Crowdfunding Becomes Mainstream

Crowdfunding Becomes Mainstream
Underwater Photography by Andy Deitsch. Why?

Crowdfunding And Peer-To-Peer For SIPP And SSAS

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Crowdfunding And Peer-To-Peer For SIPP And SSAS

Risk is a fact of investment life, which is why the Regulator has taken a close interest in the rapidly emerging market of crowdfunding

At The Dawn Of Crowdfunding Regulation, Loopholes Have Been Revealed Putting Some Investors At Risk!

Crowdfunding: A Match Made In Heaven?

Well, maybe not heaven.  But on the face of it, it’s a pretty good match.  If you appreciate the risks!

Despite a range of Government initiatives, small businesses are still struggling to raise finance.  And in an attempt to keep the economy moving in the right direction, interest rates remain at their all time low, penalising bank and building society savers in the process.  Against that backdrop, it’s not at all surprising that crowdfunding has taken off in a big way, with savers and investors likely to put around £1.6 billion into crowdfunding in 2014.

Crowdfunding is a very different concept to deposit accounts, for it’s not without risk.  It’s for this reason that the Regulator, the Financial Conduct Authority, has stepped in to oversee proceedings, as large numbers of savers have stepped out from underneath the Financial Services Compensation Scheme umbrella protecting the first £85,000 of their money held in each bank or building society.

The Regulator’s View On Crowdfunding

In a typically dry but informative document, the Financial Conduct Authority has just published the final rules on crowdfunding.  They took effect on 1 April 2014 and they’re the result of a consultation process lasting many months.  It’s been warmly greeted by the industry, providing sufficient regulation to protect both borrowers and investors, without strangling the industry with too much red tape.

Download the Financial Conduct Authority's document on crowdfunding.

Crowdfunding Regulation Is Both Good And Bad

Here’s a recent crowdfunding interview with Funding Circle co-founder James Meekings who’s in favour of regulation.

But Barry James, founder of The Crowdfunding Centre, says: "Make no mistake, the infamous 10% rule (which is set out below), however it's dressed up, does just that: it takes the crowd out of equity crowdfunding."

Crowdfunding Risks Facing Investors

Whilst lending on platforms like Funding Circle and Thincats isn’t without risk, the Regulator is more concerned with the significant risks facing investors who use crowdfunding to invest in unlisted securities.  These are often hard to value or sell on a secondary market.  To reduce the risk, the Financial Conduct Authority has proposed these investments should be limited to the following groups of people:

  • professional investors
  • retail investors classified as corporate finance contacts or venture capital contacts
  • retail investors certified as sophisticated investors or high net worth individuals
  • retail investors who receive advice from a suitably qualified independent financial adviser
  • everyone else providing they confirm they won’t invest more than 10 per cent of their net investible assets

While this is a sensible strategy, it appears potential loopholes have already emerged, undermining the protection for those classed as ‘everyone else’ in the above list.  It stems from the definitions identifying a person as a sophisticated investor, which are set out in the yellow box in SIPPclub’s Terms of Use

Here are two potential crowdfunding loopholes:

1. The first criterion says “You are a member of a network or syndicate of business angels and have been so for at least the last six months prior to the date below”.  Anyone can meet this criterion by joining one of the free online networks like Angelsden, and without even investing a penny, six months later, they'll be deemed a sophisticated investor.

2. The second criterion says “You have made more than one investment in an unlisted company in the two years prior to the date below”.  For a couple of £50 crowdfunding unlisted investments, this criterion is met.

It can’t really be the case that signing up to a free online platform, or parting with £100 makes you a sophisticated investor! 

In response to the second of these loopholes, an FCA spokesman said: “The 10 per cent rule means inexperienced investors will have to limit how much they can invest, making clear the risks involved. If an investor gains sufficient experience, they can self-certify as sophisticated and, to do so, will be acknowledging they understand and accept the risks.”

In defence of the FCA, this is a brand new and important financial market.  It’s a good thing the Regulator has imposed some guidance, which it intends to revisit in 2016.  At this time, it will carry out a full review of the crowdfunding market and the regulatory framework to identify whether further changes are required.

So in many ways, the onus is laid firmly at the doors of the crowdfunding networks.  If they abuse their position and attract in money from people who shouldn’t be investing in this area, they will only have themselves to blame if regulation is tightened significantly in the future.

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Crowdfunding And Peer-To-Peer Risk Warning

When a platform has been assessed and approved by a SIPP or SSAS operator, this does not imply that any loan or investment opportunity is endorsed in any way. A SIPP or SSAS operator's due diligence review is limited to ensuring the processes and procedures of the platform are in line with both FCA and HMRC principles.  It's entirely your responsibility for carrying out your own due diligence on any loan or investment opportunity before agreeing to lend or invest your pension money on a platform. As a SIPP or SSAS operator will continually review platforms from a regulatory perspective, it's possible for a platform to become 'unapproved' if something changes.

With peer-to-peer lending, your capital is at risk if you lend to individuals and businesses.  You may lose some or all of the capital lent if the borrower defaults and is unable to meet its liabilities. Historic loan default rates are not necessarily indicative of future default rates.  In addition, lending is an illiquid investment, which means you may not be able to access the capital you lend for the duration of the loan period, even if the platform offers a secondary market.  Investing in any business involves risks, including illiquidity, lack of dividends, loss of investment and dilution, and it should be done only as part of a diversified portfolio. Crowdfunding is generally targeted at investors who are sufficiently sophisticated to understand the risks and make their own investment decisions, based on their knowledge, experience and financial capacity. Neither crowdfunding nor peer-to-peer lending is covered by the Financial Services Compensation Scheme. The tax treatment of your investment is dependent on your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of crowdfunding investment or peer-to-peer lending, you should consult a suitably qualified independent financial adviser.