Tougher crowdfunding rules planned
Tougher rules are to be imposed on the fledgling online crowdfunding industry, amid concerns that consumers are being "enticed" by promises of high returns but do not consider that they risk losing their cash if a project fails.
Crowdfunding is a relatively new way for firms to raise finance by asking large numbers of people to act like Dragons' Den-style investors. Sometimes people will get back money with interest or shares, or they will donate because they believe in a particular cause.
The Financial Conduct Authority (FCA) estimates that the crowdfunding market is currently worth about £360 million in the UK. Around 90% of crowdfunding is carried out through peer-to-peer lending websites such as RateSetter, Funding Circle as well as Zopa, which announced this week that it has has lent more than £400 million since it launched in 2005.
Peer-to-peer lenders match businesses looking for an investment with people who have some money they are willing to lend.
The new regulations proposed by the FCA apply to peer-to-peer lenders, which it will start overseeing when it takes control of the consumer credit market next April, and equity investment-based crowdfunding, which it already regulates.
Its plans, which will be set out firmly early next spring following a consultation, aim to spur competition and help the industry grow while making sure consumers fully understand the potential risks.
The regulator is concerned that amid the current poor returns on traditional savings accounts, inexperienced investors will be " enticed by promises of high returns apparently available through crowdfunding".
Christopher Woolard, the FCA's director of policy, risk and research, said: " Consumers need to be clear on what they're getting into and what the risks of crowdfunding are.
"Our rules provide this clarity and extra protection for consumers, balanced by a desire to ensure firms and individuals continue to have access to this innovative source of funding."
Under the plans, investment-based crowdfunding will be targeted only at wealthy and sophisticated investors who can cope with any losses. Websites will have to consider whether any supporting information they give such as "star ratings" amounts to advice. If it does, the firm will need to apply to the FCA for permission to advise on investments.
The FCA said: "Research indicates that around 50% to 70% of business start-ups fail completely.
"So consumers investing in such companies need to understand that it is likely they will lose 100% of any money invested."
Meanwhile, consumers loaning money to a business through a peer-to-peer lending website will receive an explanation of the key features of the loan as standard as well as an assessment of how credit-worthy a borrower is. Lenders and borrowers will have a 14-day cooling-off period to change their mind.
Any comparison of a peer-to-peer loan interest rate with a regular savings account interest rate must be "fair, clear and not misleading", the FCA said. The regulator has powers to ban unfair advertising.
Peer-to-peer lending websites will also have to hold a pot of at least £50,000 to help them wind down their assets if anything goes wrong.
In cases where a peer-to-peer lending website goes under, consumers should still be able to continue to receive repayments from the firm at the other end of the chain that they have loaned money to, under the FCA's plans for greater consumer protection.
There are no plans to bring crowdfunding websites under the Financial Services Protection Scheme (FSCS), which protects consumers' savings if their bank or building society goes bust.
At present, new websites trying to beef up their presence may be motivated to downplay risks or over-emphasise possible returns and in most cases consumers will rely on what the website tells them rather than taking advice, the FCA said .
The social-networking nature of the industry could pose a particular risk to young investors who "may be attracted to the concept without a full understanding of the risks".
Pensioners who have large amounts of savings making poor returns may also be tempted into taking "inappropriate levels of risk" with their cash in the search for higher yields, the FCA said.
Some types of crowdfunding, such as when people donate to a good cause without expecting anything back, or when someone supports a band in return for getting a copy of their new album, are exempt from the new regulations.
But if schemes with "ethical" aims fall under the FCA's remit, they will be subject to the new rules, regardless of whether the investment aims to provide a wider benefit.
A formal review of the crowdfunding market will take place in 2016. The FCA said it will monitor the industry closely and could ban any websites which do not come up to scratch.
Peer-to-peer lenders said they are "delighted" to be coming under the new regulatory framework.
Zopa has more than 43,000 active savers who have lent between £10 and over £1 million, and those who are putting money in are typically getting an "inflation-beating" 4.4% return. Meanwhile, Funding Circle said businesses which come to it typically get access to a loan in just seven days.
Giles Andrews, CEO and co-founder of Zopa, said: "The regulation outlined makes common sense and includes a number of rules that we have in place and already adhere to, which is a positive sign."
RateSetter founder Rhydian Lewis said: " We've campaigned hard for peer-to-peer lending to be brought under the FCA's remit and are delighted by the draft policy."
James Meekings, co-founder of Funding Circle, said regulation will help to "cement" the long-term position of peer-to-peer lending.
He said: "The industry has been in conversation with regulators for many months and today's outcome is very positive.
"The FCA has shown foresight in striking the balance between enabling the industry to continue to flourish while ensuring the protection of consumers and businesses."