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UK’s new finance regulations face their first big test in crowdfunding

posted Oct 8, 2014, 12:48 AM by J Shaw   [ updated Oct 8, 2014, 12:48 AM ]
When the UK’s financial watchdog introduced new rules governing crowdfunding in April, there were fears that the fledgling industry would be regulated out of existence.

As the new regime comes into force this month, the alternative finance sector is still debating whether the Financial Conduct Authority has legitimised a market worth almost £1bn last year, or taken the crowd out of crowdfunding.


While the industry has broadly welcomed the new rules, fears remain about their potential to deter investors. Meanwhile, questions have been raised over whether traditional regulatory oversight is suited to an industry using social media to change the fundamental nature of banking.


Crowdfunding’s rise to prominence has been remarkable. In little more than a decade, it has become a recognised way for companies, both young and established, to raise finance from a wide body of investors using the power of the internet. Over 12 months, the alternative finance market grew by 91 per cent to reach £939m in 2013, according to a report by Nesta. It is expected to top £1.6bn this year, the think-tank reports, though this represents a tiny fraction of conventional bank lending.


The process, in which online platforms match a wide crowd of investors to projects, has risen on the back of two trends: the advance of the internet and social media, and the retreat of the banks, which scaled back lending in the wake of the financial crisis with tighter regulation and higher risk aversion.

As an investment case, crowdfunding has matured. “This isn’t a 50 quid punt any more,” says Julia Groves, chairwoman of the UK Crowdfunding Association, a trade body set up last year. “This is a real alternative for your savings, which aren’t getting much in the way of interest payments at the moment.”


By far the largest and best-known form of crowdfunding is peer-to-peer lending, popularised by platforms such as Zopa, RateSetter and Funding Circle. P2P, whether donation-based, lending between individuals or business loans, accounted for almost 85 per cent of the UK alternative finance market in 2013.


Much of the controversy over the FCA rules relates to the regulation of securities-based crowdfunding, which is a small portion of the total – about £28m last year – but is growing at several times the rate of the wider industry and has been used by companies from beer maker BrewDog to Kent winery Chapel Down.

This year, the FCA introduced a “10 per cent” rule, whereby retail investors who are neither “sophisticated” nor “high net worth” must certify that they are not committing more than a tenth of their net investable assets, excluding their home, pensions and life insurance. This rule does not apply to P2P loans.

“If we’re talking about a start-up in Shoreditch, nobody should invest more than 10 per cent of their assets anyway,” says Ms Groves, who backs the rules. Investors can self-certify as “sophisticated” after just two investments.


The FCA says consumers need protection if they are to have confidence in backing start-ups. Early-stage investors are more likely to be diluted as a company grows and attracts capital from new backers. Seed investments offer limited liquidity; the only exit, the distant chance of an IPO or sale.

Much worse, investors could suffer the same fate as the backers of Bubble & Balm, a fair trade soap manufacturer that raised £75,000 via equity crowdfunding platform Crowdcube in 2011, and ceased trading two years later.

Supporters of the new rules say the FCA has given the UK a distinct advantage over the US, where the concept of debt-based P2P lending was invented, but where equity crowdfunding remains illegal for retail investors.


“I certainly think that’s allowed the UK to steal a march and really pioneer the industry,” says Luke Lang, co-founder of Crowdcube, the leading equity crowdfunding platform by amounts raised and deals done.

However, there are concerns that the new self-certification process for investors might deter some. Dan Hird, head of corporate finance at ethical bank Triodos, agrees that online investors might be susceptible to “fatigue”, as they go through the process of asserting that they are aware of the risks involved.

This month, Triodos Renewables, a UK subsidiary of the Dutch lender, is launching an equity crowdfunding campaign on Trillion Fund – a platform run by Ms Groves – to raise money for wind turbines in what will be one of the first big tests for the new regulations.


There are concerns that this tech-savvy industry might be hindered by the FCA’s rules on financial promotion. Any company inviting investment must make any communication complete – including the small print, such as a risk warning. This presents problems when trying to spread the word to the crowd via Google adverts or tweets, which are limited to 140 characters.

“The lack of clarity is a big issue,” says Barry James, founder of the Crowdfunding Centre research group and a critic of the new rules. “No one’s quite sure. If I tweet or retweet, is that financial promotion and banned?”


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