Crowdfunding: Let it grow
Crowdfunding is a growing area of activity and as such the FCA is reviewing how crowdfunding firms market their offerings to consumers. It is right to do this but I believe that some of the rules around crowdfunding should be made less restrictive.
What is crowdfunding?
Crowdfunding involves those who want capital pitching for funding (either borrowing or equity) from investors. Different sites allow businesses or individuals to request money. Investors can see opportunities and choose which ones to support. Capital is raised from a large number of people (AKA the crowd) with each investor taking part of the loan or a percentage of equity. The function of channelling money from those who have funds to those who want more capital is performed through a web-based platform without requiring an institution as an intermediary, this is known as “peer to peer finance”.
Crowdfunding is growing at an impressive rate. The Peer to Peer Finance Association estimates that the industry will continue to double in size every six months.
What is the FCA doing?
Some crowdfunding websites have marketed their offerings as “risk-free” or as “savings” products. The FCA is therefore right to look at the way platforms present themselves to consumers and to ask for such materials to be altered or removed; consumers cannot make informed decisions if they do not have content which is clear, fair, and not misleading. Crowdfunding is not covered by the Financial Services Compensation Scheme which offers protection to deposits. It comes with credit risk or equity risk since those requesting investment may default on loans or go out of business. Also there is liquidity risk. Whilst some platforms provide secondary markets which enable users to sell parts of loans to others, not all websites offer this so an investor might not find a buyer to provide them with cash. Therefore, in many ways peer to peer finance is not the same as a savings product and should not pretend to be.
How should the rules change?
Whilst I think the FCA is right to review how crowdfunding is marketed, there are two ways in which I think the regulatory rules around peer to peer finance should be relaxed:
1) Remove limits to how much people can invest: The limit on unadvised retail clients investing more than 10% of their net investible assets in peer to peer finance is illiberal and unenforceable. Also, it is not consistent with rules around how much can be invested in stocks and shares.
2) Accelerate the process of crowdfunding becoming eligible for ISA status: Individuals are able to add £15,240 worth of savings to an Individual Savings Account (ISAs) each year. Such accounts provide tax savings, however, these are currently limited to cash savings or stocks and shares investments. The government has announced that from April 2016 it will allow basic rate tax payers to earn £1,000 a year free of tax (£500 for higher rate payers) and that this allowance will apply to peer to peer returns.This is not equivalent to ISA rules: crowdfunders will not get the same income post-tax if their returns are high (above 6.6% on £15,240 savings for a basic rate taxpayer or 3.3% for those paying the higher rate). Also, they will not be able to build up a pot of funds which are free from tax through accumulating ISA allowances each year. The next UK government should look to fully incorporate crowdfunding within the ISA regime as soon as possible.
Crowdfunding isn’t for everyone and banks will continue to play a vital role as intermediaries. However, in light of questions about the competitiveness of the cash savings market, some of the restrictions on this source of competition should be lifted.