rules. The Treasury now wishes to transfer “the majority” of the CCA to FCA rules, which seem likely to align with CCD2. 

Some aspects that are specific to Scotland and Northern Ireland will be addressed later in the review process.

Scope and Impact

The CCA regulates consumer credit and consumer hire, although the latter has less protection. The government has already announced plans to regulate many Buy-Now Pay-Later (BNPL) products that are currently unregulated. 

Broadly, the activities of entering into regulated credit and hire agreements require FCA authorisation and specific permission when carried on by way of business, as do the activities of exercising the rights of a lender (or owner, for hire purposes) and various ‘ancillary services’ such as credit broking, debt collection, debt counselling, debt adjusting, debt administration, operating an electronic system in relation to lending (peer to peer lending), credit information services. 

Advertising credit and hire products is also regulated, even for unauthorised firms. 

The FCA’s new Consumer Duty does not apply to unregulated or exempt individuals or products in the same way as the CCA regime, but that new duty changes the context in which the CCA protections operate; and makes authorised firms liable for certain activities of unauthorised firms in the product 'distribution chain'.

About 6,000 authorised firms have permission to enter into consumer credit or consumer hire agreements; and 36,000 FCA firms have credit permissions (mainly credit broking). 

I will update this post with a link to the more detailed note shortly.

Tougher Marketing Rules For FinTech Investments In The UK

The Financial Conduct Authority is consulting on tougher rules for the marketing of 'fintech' investments, including investment based‑crowdfunding, peer‑to‑peer (P2P) lending, other 'non‑readily realisable securities', non‑mainstream pooled investments (similar to unlisted investment funds) and speculative illiquid securities, as well as cryptoassets (when proposed Treasury regulations bring them within the financial promotions regime). The consultation ends on 23 March 2022. Firms will have 3 months to comply from publication of the final rules (cryptoasset changes will apply from the date when the Treasury changes apply). Based on experience in the P2P lending sector, the impact is likely to be severe, effectively restricting consumers to bank deposits and expensive listed instruments while shielding incumbent banks and investment firms from competition.

Classification of high‑risk investments.

The FCA intends to divide its rules into those that apply to ‘Restricted Mass Market Investments’ and those that apply to ‘Non‑Mass Market Investments.’ They have not yet applied their Speculative Illiquid Securities rules but may do so later in 2022. 

Consumer journey 

The FCA proposes to strengthen risk warnings and appropriateness tests, ban inducements to invest, introduce positive 'friction' in the investment process to give consumers a chance to reconsider their commitment and 'improve' the classification of different types of clients. 

The role of firms approving and communicating financial promotions

There will be a regulated 'section 21 gateway' for firms who approve financial promotions to ensure those firms have relevant expertise in the promotions they approve and that the quality of financial promotions is high. 

Qualifying cryptoassets

The Treasury is still considering its definition of cryptoassets for these purposes, but has indicated that a ‘qualifying cryptoasset’ for UK financial marketing rules will be "any cryptographically secured digital representation of value or contractual rights which is fungible and transferable," excluding otherwise regulated investments, e-money and fiat money, Non-fungible tokens (NFTs) and tokens that operate like gift cards/vouchers with 'one or more vendors or merchants in payment for goods or services'.

The FCA intends to generally apply the same rules to cryptoassets as currently apply to ‘Restricted Mass Market Investments’ (Non‑Readily Realisable Securities and Peer‑to‑Peer lending agreements), but would not allow ‘Direct Offer’ Financial Promotions of qualifying cryptoassets to be made to self‑certified sophisticated investors. New rules aside, financial promotions relating to cryptoassets will also need to comply with existing financial promotion rules, including the requirements for the promotion to be clear, fair and not misleading.

Controlled activities

The UK regulations (Financial Promotion Order) specifies a series of 'controlled activities' that are the main business of firms who deal in 'controlled investments'. Of those activities the government considers that only some are relevant to qualifying cryptoassets and most associated with misleading cryptoasset promotions seen by the FCA:

• dealing in securities and contractually based investments;
• arranging deals in investments;
• managing investments;
• advising on investments;
• agreeing to carry on specified kinds of activity.

The government had considered whether to add to this list activities relating to the provision of cryptoasset exchanges, cryptoasset ATMs, 'airdrops'; as well as cryptoasset lending (where firms take cryptoasset ‘deposits’ and pay ‘interest’ from the income received from cryptoasset borrowers); and 'DeFi platforms' (decentralised apps or 'dapps' which are not controlled by a central authority and use a series of smart contracts to automate peer-to-peer lending, peer-to-contract lending, borrowing or trading with financial instruments on a permissionless network, e.g. to enable users to earn interest on their tokens by connecting token holders to other borrowers). However, the government believes these activities could well be covered by the above set of controlled activities - so it is not to say those activities are exempt merely because they are not specified. 

In addition, the exemptions that currently only apply to activities relating to insurance and deposit taking; and marketing unlisted securities to certified high net worth individuals and self-certified sophisticated investors will not apply to qualifying cryptoassets.

Impact

The FCA's clear intention is to dampen enthusiasm for certain investments, particularly cryptoassets, among investors who don't understand what they are investing in and/or cannot afford to lose the amount they invest. The FCA explains it this way:

A key part of the strategy is addressing the harm from consumers investing in high‑risk investments that do not match their risk tolerance. This can lead to unexpected and significant losses for consumers and undermine wider confidence in investments, making it harder for all firms to raise capital. We do not want to unnecessarily restrict consumers who want to invest, but we want them to be able to access and identify investments that suit their circumstances and attitude to risk.

As ever, the concern must be that regulated firms and consumers facing these hurdles will be shut out of the markets for innovative products (as has happened with P2P lending). That would leave consumers with low return savings accounts and 'safe' listed products that have both high fees and low returns; and favour incumbent banks and investment firms over new market entrants.

In the UK, at least, there does not seem to be any middle ground... rather like our politics.

 

EU Regulation of Cross-border Crowdfunding Services

The EU Parliament is about to adopt a crowdfunding regulation that will enable 'European crowdfunding service providers' (ECSPs) to help businesses raise funding directly from investors across the EU more easily than they can today. The regulation calls for the related funds flows to be handled under payment services regulation, and adds operational and prudential requirements related to lending and investment in securities. I have covered the regulation in more detail for Leman Solicitors in Ireland, as the EU regulation will be of little use to UK-based platforms owing to Brexit and the end of passporting, even where the regulation applies.

Since helping start Zopa, the first peer-to-peer lending platform, in 2005 I've acted for many peer-to-peer lending platforms and some crowd-investment platforms in the UK, as well as advising in relation to e-money and payment services since 1999. If you have plans in this area, please get in touch.

 

Brussels Proposes Free Movement For Crowdfunding

The European Commission has proposed a crowdfunding regulation that would enable cross-border peer-to-peer business lending and investment-based crowdfunding. Rather than interfere with national regimes, the regulation is intended to enable platforms to apply to ESMA for an EU "label" or right to operate throughout the EEA on conditions that are more proportionate than some of the harsher national regimes (e.g. those applying MiFID). 

The regulation would not apply to platforms that facilitate consumer loans/mortgages or donation/reward-based crowdfunding, or to platforms that are already authorised as investment firms. There would be a limit of €1m on the total amount of each fundraising.

The Regulations would require effective and prudent management; complaints handling; management by people with appropriate skills and professional experience; the detection and prevention or management of conflicts of interest. There are also rules on outsourcing and client asset safeguarding. There would need to be an initial appropriateness assessment for each investors, and a "key investment information sheet" for each investment opportunity. Communications would need to be "clear, comprehensible, complete and correct." Secondary trading would need to occur via a "bulletin board" on the platform rather than a "trading system".

It is not clear when the Regulations might be made final, but they would take effect just over 12 months after publication.

All very much academic for UK-based platforms, fundraisers and investors if Brexit goes ahead...

P2P Lending Goes Global: FinTech Credit v OldTech Credit

Twelve years after the launch of Zopa and the peer-to-peer finance sector finally gets its first report from the Bank of International Settlements (BIS), the central bank of central banks. The report is surprisingly positive, given financial regulators' preference for the status quo. Basically, they believe that change increases risk and increased risk is bad, so innovation is both risky and bad. Similarly, they're fond of shoe-horning innovative services into existing regulatory frameworks without seeing that the innovation may itself be exposing and/or solving flaws in that system. At any rate, the banking situation must be pretty dire for the industry's global beacon to produce a positive report on alternatives...  But in the the interests of time I want to ignore the positives and answer a few criticisms:

Is P2P lending "procyclical"?

No.

In fairness, the BIS report only suggests that P2P finance represents the "potential for ...more procyclical credit provision in the economy", but I still disagree that this is a feature of the model.

Bank lending itself is procyclical, which is to say that banks lend lots of money when the economy is booming, yet try to protect their balance sheets when times are tough and we need credit the most. In fact, this was such an alarming feature of the recent/current financial crisis that BIS itself introduced capital rules that it thought would force banks to become less procyclical. Recently, moreover, the BIS's own Basel Committee reported that these rules are proving ineffective. They think there is too much bank credit available and/or the quality of creditworthiness is in decline.

If that's the case, then we really are in trouble, since UK banks have been lending progressively less to real businesses, and we aren't exactly in the grip of an economic boom...

Compare this to the rise of P2P lending. We started Zopa in 2005 when the 'spread' between high bank savings rates and cheap credit was actually very narrow (heavily subsidised by PPI revenues) - yet proved that lending directly between humans without a bank in the middle produced a better deal for both lenders and borrowers. This is why P2P lending has become ever more popular since 2008, while banks have sat on the sidelines waiting for the good times to roll. Lenders get higher interest on their money, diversify risk by lending to lots of people and businesses who are starved of bank loans - apparently leaving the banks with leaner opportunities...

But I believe the banks have simply chosen to chase higher yielding loans and other assets because their cost base does not allow them to make money serving the better risk customers.

Indeed, the BIS report acknowledges that banks have "left room" for platforms that enable people to lend directly to each other "by withdrawing from some market segments" after the financial crisis (which, I'd like to emphasis, still hasn't ended).  The report notes that P2P lending equated to 14% of gross bank lending flows to UK small businesses by 2015... only 5 years after the launch of the first P2P business lending platform.

So, P2P finance is actually counter-cyclical by its very nature.

The real issue, perhaps, is what happens when banks start being able to offer better interest rates and cheaper loans. Yet Zopa's early experience shows the new platforms will still be able to compete successfully (especially because those PPI cross-subsidies are no longer available: refunds and compensation have now reached £26.9bn, according to the FCA!).

Is it likely there will be a 'run' on P2P lending?

No. Far from seeing a potential 'run' on P2P lending platforms by lenders trying to get their money out, many platforms are seeing excess lender demand due to continuing low yields on bank deposits (not to mention high fees on investment products). Zopa, for example, has been closed to new lenders for some months, even while seeing record borrower demand, yet still plans to offer P2P lending within Innovative Finance ISAs. Everyone is chasing yield, not just the banks. But, again, the early experience shows that the rates will still be more attractive if and when banks are able to offer higher rates to savers, because they need fatter margins than P2P platform operators.

Meanwhile, the P2P model has expanded from consumer and small business loans into car finance and commercial property loans. But so far the regulators have protected banks against head-to-head competition for other forms of finance, such as retail sales finance or mortgages, through lack of reform to arcane procedures dictated by consumer credit and mortgage regulation and refusing to allow longer term finance to be supported with short term loans - which banks are allowed to do all the time.

So, rather than a run on P2P lending, we're more likely to see successful P2P lending operators adding a bank to their group, at the same time as expanding their existing P2P offerings. In other words, a twin-track attack on Old Tech banks and banking models.

Will P2P lending help solve problems with banks' legacy systems?

No.

There's no doubt that this BIS report and the regulatory obsession with 'FinTech' generally, springs partly from regulators' fervent wish that OldTech banks will simply take advantage of the latest trend to rejuvenate their systems for the longer term.

But there are many reasons why established retail banks won't do that - and will continue to passively resist regulatory edicts to do so. That's why the UK government had to impose the open banking initiative (not to mention sharing business credit information and declined loan applications); why the Bank of England has opened up the Real Time Gross Settlement system; and why PSD2 regulates a new class of  third party 'account information' and 'payment initiation' service providers.

Why won't the banks renew their legacy systems to save themselves? For starters, they don't actually have legacy "systems" so much as separate bits of very old kit connected manually by employees holding hands with electrical chord between their teeth using their own spreadsheets. So the shiny new government-mandated open banking interfaces will likely be connected to computers that aren't really party of any type of integrated "system" that, say, a Google engineer might recognise.

Aside from that insurmountable IT challenge, bank management teams are simply not incentivised or empowered to think about the long term, and all their key decisions are made (after a very long time) in committee to avoid personal blame.

So it's more likely that the aspects of 'banking' which are within the scope of P2P lending will gradually drift away from banks altogether, while activities outside that competitive scope will need to be reinvented by others, including new banks, from the ground up.

Will traditional banks launch their own P2P lending platforms?

Probably not.

Some have bought shares in such platforms and others have actually lent their own funds on P2P lending platforms. But that's a long way from allowing their depositors to lend directly to their borrowers.

That's because bankers make their money by keeping savers and borrowers separate of each other and treating deposits as their own funds. 

It's high time regulators admitted this to themselves and got on with the job of supporting more transparent, fairer mechanisms for allocating people's spare cash to other people who need it.

Is P2P lending an "originate-to-distribute" model?

No.

Here, again, P2P lending is a reaction away from this type of model and is transparent enough to reveal attempts to introduce it. BIS says that "originate-to-distribute" refers to the fact that neither the primary lender nor the operator of the platform retains any ownership or interest in the loan that is agreed. But this does not fully describe the model or its potential hazards.

The "originate-to-distribute" model may have that basic feature but the point is that it's driven by a market for secondary instruments (bonds and other derivatives) that are based on underlying loan contracts, where demand in that secondary market has outpaced the supply of loans. In that case, loans may start to be originated solely to support the secondary market. This transpired in the context of the sub-prime mortgage crisis, where investment banks arranged bond issues in a way that effectively concealed the poor quality of underlying loans. From their own problems with undertaking due diligence, they knew that the underlying loan data was hard to find and in many cases unreliable (hence the related 'fraudclosure' issue of investors foreclosing on mortgages they could not prove they owned). That's why the banks involved have since been paid billions in fines and compensation towards the repayment of bailouts (at least in the US).

But, as the name suggests, P2P lending - at least in the UK - involves a direct loan between each lender and borrower on the same platform, where the data concerning the loans is available to the participants, including lenders who may receive assignments of loans already made on the same platform. The visibility of the loan performance data and reputational impact for the platform operator if all goes wrong limits the temptation to conceal the original credit quality or performance of the loan.

So, BIS's assertion that P2P lending represents the same model or suffers from the same potential for moral hazard is not right.

It is possible for a lender to ask a P2P platform to provide it with access to some less creditworthy borrowers to achieve a higher overall yield, perhaps even with a view to selling the resulting loans to other lenders or even securitising them; but even if you deem that to be 'originate-to-distribute', the 'moral hazard' is not there because the data is readily available for all to understand the lesser quality or performance of the loan.

The BIS report cites the Lending Club 'scandal' in 2016. But, ironically, Lending Club is not based on a genuine P2P lending model at all, because the SEC refused to allow direct 'peer-to-peer' loans without full security registration requirements (just ask Prosper!). So the regulators forced the US platforms to operate the same securitisation model that the banks pioneered in the sub-prime crisis... We abandoned attempts to launch the direct P2P model in the US because this model is nothing new - as well as being cumbersome, convoluted and expensive. But even there the relevant 'scandal' was 'only' that when selecting a portfolio of loans to issue bonds to the relevant investor, Prosper selected some loans that did not meet the investor's specified criteria. Not great where the data is available, but the point was that the problem was spotted quite quickly because the relevant data was readily available, so the loans could be re-purchased by the issuer.  

The report also cites the problems at Trustbuddy, in Sweden, but the problems there were again detected early by new management looking at the collections data, who promptly alerted the authorities; and Ezubao, in China, which was a ponzi scheme operated between July 2014 and December 2015 that was detected quite quickly - certainly faster than Madoff's activities in the supposedly heavily regulated US investment markets.

It is worth acknowledging, however, that there is always scope for something to go wrong. This is why the UK P2P lending industry pushed for specific regulation of P2P lending from 2011; and highlights why regulators should stop their hand-wringing about innovation and get on with the job of adapting to change.

FCA Calls For Input On #P2Plending and #CrowdInvestment Rules

It's been two years since the FCA created specific rules governing peer-to-peer lending and crowd-investment in securities, and the FCA promised a review of those rules in 2016. That review has just begun with a call for input closing on 8 September. 

This comes at an important time for the industry, as the FCA's report reveals that it has only processed 9 of 97 applications for authorisation by P2P lending platforms (44 of which operate under a two year old interim permission) and only 9 firms have been authorised to join the 25 firms that were operating in the crowd-investment market during the FCA's interim review in 2015. This shows that the FCA authorisation process, and regulation itself, are significant 'choke points' in the development of innovative financial services, notwithstanding firm support for the sector from the Treasury and strong growth in supply and demand from consumers and small businesses on existing platforms. 

It remains to be seen whether the FCA will further complicate life for crowdfunding entrepreneurs and their customers or clear the regulatory path to facilitate the growth of alternatives to the declining supply of bank finance, likely to worsen post-Brexit...

EBA Sees #Payments Regulation As Best Model For #P2Plending - Updated

When the UK peer-to-peer lending industry began calling for proportionate regulation in 2011, we pointed to payments regulation as the ideal model. By the end of 2012, about 30 firms from across Europe signed an open letter calling for that approach to the regulation of crowdfunding generally. And that was the thrust of my response to the EC consultation on the topic. After all, these marketplaces are all basically payment platforms that enable the wallet-holders to agree to lend or invest money rather than just pay it. They have far more in common than there are differences.

Unfortunately, the UK authorities were determined to apply the existing investment rules to the P2P model, with consumer credit rules adapted to cover loans to individual borrowers and some small businesses. So instead of a dedicated set of regulations dealing with common operational risks among all platforms, with some extra rules to cover different types of instruments, we ended up with rules sprinkled all over the giant FCA Handbook.

Since then, however, the French have opted to apply payments regulation to P2P lending, and last week the European Banking Authority suggested a similar approach.

Of course, the additional attraction to payments regulation is that it is the subject of a 'maximum harmonisation' directive that allows for passporting throughout the EEA far more easily than under investment regulation.

If I were a betting man, I would put good money on the EBA's approach eventually winning out, with the real battle being fought over whether there should be any restriction on the amount that individuals should be able to lend [see update below]. The UK, France and Spain have each taken different approaches to this question. I'm glad to say that the UK has been the most pragmatic in recognising that platforms will struggle to generate enough liquidity without the possibility for some individual investors to lend significantly more than others to any one borrower, particularly in the SME lending markets. As I mentioned in the context of the recent European crowdfunding conference, my sense is that French and Spanish platform operators will realise this problem as they try to scale...

[updated as follows on 18 March 2015]

The battle over the restrictions around who should lend on P2P lending platforms, and how much, seems to flow from the mistaken belief by some authorities (the EBA included) that 'loans' are somehow 'debt securities'. Ironically, in its discussion of why investor type restrictions might be extended to simple loans, the EBA opinion underscores why that should not be the case - and indeed isn't the case in the UK.

For instance, in summarising the risks to lenders involved in P2P lending, the EBA, states (at para 28) that "the assessment of an investment opportunity requires a profound analysis as well as a thorough understanding of the project or business of a potential borrower." Yet making a loan does not equate to an 'investment' opportunity (and you would have thought that a banking regulator could fully elucidate the difference).

A loan is just a debt - which is a simple enough concept for anyone to grasp. It chiefly involves 'credit risk', not 'investment risk'; unlike bonds, for example, which are typically held for investment purposes rather than simply to earn interest (hence the focus on bond 'yields' rather than the interest rate or 'coupon').

The EBA later refers to the need for "explanations about a project, financing mechanisms and other investor education material", which also seems to misunderstand the straightforward nature of credit. Later still, the EBA states that P2P lending "usually means that lenders enter into loan agreements with a borrower which is, in many cases, a start-up enterprise." But that is certainly not the case in the UK, where such companies typically turn to equity investors who are looking for a share in the growth of a business, rather than simply the repayment of their capital plus interest. A subsequent discussion of "investment advice" and "investment recommendations" also highlights the EBA's mistaken assumptions about the essence of P2P lending. It's almost as if someone simply substituted "loan" for "equity" in a section about equity-based crowdfunding platforms.

This mistaken classification of lending as an investment is doubly ironic, given that the EBA is responsible for policy related to payments, banking, savings and loans and not securities (which is ESMA's territory). In fact, were it not for the EBA's view that payments regulation is the best fit for regulating the common operational risks of P2P lending, I would suspect the it of trying to limit competition with the banking sector by pushing P2P lending into the investment world. Yet, somewhat weirdly, when it comes to the section on credit risk the EBA suggests that platforms might be "required to cooperate with a bank, either in the way that the bank processes the assessments [of creditworthiness] on a professional basis or takes over any credit risk by contracting with each borrower directly." Which also ignores the fact, of course, that banks are busy walking away from the markets now served by the P2P lending platforms!

The EBA is also being somewhat disingenuous in suggesting that P2P lending platforms should carry out criminal records checks on borrowers - an extremely time-consuming, personally intrusive and costly process that not even banks are required to undergo when making loans. Compliance with anti-money laundering regulations, PEP/sanctions screening and membership of industry anti-fraud databases are adequate and proportionate controls for screening borrowers. Likewise, P2P lending platforms do not represent any greater source of risk to a lender's personal data than many other types of business, and data protection law should govern this type of risk, as it already requires appropriate IT and information security controls.

Overall, one is left with a nagging concern that, while it has made the best choice of regulatory frameworks for controlling the common risks associated with P2P lending, the EBA has not really engaged properly with the concept or the sector. Let's hope that changes soon.

A Short History Of The P2P Marketplace Model in UK Finance

During a recent panel discussion at the annual conference of the Society for Computers and Law, I explained briefly how the online peer-to-peer marketplace, pioneered by eBay in the US, came to be applied in financial services in the UK. The slides are here, and below is a slightly longer written explanation. Note that the focus is on the history, rather than explaining the differences between various types of 'crowdfunding'.

eBay pioneered person-to-person sales of second-hand items in the US from 1995, proving the concept to be hugely attractive. The particular "'Aha!' moment" came when people actually paid for the item they'd agreed to buy, not to mention the delivery of the item.

In 1999, the team at X.com (later PayPal) expanded the eBay model into payments by enabling consumers to pay each other using a credit card. This was rapidly adopted by eBay users (to the point where eBay eventually had to buy PayPal as a defensive measure). Coincidentally, in the same year it became clear to the entrepreneurs who had created PlusLotto, an online lottery in aid of the Red Cross, that the payment part of their system, which enabled people to prepay funds in many different currencies to centralised bank accounts then log-in to their data accounts or 'wallets' to purchase lottery tickets with the balance, should be made available to other merchants. They started Earthport as a separate payments provider the same year, and I was among those asked to join the board of the new entity. The initial strategy was to roll-out the wallet offering directly to consumers and merchants. But in 2000 we raised £25m through a private placement - literally weeks before the DotCom bubble burst - to fund a switch in strategy. The plan was to leverage the marketing budgets of banks, telcos and major Internet portals to offer own-branded wallets to their customers. Of course, those plans ran into the headwind created by the tech slump. But I'm happy to report that Earthport remains alive and well.

Meanwhile, in 2003, a team at artistShare in the US adapted the P2P payments model to enable music fans to donate money to fund musicians and music projects. The reason for this donation-based model of 'crowdfunding' was the need to avoid US securities regulation, which is notoriously rigid and complex, and applies expensive registration requirements even to very simple loans. The battle to liberate that regime continues to this day (see below).

At any rate, late in 2003, a small group of executives left Egg, the internet bank (which also happened to be one of Earthport's early customers), to try to reinvent financial services. During their brainstorming process, Dave Nicholson, suggested 'eBay for money' and the idea took hold. Coincidentally, they approached me in the summer of 2004 to see if I could help avoid any US-style regulatory problems. By the time we launched Zopa, the P2P lending platform, in March 2005 we had moved away from the idea of eBay-style 'auctions' to a more automated marketplace for personal loans. Borrowers and lenders had told us they did not want to reveal too much about themselves to each other, but were happy to give Zopa enough information to guard against fraud, assess creditworthiness and match their bids and offers to produce loan contracts directly between them.

 

In 2010, the team at FundingCircle applied the P2P lending model to the small business lending market. They also enabled direct loans between each lender and business entity. But to provide security for the additional risk of lending larger amounts to businesses, they introduced a separate entity that would hold security over the assets of the borrower in trust for the lenders. That trustee entity could then enforce the security on the lenders' behalf if the borrower defaulted under the P2P loans. Since then, this model has also been introduced to the commercial property sector.

It was only a matter of  time before the P2P marketplace model penetrated the investment world. In 2011, Crowdcube launched the concept of enabling many individual investors to finance unlisted start-up companies in return for shares. And a team that included Bruce Davis, an ethnographer who had helped develop both Egg's and Zopa's marketing propositions, launched Abundance Generation to fund alternative energy projects by selling long term debentures to retail investors who could use the returns to pay their own energy bills.

 

The same year, the Peer-to-Peer Finance Association was launched to call for proportionate regulation of the peer-to-peer lending sector.

 

Since 2011 many different types of P2P lending, crowdfunding and crowd-investment platforms have launched. Approximately 30 platforms signed a letter to EU and UK policy makers at a P2P finance policy summit held in London in December 2012, and many others have launched since.

 

In March 2014, the first FCA rules took effect which specifically regulate both peer-to-peer lending and crowd-investment. The EU has since convened a "European Crowdfunding Stakeholders Forum" to help determine whether there is scope for EU regulation to help develop the sector.

 

Clearly we are still witnessing the dawn of this trend. 

 

PS on the US:

 

While this post has focused on the UK, it is worth mentioning that we attempted to launch Zopa's P2P model in the US during 2006-07. However, it was clear from our own regulatory discussions, and the subsequent experience of Prosper.com, that the Securities Exchange Commission was determined to view simple loans as securities that require registration and intermediation using the same model that applies to more complex instruments. Zopa declined to launch that type of model, but it had to be deployed subsequently by Lending Club and Prosper (a similar version was also deployed by Prodigy Finance in the UK, due to the need to support international cross-border lending activity). Essentially, rather than agreeing loans directly with individual borrowers, investors buy bonds that are backed by loans made to those borrowers by a licensed lending entity. The lending entity sells the loans to the bond issuer, which distributes the loan repayments to the bondholders. While the JOBS Act was supposed to liberate crowdfunding in the US, the SEC has been less than enthusiastic in implementing it. Fortunately, UK regulators have been positively supportive and it's important to note that the SEC does not have any responsibility to promote innovation and competition, while the FCA clearly does. 

EC Support For Crowdfunding

The European Commission today published its communication on crowdfunding, following its consultation in 2013.

The EC proposes to facilitate, rather than regulate - a strategy I wish they would adopt in most areas. Specifically, it plans to:

• establish an Expert Group on crowdfunding to provide advice and expertise to the Commission, particularly on the potential for a "quality label" to build trust with users; and promote transparency, best practices and 'certification';

• raise awareness of crowdfunding, promoting information and training as well as raising standards;

• map national regulatory and self-regulatory developments and hold regulatory workshops to ensure an 'optimal functioning of the internal market', and to assess if EU regulation is necessary;

• issue recommendations via the SME Envoy network;

• consider the possibility of matching public funds with private funds via crowdfunding channels, subject to State aid rules etc;

• support efforts to promote regulatory conver gence of approaches at international level.

There will also be two EU studies - one on how crowdfunding fits in the wider financial ecosystem and which projects use what type of crowdfunding; and another on the potential for crowdfunding to support research and innovation, which will include consider possible tax incentives.

The Commission will report on its progress during 2015.

Could The FCA Do More To Foster Innovation In Financial Services?

Previously I've suggested that two things are choking the flow of money to people and small businesses who need it: broken regulation and perverse incentives. So it's important to give some credit for work on both fronts.

Financial regulation remains overly complex, but at least some reforms have been made to welcome innovation and competition at the retail level. And the recent budget showed the government is keen to ensure that ISAs and pensions encourage people to put their eggs in more than one basket. The FCA has also done some impressive research into insurance add-ons.

However, for this momentum to be maintained, financial regulation must become even more welcoming of innovation and competition - and much simpler and transparent for everyone to understand. So here are seven suggestions:

1. Tailored rulebooks: By the FCA's own admission, about 10% of the rules spread throughout its giant, ever-expanding 'Handbook' are relevant to each regulated activity. But the FCA does not gather the relevant rules into 'tailored' rulebooks, as the FSA used to do. That means everyone must waste time and resources wading through the 90% of rules that don't apply to their given activity. But it's worth noting that the FCA still maintains the helpful “Approach” documents that explain its separate regimes for e-money and payment services. Why not adopt this same 'approach' in other areas?
2. Registered small firms option: The FCA authorisation process involves 6 to 9 months' work in advance of filing, at an estimated cost of £150,000 per firm (see note 10 from this Treasury/Cabinet Office workshop). It then takes another 3 to 12 months to become authorised, depending on the permission required. This makes funding the launch of a new financial service very expensive compared to an unregulated service, and the slow time to market increases the risk of failure (ironically). A 'registered small firms' option already exists in relation to e-money and payment services, and would reduce the cost and delay of market entry for firms preparing for full authorisation. It should be brought in more broadly.
3. Client-money banking platform: Many authorised firms are obliged to 'safeguard' their clients' money by keeping it separate from their own funds in 'segregated' bank accounts. UK banks can be particularly slow and uncooperative in opening these accounts, which delays time to market. This, along with the recent financial and IT problems amongst UK banks, suggests it might be wise to 'ring fence' segregated accounts on a separate platform, possibly under the supervision of the new Payments Regulator.
4. Small Investor Option: Any web designer will tell you that the more 'clicks' you put in the way of a consumer, the less likely it is the consumer will go through a process. So 'dialogue boxes' that require people to certify things or take tests to invest in bonds or shares will also deter them. That's a barrier to the adoption of new 'crowd-investment' services, which many people might prefer to try out with small amounts. In fact it's far easier to gamble on lotteries and bingo than it is to invest. So allowing people to be invited to invest up to, say, £250 in debt securities or shares per project on authorised crowd-investment platforms with a clear, fair and not misleading description of the risks, but without any form of certification, advice or appropriateness test would seem appropriate (see the French proposals for crowd-investment).
5. Platform-level regulation: current financial regulation operates on the basis of different types of activity related to certain types of legal instrument, regardless of the customer experience. However, the online 'marketplace' model is now being applied to many different types of financial service, enabling people to transact directly with each other in relation to payments, savings, loans and investments, for example. Insurance and other services will likely follow down this path. This offers the chance to removing doubt and duplication by regulating common operational risks with a single set of rules at the platform level, with relatively few extra rules for different types of instruments or different types of activity being financed.
6. FCA 'Sandbox': coupled with the registered small firms option, the FCA could maintain a more dynamic focus on innovation and competition if it offered a dedicated space or channel for evaluating new services - both inside and outside the regulated sphere - which would also help it decide whether to flex its rules to suit.
7. Seek solutions from outside the existing market: the FCA should not assume that every innovation is designed to circumvent the existing regime to the detriment of customers. There are plenty of entrepreneurs who have spotted opportunities created by poor banking and are trying to increase transparency and reduce costs. So where the FCA is aware of existing consumer detriment or other market problems, it could present these to the market in open 'innovation workshops' - similar to those fostered by the Treasury/Cabinet Office - and/or release them into its 'sandbox'.

Your thoughts?

At Last: ISAs Go To Work!

Readers of this blog will be familiar with my rants on ISAs. So you can imagine my delight that the Chancellor has finally announced an the extension of the scheme:

"To further increase the choice that ISA savers have about how they invest, ISA eligibility will be extended to peer-to-peer loans, and all restrictions around the maturity dates of securities held within ISAs will be removed. The government will also explore extending the ISA regime to include debt securities offered by crowdfunding platforms."

In addition, from 1 July 2014 ISAs will be reformed into a simpler product, the ‘New ISA’ (NISA), with an overall limit of £15,000 per year. You will be able to hold cash tax-free within your Stocks and Shares NISA (if your provider allows it). And you'll be able to ask NISA providers to switch your money between cash-NISAs and Stocks and Shares NISAs.

As explained here, these changes offer a huge boost to the real economy, because savers will be able to lend their 'dead' savings directly to each other and to small firms to help fill the funding gap left by the banks. At the same time, savers will improve the value of their investments, not only by diversifying into a new asset class, but also one that provides a decent return.

Hats off to the government and the Treasury for putting in the work to turn this situation around.

FCA's Response And Final Rules On Crowdfunding

The FCA today published its response to its recent 'crowdfunding consultation'. 

In essence, the paper merely justifies why the FCA has refused to alter its earlier proposal. Accordingly, all the previous criticisms still apply... [sighs].

This won't be terribly welcome news, but at least crowd-investment platforms now know they can market to a restricted area of the 'crowd', if not everyone.

And, following Friday's release of the consumer credit rules that also apply to 'P2P agreements', peer-to-peer lending platforms now have the two rulebooks they need to begin preparing for the first wave of regulation in 25 days' time, followed by full regulation from 1 October.

FCA's Final Consumer Credit Rules

The FCA has published its final consumer credit rules, including its response to the feedback it received during the recent consultation process.

In its email alert, the FCA claims not to have significantly altered the rules that it consulted upon other than in relation to high-cost short-term credit, including amending the risk warning for financial promotions and rules on using continuous payment authorities.

However, the scope of peer-to-peer lending has been amended slightly in a new statutory instrument to add conditions necessary for the platform's operations to be within scope. In summary, the platform operator (or another person acting under an arrangement with it or under its direction), must undertake to: 

• receive payments in respect of interest and capital due under the loan contract and to make payments in respect of interest and capital due to lenders; and 

• perform, or undertake to appoint or direct another person to perform, either or both of (a) taking steps to procure the payment of a debt under the loan contract; (b) exercising or enforcing rights under the loan contract on behalf of the lender.

In addition, any activity of a kind specified by article 14 (dealing in investments as principal), 25 (arranging deals in investments), 37 (managing investments) or 53 (advising on investments) are excluded from article 36H (operating an electronic system in relation tolending). 

The FCA also says it has provided new guidance on lending in the course of a business, but this is not immediately apparent, so stay tuned there.

The FCA Handbook will be updated in March to include the consumer credit rules as "CONC".

Response to EC Consultation on Crowdfunding

New Years' Eve marks the deadline for responding to the European Commission consultation on crowdfunding. 

The response page is here (scroll to "How to Submit..."). You can respond as either a citizen or an organisation. I chose the citizen option as I was responding in a personal capacity rather than on behalf of any client. The compulsory questionnaire (embedded below) took about 20 mins to complete. It gave me the option to upload a document and I chose yesterday's response to the FCA consultation.

Have your say! ;-)

Response to EC crowdfunding consultation Dec 2013 from Simon Deane-Johns

Response to FCA Crowdfunding Consultation

I have embedded below my personal response to the UK Financial Conduct Authority's consultation on rules for regulating peer-to-peer lending and crowd-investment platforms, submitted today.

Interested in any thoughts or feedback you may have.

Response to FCA crowdfunding consultation simon deane-johns - final from Simon Deane-Johns

A PSD Passport For P2P Lending?

I was interested to read the overview of European national laws that might apply to various types of peer-to-peer finance ('crowdfunding'), published this week by the European Crowdfunding Network (ECN). It's fair to say that the UK is somewhat more advanced in its decision to specifically regulate, but it's proving fairly easy for other member states to catch up - principally via payment services regulation.

While self-regulation of the peer-to-peer lending in the UK borrowed heavily from the UK's implementation of the Payment Services Directive, no one suggested that a peer-to-peer lending platform was actually a payment service (in my view, it's out of scope, or otherwise exempt in several respects). Whereas, the peer-to-peer foreign exhange platforms, such as Kantox (in the UK) and Currency Fair (in Ireland) did take advantage of the PSD as a regulatory basis for their activities.

The EU passport rights that authorised payment institutions enjoy are obviously important for a foreign exchange platform, but less so for lending - due to the challenges in establishing a cross-border market for consumer credit.

Until now, that is.

Unfortunately, the FCA has been rather heavy-handed in its approach to the regulation of peer-to-peer lending, particularly in terms of financial promotions, client money rules and the red tape deterrent requirement for anyone 'lending [to consumers] in the course of a business' (whatever that means) to hold their own consumer credit authorisation, in addition to the platform. In other words, the FCA ignored pan-European calls for a PSD-like approach and has instead opted to import the activity into its investment regime. The French, on the other hand, are consulting on a PSD-based approach, although they have proposed some ridiculously low limits and appear to restrict the volume to the €3m per month to stay below the threshold for fully authorised payment institution status (where a passport would be available), which need to be lifted if it is genuinely going to enable P2P lending, especially to SMEs. 

The ECN overview reveals that other member states appear to be all over the place on the question of whether platforms fall within the scope of the PSD. Some commentators suggest the payment element of P2P lending is in scope, in which case that aspect should be outsourced, or that the platform operator become registered as a small payment institution or fully authorised as a payment institution (or become appointment as a PSD agent). Others suggest that P2P lending may be in scope but exempt under the commercial agents exemption.

Interestingly, however, the European Commission has proposed a new Payment Services Directive (PSD2), which it would like to finalise by Spring 2014. PSD2 is still somewhat flawed, sure, but even in its current form it would seem more proportionate than what the UK is proposing in relation to P2P lending. Including P2P lending within its scope would also provide the Commission with an opportunity to clarify that, so long as the platform is authorised, lenders (payers) should not also need to be authorised under the Consumer Credit Directive - to enable businesses to lend to consumers and other businesses.

Any port in a storm...

French Crowdfunding Proposals

French officials are consulting on their own crowdfunding proposals until 15 November. These appear to be more consistent with the industry recommendations made last December, and seem somewhat more proportionate than the FCA's proposals for the UK.

Unfortunately, no official English version has been made available but Frederic Baud has kindly pointed me to an article by Aurélie Daniel on the proposals.

Frederic has explained that the intention is to use the transposition of the small payment institution provisions of the Payment Services Directive to require registration by donation-based and loan-based crowdfunding platforms. As a small payment institution, platforms would need capital of €40K, and be subject to a rolling 12 month average limit of €3 million transaction per month (that could be lowered to €1 million under proposals for PSD2). Above that threshold, platforms would need to be fully authorised as a payment institution, with minimum capital of €125K and higher amounts based on various optional calculations.

So far, that is completely consistent with the regulatory approach that the industry called for at the Peer-to-Peer Finance Policy Summit in London last December (which the FCA has ignored), and would represent a far lighter regime than the FCA has proposed for UK loan-based platforms. Regulating loan-based crowdfunding via payment services regulation is also consistent with the traditional view that simple loans are not 'debt securities' and therefore do not properly fall within the scope of specified investments currently regulated by the FCA.

But Aurélie points out that the French proposal contains controversial "upper limits for loan-based crowdfunding... [namely] a maximum loan amount around €250 per individual per project and a global maximum loan amount around €300,000 per project." While this might not trouble consumer loan-based platforms, it would negatively impact platforms that facilitate loans to businesses and for the purchase or development of larger assets such as commercial property. Ironically, the French appear to have reserved such loans for banks, and in this respect the FCA's proposals are of course more helpful. The limits apparently do not apply in relation to investment-based crowdfunding.
 

FCA Crowdfunding Consultation

The FCA has today published its crowdfunding consultation, covering both crowd investment in equities and debt securities (which the FCA calls 'investment-based crowdfunding'), as well as the lender side of peer-to-peer lending ('loan-based crowdfunding'). The borrower side of loan-based crowdfunding was covered in the FCA's consumer credit consultation earlier this month. The consultation paper will be of interest not only to platform operators, but also to those looking to raise or contribute funds in a bid to escape bank products, in particular.

The FCA is clearly aware of the general anxiety that any rules it makes should not exclude the 'crowd'. But based on the FCA's summary of its proposals, in my view it has not struck the right balance (called for by the industry last December) for the reasons below. In summary:

• The proposals seem to land quite heavily on peer-to-peer lending (perhaps partly because investment-based platforms are already subject to the investment regime). While in principle the FCA has followed the thrust of the P2PFA's Operating Principles (which was based on payments regulation) the decision to bring simple P2P loans into the investment regime will make it substantially more expensive in time and money to establish a platform. The costs of ongoing compliance will also increase, though largely through the undue complexity of the investment regime, rather than any substantive change in how operational risks are managed. In addition to potentially discouraging entrepreneurs from establishing a platform, the red tape requirement for a lender to be authorised, in addition to the platform, where 'lending in the course of a business' on a platform may discourage business and institutional participation, especially without clarity on where compliance responsibilities lie given that the lender's own operational systems aren't involved at all. There is little proportionality according to the relative risks associated with different types of loan (e.g. unsecured prime, secured, short term high rate and so on). However, there is some good news in that the FCA seems to advocate the introduction of a 'secondary market', where platforms don't already operate one, without apparent restrictions on how these should operate or whether one could participate without first lending into the 'primary market'.

• The proposals for investment-based crowdfunding do at least allow for wider 'retail' participation than the FCA has seemed to support to date. However, people will be asked to certify that they will not invest more than 10% of their 'net investible portfolio' in unlisted shares or unlisted debt securities (excluding their primary residence, pensions and life cover), and they face an 'appropriateness test' if they aren't investing on advice. So it will still be much easier to stick a tenner on a pony, where the house always wins, rather than to back a local business in support of the economy. The risks that the FCA points to in justification for this can all be explained transparently on websites. But who in government will take responsibility for the strange inconsistencies in the way we are allowed to use our money?

Comments are due by 19 December, and it would be best to get involved. The FCA plans to review the overall crowdfunding regime again in 2016, so it could be a long wait before any problems missed will be rectified...

Loan-based crowdfunding

Firms operating loan-based crowdfunding platfroms are to be regulated from 1 April 2014 as ‘operating an electronic system in relation to lending’ (under article 36H of the Regulated Activities Order). The FCA is aware of about 25 firms in this category.

The FCA sees loan-based crowdfunding as "generally of lower risk than that made via investment-based platforms" although it sees the potential for innovation that may bring higher risks, so will keep the sector under review. For the time being, however, the FCA is consulting on:

• minimum prudential requirements that firms must meet in order to ensure their ongoing viability (£20,000 to £50,000 minimum capital and a further 0.3% to 0.1% of volumes on a scale of £50m to £500m);
• the requirement for firms to take reasonable steps to ensure existing loans continue to be managed in the event of platform failure;
• rules that firms must follow when holding client money, to minimise the risk of loss due to fraud, misuse, poor record-keeping and in the event of a firm's failure;
• rules on the resolution of disputes, and
• reporting requirements for firms to the FCA in relation to their financial position, client money holdings, complaints and loans arranged.

It is reassuring that all these issues (other than FCA reporting obligations), have long been addressed by the Peer-to-Peer Finance Association in its Operating Principles. However, those were modelled on payment services regulation (under the Payment Services Regulations 2009), whereas the FCA proposes to apply more or less the full weight of its retail investment regulation on the sector for little real benefit. For instance, the effect of the voluminous client money 'sourcebook' ('CASS') is not terribly different to payment services segregation requirements that would only need to be tweaked slightly). Firms might decide to outsource the handling of client money to other authorised firms, rather than accept the additional red tape that CASS creates (as investment-based platforms tend to do).

Unfortunately, too, the FCA interprets the Consumer Credit Directive to mean that any person or firm lending in the course of business via loan-based crowdfunding platforms will need to be authorised as they are carrying on a regulated activity. That interpretation is inconsistent with the FCA's view that such a person is actually an investor in loans, rather than a lender, but may be driven by the use of the word 'creditor' in the Directive. Moreover, such dual authorisation makes no sense, given that all the operational activities associated with the marketing, creation and servicing of the loans takes place in the platform operator's systems, rather than the lender (even where that lender is, say, a bank). In other words, the lending is being done in the course of the platform operator's business, not any business being run by the lender. Responsibility for compliance in such circumstances is not clear. How is a business lender supposed to comply with consumer credit rules when it is not directly advertising, processing loan applications or servicing the loans? Further, the FCA (like the OFT) declines to give any guidance on what it means to be 'lending in the course of a business', other than to refer to its existing guidance around the 'business test'. Early case law cited in HMRC guidance on this topic, however, requires an assessment of the operational reality which in this case suggests lenders on loan-based crowfunding platforms are not lending in the course of a business operated by them but in the course of a business of the platform operator.

In my view, the FCA's interpretation of the Consumer Credit Directive is another example of UK officials failing to take a purposive approach to interpreting EU law and needlessly creating a rod for our own backs. I doubt very much whether the purpose of the Directive was to ensure dual regulation in the context of loan-based crowdfunding.

Notwithstanding the 'low risk' classification, the FCA plans to treat investments on loan-based crowdfunding platforms largely as it does other designated investments (though there is no guidance on what distinguishes a 'loan' from 'debt securities' in the FCA's view). So rules that apply to firms arranging transactions in designated investments will therefore also apply to firms running loan-based crowdfunding platforms. As a result, such firms will have to comply with two separate FCA rule books - one for borrowers ("CONC"), and one for lenders (now to be called 'investors') ("COBS"), including rules applicable to 'financial promotions'. 

Finally, the FCA seems to advocate the inclusion of a 'secondary market' on loan-based platforms, in the context of a discussion on cancellation rights. The FCA does not explain its view as to whether or how certain exemptions to the right to cancel apply, for instance, where the lender is not acting in a commercial or professional capacity, the main service contract is not a 'distance contract' so the loan can't be a 'secondary contract' for cancellation purposes or the lender makes an irrevocable offer to lend within the cancellation period.

As to the nature of the 'secondary market itself', in its cost benefit analysis, the FCA also points to the fact that most of the main platforms have one and states:

"we estimate a one-off cost of 20 days of web programming to add secondary market functionality to platforms. We assume a cost per day of web programmer time of £200.29 This would mean that adding a secondary market to a platform could create a one-off cost of around £4,000. We also estimate ongoing costs of four hours per day to oversee the functioning of the secondary market. We estimate a cost per hour of £10 for administration work in small to medium firms, so the annual ongoing cost per firm of this option would be £10,000. It appears that, as platforms mature, they prefer to offer a secondary market, so in the long term most platforms are likely to aim to introduce a secondary market."

At last, a little ray of pragmatism, perhaps. But on what functional specification was this estimate based?

Left unanswered are a bunch of awkward issues, such as the distinction between loans and debt securities (now that both seem to be specified investments), how 'hybrid' loan-based and investment-based crowdfunding platforms should be treated, how a platform might facilitate loans above and below the £25k per loan cap, that some types of loan-based platform are lower risk than others and should receive more proportionate treatment (e.g. secured vs unsecured, or smaller numbers of customers) and confirmation that platforms do not qualify as certain other forms of investment activity (as well as others identified in Annex 2 of a submission on the Financial Services Bill in June 2012).

The new rules will take effect from 1 April 2014, but firms with 'interim permission' will have until 1 October 2014 to comply.

Investment-based crowdfunding

A crowd-funding platform needs to be authorised if it carries out the regulated activity of enabling a business to raise money by arranging the sale of unlisted equity or debt securities, or units in an unregulated collective investment scheme. The FCA is aware of about 10 authorised firms and 11 appointed representatives of authorised firms in this sector. However, exemptions may be available. For example if the firm operating the crowdfunding platform is an appointed representative of an authorised person or an Enterprise Scheme they will not need to be directly authorised.  

While the FCA already authorises investment-based platforms under existing investment regulation, the FCA concedes that the current rules don't really fit. The FCA has imposed restrictions on the authorised platforms on a case-by-case basis, which "restrict firms to dealing with professional clients and retail clients who are either sophisticated or high net worth." However, the FCA believes that its new proposals "should mean crowdfunding investment opportunities are available to more retail investors than currently, but with appropriate safeguards to check that investors are able to understand and bear the risks involved." The FCA also intends "to provide adequate consumer protections that do not create too many barriers to entry or significant regulatory burdens for firms." The new rules will take effect from 1 April 2014, but firms will have until 1 October 2014 to comply.

The FCA is proposing to limit the direct offer financial promotion of unlisted shares or debt securities (including websites) by firms to one or more of the following types of client:

• retail clients who are certified or self-certify as sophisticated investors, or
• retail clients who are certified as high net worth investors, 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 certify that they will not invest more than 10% of their net investible portfolio in unlisted shares or unlisted debt securities (i.e. excluding their primary residence, pensions and life cover).

Where advice is not provided, firms will need to apply an appropriateness test before selling them promotions for unlisted equity or debt securities.

Where crowdfunding platforms allow investment in units in unregulated collective investment schemes, the existing marketing restrictions will apply. These can only be promoted to certain types of customer, and changes to those restrictions were also recently consulted on and were made here.

Left unanswered are a bunch of awkward issues, such as the distinction between loans and debt securities (now that both seem to be specified investments), how the financial promotion rules actually apply, how 'hybrid' loan-based and investment-based platforms should be treated, and confirmation that platforms do not qualify as certain other forms of investment activity (as well as those identified in Annex 2 of a submission on the Financial Services Bill in June 2012).

The FCA considers investment-based crowdfunding to be high risk, owing to the the high rate of start-up business failures, the possibility of unauthorised advice, professionals picking the best offers, lack of dividends, equity dilution and the lack of a secondary market.

It seems bold to assume that professionals are any better than others at 'picking the best offers'. Research reveals that no one can predict which businesses will be successful. However, these risks can all be explained. What the FCA proposals views don't account for is the ability for people to lose unlimited amounts by betting on the ponies without going through any hoops at all. The FCA states that it has "no evidence to show that the wrong type of investor is investing in unlisted shares or debt securities" but concedes that "it is possible our current regulatory approach is effectively preventing this." Why is someone who bets on the ponies, for example, the 'wrong type' to be investing in a start-up?

From a policy standpoint, if it's ok for somebody to stick a tenner on the next race, when the betting shop is the real winner, then surely, so as long as the risks are clearly explained, the same person should be able to back a small business, where the economy is the winner. 

But who in government will take responsibility for this inconsistency?