FCA guidance changes ring in the new year

What Santa (the FCA) brought this new year for the alternative finance industry

In a nutshell

If investing on a Property Crowdfunding platform is something you've previously done, or even if it's something you're perhaps considering in the future, whilst you were enjoying the break over the Christmas period, 2020 rang in with some important Alternative Finance news.

The Financial Conduct Authority (FCA), the regulating body of the UK's financial services firms and markets, has made an announcement that from 1st January 2020, the promotion of speculative mini bonds to restricted investors will be banned.

As stated in a press release on the FCA's website;

"Ahead of the upcoming Individual Savings Account (ISA) season, the FCA is introducing the restriction without consultation, using its product intervention powers. The restriction will come into force on the 1st January 2020 and last for 12 months while the FCA consults on making permanent rules."

But what does this specifically mean for Property Crowdfunding, and how will it affect individual investors?

Why did the FCA introduce these changes?

As you may have seen on the CrowdLords platform, before investing in any of our projects, you must first classify yourself as either a "Restricted Investor", a "self-certified Sophisticated Investor" or a "High Net Worth investor".

The FCA separates investors into these three categories too. Therefore, as long as prospective investors could demonstrate that they understood the risks and consequences of investing, they were free to invest wherever they chose.

However, due to what the FCA describes as:

"Evidence of a substantial increase in promotions which are frauds or scams, with no attempt to meet financial promotion rules."

And its assessment that the high risk nature of speculative investments was not being made sufficiently clear to investors, the authorities have now decided to ban the mass-marketing of these mini-bonds to restricted investors.

As a result, where Property Crowdfunding is concerned, people who classify themselves as "restricted" investors will now only be able to invest in full equity investments or qualifying debt investments linked to rental projects.

Admittedly, there has been some initial confusion about why "restricted" investors are now only free to invest in certain products. As we know from the Capital Stack, equity investments typically carry more risk and so it might initially be assumed that more inexperienced investors should be restricted from taking part in these potentially riskier forms of investing.

However, the FCA's reasoning is as follows, as described by Andrew Bailey, Chief Executive of the FCA;

"We remain concerned at the scope for promotion of mini-bonds to retail investors who do not have the experience to assess and manage the risks involved. This risk is heightened by the arrival of the ISA season at the end of the tax year, since it is quite common for mini bonds to have ISA status, or to claim such even though they do not have the status.

"In view of this risk, we have decided to complement our substantial existing actions with a further measure which will involve a ban on the promotion and mass marketing of speculative mini bonds to retail consumers. We believe this will enable us to increase consumer protection to be consistent with our regulatory principles and the FCA Mission."

What has the FCA done so far?

Over the last year, the FCA has undertaken an extensive programme of work to tackle the risks that investors can encounter in debt-based investing. This programme includes:

• Investigating more than 80 cases of regulated activities potentially being carried out without having the right FCA authorisation.

• Assessing over 200 cases of financial promotions that appeared not to have complied with the FCA rules.

• Seeking to persuade the internet service providers, particularly Google, to take more action. For instance, taking down websites promptly where they are likely to involve a breach of law or regulations.

• Contact with the Department of Culture, Media and Sport to urge inclusion of financial harm in the proposed legislation on online harms.

• Developing tools for data analysis, for instance introducing web scraping to assist in the identification of mini-bond promotions.

Is your accreditation still accurate?

Although the FCA's good intentions are to protect inexperienced investors from losing capital due to fraudulent activity or inadequate descriptions of risks, this news may still seem initially frustrating for people using Property Crowdfunding platforms and who wish to keep investing in debt-based projects. The ban will mean that this debt-based form of investing can only be promoted to investors that platforms have confirmed to be "self-certified sophisticated" or "high net worth".

To help ensure that users on our platform are correctly classified, CrowdLords will shortly be sending out a newsletter reminding how investors of the parameters of the "sophisticated" and "high net worth" classifications.

For example, in order to classify yourself as a "sophisticated" investor, you only need to have taken part in more than one investment of this type over the past two years either on the CrowdLords platform, or indeed any other platform.

Alternatively, you also qualify as a "sophisticated" investor if you are the director of a company with an annual turnover of £1,000,000 or more. By fulfilling either of these two requisites, you are able to carry on investing in debt-based and interim equity investments.

Likewise, if you have an annual income of £100,000 or more or you have net assets of £250,000 or more (excluding the value of your main residence, insurance rights or benefits, or withdrawals from pension savings), you can classify yourself as a high net worth investor, meaning you will be eligible to invest in debt-based and interim equity investments.

What does the future hold for Property Crowdfunding platforms?

In order to comply with the changes that the FCA has brought into place, platforms will have to tighten up their procedures when promoting investments and also adhere to the FCA's temporary decision to restrict speculative debt-based investments to retail consumers.

At CrowdLords, we have always targeted our investments primarily at "High Net Worth" and "sophisticated" investors so we do not expect to have to change things too much.

On the other hand, many of our competitors have tried to appeal to as wide an audience as possible and so they are likely to feel the impact of these changes more than we will.

After the twelve-month period is up at the end of 2020, it will be interesting to see whether the FCA takes any further action and establishes permanent rules, or alternatively whether we see the regulators reverting to how things were in 2019.

However, most importantly, after introducing these rules solely designed to prevent harm to investors, the FCA will not want to simultaneously stifle innovation in the Property Crowdfunding sector. The new rules should be specifically designed to better protect the people investing their capital, allowing fundraisers to operate in a long-term, sustainable manner.