Britain makes landmark decision to protect individual 'crowdfunding' borrowers

Britain has taken a step towards regulating the fast-growing crowdfunding sector, which allows individuals and companies to raise cash from members of the public, setting out rules aimed at protecting individual borrowers.

The rules, which were announced along with a clampdown on payday lenders, come in response to the rapid growth of a sector in which the amount raised globally rose 81 percent in 2012 to $2.7 billion, according to research and advisory firm Massolution.

Yet the future shape of crowdfunding could be determined more by detailed rules to be proposed by the Financial Conduct Authority (FCA), a UK financial watchdog, later this month.

Crowdfunding sites and peer-to-peer lenders have developed to help fill a gap left by reduced bank lending due to tougher capital rules and greater regulatory scrutiny.

While the industry has been calling for regulation in a belief it could give investors and businesses more confidence in the sector, it fears overly restrictive rules on who is allowed to take part and how much money they are permitted to risk.

"It is really important from our point of view as an industry that the crowd remains in crowdfunding, that it isn't limited to sophisticated investors or high net-worth individuals," said Luke Lang, co-founder of Crowdcube, which has more than 46,000 registered investors and has helped firms raise more than 12 million pounds since early 2011.

Some sites allow individuals to provide loans, while others, like Crowdcube, facilitate investments of as little as 10 pounds in small companies in return for shares.

The British government has pledged to lend 85 million pounds through non-bank lenders, including peer-to-peer sites, as part of its efforts to help drive economic recovering by boosting funding for small businesses.

But the sector's rapid growth has prompted some concern that not all individuals are aware of the risks involved.

Peer to peer
The United States is in the process of setting rules to govern crowdfunding, while the European Commission said on Thursday it was looking at whether to propose pan-European regulations for the industry.

From April next year British peer-to-peer lenders, such as Zopa and Funding Circle, will be regulated by the FCA, while some equity crowdfunding sites including Crowdcube are already authorised by the regulator.

On Thursday the FCA set out rules aimied at protecting individuals borrowing through peer-to-peer sites, including requiring sites to assess the creditworthiness of borrowers and giving people 14 days to change their mind about taking a loan.

These rules, in a document largely about regulating payday lenders such as Wonga, were welcomed by peer-to-peer lenders who on the whole already had the protections in place.

But the FCA plans to publish a second set of proposals later this month, specific to peer-to-peer and crowdfunding, more focused on lending and investment than borrower protections.

These rules are expected to apply to peer-to-peer lenders and some equity crowdfunding sites, but not sites which seek donations for charity or funding for creative projects in return for a non-financial reward.

It is equity crowdfunding, perceived to be more risky, that could see the most impact.

"In the context of crowd investment you are seeing a greater difference of opinion," said Simon Deane-Johns, consultant lawyer and co-founder of peer-to-peer site Zopa. "The FCA seems quite concerned about the idea that just anyone should be able to subscribe to shares in a start-up for a tenner."

Those working in the industry expect proposals could include caps on the amount an individual is allowed to invest as a percentage of their net worth, or a higher minimum investment level intended to deter those who can't afford to lose money.

A minimum of 1,000 pounds, which has been talked about, would make it harder for individuals to diversify their risk across investments, said Deane-Johns, when the key issue should be ensuring the risks are explained and understood.

"The fear may be not so much that they will ban it, but it becomes so restrictive as to be beyond the reach of most people," Deane-Johns added.

© Thomson Reuters 2013