Forum A CASE OF REGULATORY successful integration of sector regulation, alongside continued government support for alternative finance. EVOLUTION – A REVIEW OF While many member states have opted for a “wait and THE UK FINANCIAL CONDUCT see” approach to crowdfunding regulation, the United Kingdom was of the first nations to create bespoke reg- AUTHORITY’S APPROacH TO ulation for crowdfunding activities. As the regulating CROWDFUNDING body that monitors and supervises crowdfunding ac- tivities in the UK is the Financial Conduct Authority (FCA)2, this article will centre on the regulatory regime that it has adopted. ROBERT WarDROP AND 1 The FCA defines crowdfunding as an umbrella term to TANIA ZIEGLER capture various “categories” of activity, some of which are regulated whilst others are not. The general defini- Introduction tion of crowdfunding, according to the FCA is “an inter- net-based business model […] in which people and busi- Across Europe, crowdfunding is quickly moving from a nesses (including start-ups) can try to raise money from fringe funding instrument to becoming a mainstream fi- the public, to support a business, project, campaign or nance channel, connecting “crowds” to fund businesses, individual” (FCA 2016a). This broad term includes four projects and individuals. In its recently published Report sub-categories: on Crowdfunding in the EU Capital Markets Union, the European Commission details the importance of crowd- • Donation-based crowdfunding: people give funding as “an important source of non-bank financing money to enterprises or organisations whose activi- in support of job creation, economic growth and com- ties they want to support. petitiveness” (European Commission 2016). While there • Pre-payment or rewards-based crowdfunding: remains no harmonised regulatory framework applica- people give money in return for a reward, service or ble to crowdfunding across Europe, individual mem- product (such as concert tickets, an innovative prod- ber states have adopted national regulatory approaches uct, or a computer game). to supervise crowdfunding activities – “tailoring their • Loan-based crowdfunding: also known as “peer- regulatory frameworks to the characteristics and needs to-peer lending”, this is where consumers lend mon- of local markets and investors, which results in differ- ey in return for interest payments and a repayment of ences on how the rules are designed and implemented” capital over time. (European Commission 2016, 4-5). This article will • Investment-based crowdfunding: consumers in- focus on the regulatory regime in the United Kingdom vest directly or indirectly in new or established that regulates and supervises online alternative finance businesses by buying investments such as shares or activities that fall under the crowdfunding umbrella. debentures (FCA 2016a). The first two categories are exempt from regulatory The United Kingdom is the leader in online alternative oversight from the FCA, as the party providing funds finance in the European market, accounting for just does so for altruistic purposes or to receive a “reward”, under 75 percent of all transaction volumes in Europe rather than to profit financially. As such, these two cat- (Wardrop et al. 2015). In 2015, online alternative finance 2 It should be noted that the financial regulation of crowdfunding of- in the United Kingdom grew to GBP 3.2 billion, increas- ten involves several other government bodies or agencies, including HM Treasury, the Prudential Regulation Authority, etc. Although other ing by 84 percent from GBP 1.74 billion in 2014 (Zhang agencies and bodies have impacted the way in which crowdfunding has et al. 2016). Sizeable growth in 2015 coincided with developed in the UK, this article will only review the regulatory regime put in place by the FCA, as the FCA serves as the key regulator and supervisor of crowdfunding activity in the UK. Discussion of policy or 1 Cambridge Centre for Alternative Finance (CCAF) and Cambridge regulation that overlaps with additional government agencies will only Judge Business School (both). be discussed in the context of how activity is supervised by the FCA. 23 CESifo DICE Report 2/2016 (June) Forum Table 1 Alternative finance models Model name FCA Crowdfunding Category Definition Peer-to-Peer Business Secured and unsecured debt-based transactions between Loan-based Crowdfunding individuals/institutions and businesses with trading history; Lending most of which are SMEs. Property-based debt transactions between Peer-to-Peer Business Loan-based Crowdfunding individuals/institutions to businesses; most of which are Lending (Real Estate) property developers. Peer-to-Peer Consumer Loan-based Crowdfunding Debt–based transactions between individuals/institutions Lending to an individual; most are unsecured personal loans. Businesses sell their invoices or receivables to a pool of Invoice Trading Loan-based Crowdfunding primarily high net worth individuals or institutional investors. Investment-based Sale of registered securities, by mostly early stage firms, Equity-based Crowdfunding Crowdfunding to both retail, sophisticated and institutional investors. Direct investment into a property by individuals, usually Equity-based Crowdfunding Investment-based through the sale of a registered security in a special purpose (Real Estate) Crowdfunding vehicle (SPV). Individuals purchase debt-based securities (typically a bond Investment-based Debt-based securities Crowdfunding or debenture) at a fixed interest rate. Lenders receive full repayment plus interest paid at full maturity. Donors have an expectation that fund recipients will provide Reward-based Pre-payment or rewards-based Crowdfunding Crowdfunding a tangible but non-financial reward or product in exchange for their contributions. This model falls outside of FCA purview. Non-investment model in which no legally binding financial Donation-based Donation-based obligation is incurred by fund recipients to donors; no Crowdfunding Crowdfunding financial or material returns are expected by the donor. This model falls outside of FCA purview. Source: Zhang et al. 2016. egories fall outside of the FCA remit and are exempt “social promotion” and “P2P Advice” were set forth in from requiring FCA authorisation in order to operate. 2016, this review document serves as the most compre- The second two categories are monitored and super- hensive analysis of the authorisation process for invest- vised by the FCA, as these categories are transactional ment-based and loan-based crowdfunding. activities where financial profit is possible for the indi- vidual funder. Given the broad definition employed by the FCA, Table 1 indicates the category under which Investment-based crowdfunding key alternative finance models fall within. These model definitions are based upon the working industry taxon- Investment-based crowdfunding, as noted above, re- omy created by the Cambridge Centre for Alternative lates to activities in which individuals invest in unlist- Finance and its research partners (Zhang et al. 2016). ed shares or debt securities issued by a business. At the time of the February 2015 review, the FCA publically In February 2015, the FCA published its review on the acknowledged the full authorisation of ten firms as of state of crowdfunding since the sector fell under its aus- 1 April 2014, with an additional four platforms receiving pices in April 2014, pending a transition period for key authorisation by the end of 2014. The document noted an activities (FCA 2015a). Examining the implementation additional ten applications in review at the start of 2015. of the new crowdfunding rules, the review discussed the The ten firms that were authorised on or before 1 April efficacy of the newly-formed regulatory regime. The re- had until 1 October 2014 to become fully compliant view raised several key concerns around promotions to with the new rules, whilst any platform that began the retail clients, and pre-empted the FCA’s plan to publish authorisation process after 1 April 2014 had to comply additional guidance around consumer communication with all the new rules from their date of authorisation. relating to promotion and advice. While additional rules While the FCA has yet to release a 2016 crowdfunding and guidance around “segregation of client money”, review, our assessment is that as of March 2016, a to- CESifo DICE Report 2/2016 (June) 24 Forum tal of 24 crowdfunding platforms Figure 1 have permission to function as an Total transaction volumes attributed to investment-based investment-based crowdfunding crowdfunding models, 2015 business in the UK. Additionally, Mio. £ 250 a closer examination of the FCA’s registry indicates that at least 12 200 platforms are operating an invest- ment-based crowdfunding busi- 150 ness as an appointed representa- 100 tive (see Appendix). 50 The size of investment-based 0 Equity Crowdfunding Equity Crowdfunding Debt-based securities crowdfunding (Real estate) Source: Zhang at al. (2016). As noted in Table 1, invest- ment-based crowdfunding is an umbrella term which captures the activities of a number of online alternative finance mod- Application of new rules els including equity-based crowdfunding, real estate equity-based crowdfunding and debt-based securities, The FCA defines the instruments traded on invest- such as mini-bonds and debentures. At the end of 2015, ment-based crowdfunding as “non-readily realisable se- these models raised GBP 337.8 million. curities” that are not listed on regulated stock