Are you thinking of starting a crowdfunding or peer-to peer (P2P) lending platform? Then I have some good and some bad news for you!
The good news is that barriers to entry are breaking down fast. Technology was once the biggest barrier but now hardly pose a challenge to new entrants. There are many white-labelled platforms ready to be bought and customised for any type of crowdfiunding and P2P businesses. Fierce competition is bringing the price of these white-labelled platforms down considerably.
This means that start-up costs are lower, as platform build is often the biggest expense in starting a crowdfunding business. Start-ups now require no or little external funding, and the needed capital can be raised via other platforms. Investors are now waking up to the crowdfunding world and are getting attracted to the disruption that crowdfunding and P2P platforms are likely to introduce to the financial services industry.
The bad news however is that regulation have now become the biggest barrier to entry in this market.
In the UK, 1st of April 2014 marked the turning point when the regulator, the Financial Conduct Authority (FCA), took over the regulation of the consumer credit market, including crowdfiunding and P2P lending. They introduced a new regulatory framework, and come with much more power compared to the Office of Fair Trade (OFT) who regulated the consumer credit market previously.
Oh and by the way, the FCA hasn’t been reluctant to use their powers. In its first 10 months of existence, the FCA issued a massive £ 408 million worth of penalties compared to the £752 million issued by its predecessor, the Financial Services Authority, during its entire 11 year tenure (source FT Advisor).
Many argue that the new rules do not fit this disruptive market, as they are derived from the Financial Services Market Act which came into force as far back as 2000, when social media was hardly in existence and since then, technology has progressed rapidly.
In the main however, most existing platforms and interested stakeholders are supportive of these new regulations, as:
- It introduces higher standards for the industry;
- It strengthens retail investors and borrowers protection; and
- Most importantly (especially for crowdfunding platforms), it opens the door to a larger retail (deemed to be “unsophisticated”) investor base, who are able to invest up to 10% of their funds available for investment).
So why do the new regulations pose the biggest barrier to entry?
Crowdfunding and P2P lending rules are part of the overall consumer credit regulations. Prior to 1 April 2014, the OFT didn’t do such a good job of regulating this market, and this resulted large-scale consumer detriment. To address this, the UK Treasury passed on the baton to the FCA, who has much wider enforcement powers and a more comprehensive rulebook. Because the new regulation and the regulator is set to be much more tougher, the FCA themselves expect one third of this market to disappear as weaker players will not be able to comply.
Whilst the FCA haven’t found any bad practices (as yet) in the crowdfunding and P2P space, they are nevertheless imposing the stricter consumer credit regime on this new market, creating the barriers, which include:
- High Risk Business: – The FCA makes a distinction between high and low risk consumer credit businesses. Both equity crowdfunding and P2P lending are regarded as high-risk businesses required to meet much higher regulatory standards.
- Regulatory Gateway: Platforms will have to get through a tough regulatory gateway before they can start their businesses. This applies equally to exiting platforms currently operating under an interim permission. They will be required to prove to the FCA that they: have adequate financial resources to run the business; have robust systems and controls to identify and manage risks; put fair treatment of customers at the heart of their business; have strong governance arrangements providing adequate checks and balance; and their leadership team comprise fit and proper people striving to protect consumer interests and do the right thing.
Failing to get through this gateway will prevent platforms continuing their business or at the least delay launching their business, if the application is found to be incomplete. The authorisation process will require significant effort, management time and costs.
- Approved Persons: Key personnel will need to be approved, in their own right, as being fit and proper. The implications are significant for the individuals concerned, as any regulatory breach or negligence on the part of the firm can have personal consequences for the approved person. They could be fined, be open to criminal prosecution and be barred from working in the financial services sector.
- On-going Compliance: Once authorised, firms will have to evidence on-going compliance. They will have to maintain adequate policies, procedures and manuals, and keep them updated.
Compliance experts may need to be hired or the activity outsourced to a credible third party firm. The FCA will expect a comprehensive on-going compliance-monitoring, that will impose additional burden on the business.
- Wide-ranging Powers: FCA has wide-ranging powers and their short history of existence have shown that they are not reluctant to exercise these powers. They have the powers to:
– Impose injunctions, penalties, censure, suspension and criminal prosecution;
– Cancel regulatory approval;
– Force restitution and redress to aggrieved customers;
– Intervene on certain products and force its withdrawal; and
– Intervene on financial promotions and stop them if consumers would be harmed.
This brings a level of uncertainty to the business, requiring them to tread carefully, and in some cases, it may dis-incentivise innovation.
Its not all bad news however!
If the platforms start out with the deliberate intention to get the best return on their investment in compliance, then by going through this exercise, they may actually end up with a more efficient and smoother running business with happier customers and the potential to acquire greater market share from competitors struggling to comply.
Jay Tikam is a Director of Vedanvi, a niche risk and regulatory consultancy focusing on the financial services sector. Vedanvi has deep expertise in crowdfunding and consumer credit regulations and is currently assisting several clients interpret regulations and get through the FCA authorisation process. Jay is a member of the Westminster Crowdfunding Forum, and was actively involved in lobbying against regulation during the consultation process.
Get in touch with Jay at firstname.lastname@example.org.
We would love to hear about your thoughts. So please leave a comment. Also get in touch with Jay or leave a comment if you have any questions about the regulations you want answered.