0908/2016

FCA Authorisation for crowdfunding platforms

 

Introduction

 

This article outlines the application process in respect of obtaining authorisation from the FCA to run a debt and equity crowdfunding platform and outlines what information is required, the process and likely timescales to obtain FCA authorisation.

 

Regulation  

 

Whilst there are several forms of crowdfunding, the FCA regulates two types of crowdfunding:

 

  • loan-based crowdfunding: this is where consumers lend money in return for interest payments and a repayment of capital over time[1]. This is debt crowdfunding.

 

  • investment-based crowdfunding: consumers invest directly or indirectly in new or established businesses by buying investments such as shares or debentures[2]. This is equity crowdfunding.

 

In order to do either of the above, you will need to be authorised by the FCA.

 

Preparing your application

 

Before you submit an application:

 

  • Decide what permission you are applying for
  • Prepare a business plan
  • Ensure that you are prepared to comply with your obligations under the FCA handbook (www.fshandbook.info/FS/index.jsp)
  • Decide on the minimum financial requirements
  • Decide which systems and controls will support the activities and meet the FCA’s rules
  • Check that you have the right staff and check they have the appropriate qualifications
  • Decide on who will be the ‘approved person’ (or approved persons if more than one) and apply for this approval
  • Check that you meet the FCA’s threshold conditions which can be found here (https://www.handbook.fca.org.uk/handbook/COND/2/) including ensuring you have sufficient funds to meet the FCA’s capital requirements 

 

Permission

 

Before applying for authorisation, you must decide what permission you will need from the FCA. We have found that it is common for crowdfunding platforms to have the following permissions for regulated products and services: providing credit to consumers (specifically operating an electronic system in relation to lending), giving investment advice and arranging deals in investments. This is not an exhaustive list and the permission you seek can be tailored specifically to the activities you will carry out.

 

Business plan

 

The FCA lists the following as to what should be included in the business plan. It is not an exhaustive list:

 

  • A full explanation of your business, its background (including its legal structure and creation) and what it is intending to do
  • If you have identified a specific business opportunity or customer base
  • Your objectives (things like market share, aims, assets under management)
  • Any long-term strategy and expansion plans
  • A clear view on your target market, key customers, distribution, products and pricing
  • The experience your customer will have of your business from day one
  • Details of your intended investment strategies, fee and remuneration policies, governance framework and key personnel
  • What experience your firm's principals have of the type of regulated activities you want to conduct
  • The employment background, experience and relevant qualifications of all individuals who will be performing significant influenced controller functions and how this will help them with their role
  • Financial projections for at least one year (although you can send these separately with your financial accounts) including provisions to meet FCA capital requirements
  • Any key dependencies and business risks
  • Your marketing strategy
  • Details of any outsourcing plans or other key operational matters
  • An analysis of key conduct risks

 

Financial requirements

 

The FCA sets out minimal financial regulatory requirements which must be met before authorisation is obtained. Firms must satisfy the FCA that they have robust governance, effective risk procedures and adequate internal control mechanisms to manage their financial crime risk. By using effective systems and controls, your firm can detect, prevent and deter financial crime.

 

Your systems need to be appropriate and proportionate to the nature and scale of your business. There is no 'one size fits all' approach that we expect firms to adopt. It will vary, for example, between large firms and small firms, firms operating in products or areas of high risk, and those offering products to customers where the firm assesses there is less financial crime risk. [3]

 

Capital requirements

 

‪There are initial and ongoing capital requirements that FCA regulated firms must comply with. The capital requirements vary depending on the type, or types, of regulated activity undertaken. In some cases complex calculations are involved to ascertain the required capital that should be held and there are often minimum levels of capital that firms are expected to hold. 

 

The basis of the capital calculation varies depending on the type of activity undertaken. For example, it could relate to the total value of a loan portfolio managed by a firm (such as a consumer credit firm), the level of deposits held, the total amount of payment transactions carried out or the income received from the regulated activity or activities. This will be assessed at the outset and then on an ongoing basis.

 

We have given an indication of the level of capital resources you need if you wish to operate an electronic system for lending (a peer to peer platform for crowdfunding) below.

 

Following consultation, the FCA decided that firms would need to hold the following capital:

 

The higher of:

  • The sum of:
    • 0.2% of the first £50 million of total value of loaned funds outstanding;
    • 0.15% of the next £200m of total value of loaned funds outstanding;
    • 0.1% of the next £250m of total value of loaned funds outstanding; and
    • 0.05% of any remaining balance of total value of loaned funds outstanding above £500m;
    • £20,000 until 31 March 2017; or
    • £50,000 from 1 April 2017. [4]

 

The types of financial resources that a firm must hold to meet their financial resources requirement are detailed in IPRU(INV)12.3.2R section of the FCA Handbook and are copied below for reference:

 

Item

Additional explanation

Share capital

This must be fully paid and may include:

(1) ordinary share capital; or

(2) preference share capital (excluding preference shares redeemable by shareholders within two years).

 

Capital other than share capital (for example, the capital of a sole trader, partnership or limited liability partnership )

 

 

The capital of a sole trader is the net balance

on the firm's capital account and current account. The capital of a partnership is the capital made up of the partners' :

(1) capital account, that is the account:

(a) into which capital contributed by the partners is paid; and

(b) from which, under the terms of the partnership agreement, an amount representing capital may be withdrawn by a partner only if:

(i) he ceases to be a partner and an equal amount is transferred to another such account by his former partners or any person replacing him as their partner ; or

(ii) the partnership is otherwise dissolved or wound up; and

(2) current accounts according to the most recent financial statement. For the purpose of the calculation of financial resources , in respect of a defined benefit occupational pension scheme :

(1) a firm must derecognise any defined benefit asset;

(2) a firm may substitute for a defined benefit liability the firm's deficit reduction amount, provided that the election is applied consistently in respect of any one financial year.

Reserves (see Note)

 

These are, subject to the Note below, the audited accumulated profits retained by the firm (after deduction of tax, dividends and proprietors' or partners' drawings) and other reserves created by appropriations of share premiums and similar realised appropriations. Reserves also include gifts of capital, for example, from apparent undertaking. For the purposes of calculating financial resources , a firm must make the following adjustments to its reserves, where appropriate:

(1) a firm must deduct any unrealised gains or, where applicable, add back in any unrealized losses on debt instruments held, or formerly held, in the available-for-sale financial assets category;

(2) a firm must deduct any unrealised gains or, where applicable, add back in any unrealized losses on cash flow hedges of financial instruments measured at cost or amortised cost;

(3) in respect of a defined benefit occupational pension scheme :

(a) a firm must derecognise any defined benefit asset ;

(b) a firm may substitute for a defined benefit liability the firm's deficit reduction amount, provided that the election is applied consistently in respect of any one financial year.

Interim net profits (see Note)

 

If a firm seeks to include interim net profits in the calculation of its financial resources, the profits have, subject to the Note below, to be verified by the firm's external auditor, net of tax, anticipated dividends or proprietors' drawings and other appropriations.

Revaluation reserves

 

 

Subordinated loans/debt

 

Subordinated loans/debt must be included in financial resources on the basis of the provisions in this chapter that apply to subordinated loans/debt.

Note

Reserves must be audited and interim net profits, general and collective provisions must be verified by the firm's external auditor unless the firm is exempt from the provisions of Part VII of the Companies Act 1985 (section 249A (Exemptions from audit)) or, where applicable, Part 16 of the Companies Act 2006 (section 477 (Small companies: Conditions for exemption from audit)) relating to the audit of accounts.

 

If you have additional permissions you may also need to hold additional capital if they relate to the holding of assets or lending, for example if you became an authorised payment institution, e.g. to facilitate payments between the parties involved, you would need to hold at least £125,000 or a larger amount based on either:

 

  • Your fixed overheads for the preceding financial year
  • Your payment volume
  • An amount taking into account interest income, interest expenses, gross commissions and fees received and gross other operating income

 

More accurate estimates can be made once you have a finalised business plan.

 

Systems and controls

 

You will need to decide which systems and controls will support the firm’s activities and meet the FCA’s rules – you should plan to test and launch these before the FCA makes a decision on the application.

 

Personnel

 

You must ensure that the those running the business have the appropriate qualifications and experience.

 

Approved persons

 

This person has to know and meet the FCA’s regulatory requirements, as well as understand how the FCA apply them.

 

They must:

  • Meet the requirements of the FCA’s 'fit and proper' test and follow its principles
  • Comply with the Statements of Principle and Code of Practice (these explain the behaviour expected of people the FCA approve)
  • Report anything that could affect their ongoing suitability to us and the authorised firm.

 

The FCA can only approve people when they are satisfied that they are fit and proper to perform the controlled function(s) they apply for.

 

The FCA will want to approve at least one person in a consumer credit firm when it applies to be authorised. Individuals cannot perform regulated activities unsupervised until they are assessed as competent.

 

Anyone who deals with customers will probably need approval. Most advisers (eg financial and retail advisers, investment managers) will need approval.

 

Threshold conditions

 

The threshold conditions are set out in the Financial Services and Markets Act 2000 (FSMA) and are the minimum requirements that firms need to meet to become and remain authorised.

 

The FCA threshold conditions for FCA-authorised firms include:

 

Location of offices (see Location of offices (COND 2.1).

 

In broad terms, it requires a firm's head office and, in particular, its mind and management to be in the UK if it is incorporated in the UK.

 

Effective supervision (see Effective supervision (COND 2.3).

 

The effective supervision threshold condition means that a firm must be capable of being effectively supervised by the FCA. The condition covers all circumstances, including the nature and complexity of the firm's regulated activities, the complexity of its products and the way in which its business is organised. It complements the FCA's duty to supervise the firms it regulates.

 

COND 2.3.3G states that, in assessing the effective supervision threshold condition, factors that the FCA will consider include whether:

 

  • It is likely that the FCA will receive adequate information from the firm, and those persons with whom the firm has close links, to enable it to determine whether the firm is complying with the requirements and standards under the regulatory system for which the FCA is responsible and to identify and assess the impact on its statutory objectives
  • The structure and geographical spread of the firm, the group to which it belongs and other persons with whom the firm has close links, might hinder the provision of adequate and reliable flows of information to the FCA

 

Appropriate resources (see Appropriate resources (COND 2.4).

 

Resources includes both financial and non-financial resources:

 

  • Non-financial resources. - for the purposes of the threshold conditions, a firm's "non-financial resources" include any systems, controls, plans or policies that the firm maintains, any information that the person holds and the human resources that the firm has available.

 

  • Financial resources. The FCA will consider whether FCA-authorised firms are ready, willing and organised to comply with the detailed financial resources requirements set out in the Prudential Standards part of the FCA Handbook (as detailed above) when assessing if they have appropriate financial resources for the purposes of the threshold condition. Relevant matters to which the FCA may have regard when assessing whether a firm will satisfy, and continue to satisfy, this threshold condition may include but are not limited to:
    • Whether there are any indications that the firm may have difficulties if the application is granted, at the time of the grant or in the future, in complying with any of the FCA's prudential rules
    • Whether there are any indications that the firm will not be able to meet its debts as they fall due
    • Whether there are any implications for the adequacy of the firm's resources arising from the history of the firm. For example, whether the firm been adjudged bankrupt or entered into liquidation
    • Whether the firm has taken reasonable steps to identify and measure any risks of regulatory concern that it may encounter in conducting its business and has installed appropriate systems and controls and appointed appropriate human resources to measure them prudently at all times
    • Whether the firm has conducted enquiries into the financial services sector in which it intends to conduct business that are sufficient to satisfy itself that:
      • it has access to adequate capital, by reference to the FCA's prudential requirements, to support the business including any losses that may be expected during its start-up period; and
      • client money, deposits, custody assets and policyholders' rights will not be placed at risk if the business fails
      • Whether the firm's resources are commensurate with the likely risks it will face

 

Suitability (see Suitability (COND 2.5).

 

The emphasis of this threshold condition is on the suitability of the firm itself. The suitability of each person who performs a controlled function will be assessed by the FCA under the approved persons’ regime. In certain circumstances, however, the FCA may consider that the firm is not suitable because of doubts over the individual or collective suitability of persons connected with the firm.

 

Business model (see Business model (COND 2.7).

 

The business model threshold condition involves the FCA assessing whether a firm's strategy for doing business is suitable for its regulated activities. It is intended to demonstrate the importance that the FCA places on a firm's ability to put forward an appropriate, viable and sustainable business model that reflects the nature, scale and complexity of the business the firm intends to carry out.

 

COND 2.7 identifies the issues that firms should take into account to demonstrate to the FCA that their business model is appropriate to the regulated activities they undertake. These include:

  • The assumptions underlying the firm's business model and justification for it
  • The rationale for the business the firm proposes to do or continues to do, its competitive advantage, viability and the longer-term profitability of the business
  • The needs of and risks to consumers
  • The expectations of stakeholders (for example, shareholders and regulators)
  • The products and services being offered and product strategy
  • The governance and controls of the firm and of any member of its group (if appropriate)
  • The growth strategy and any risks arising from it
  • Any diversification strategies
  • The impact of the external macroeconomic and business environment
  • How the firm intends to implement its business model, including such areas as the procurement, outsourcing and recruitment arrangements
  • Sustainability. For example, the identification and mitigation of potential risks and any contingency plans
  • Firms should ensure that any adjustments to its business model:
    • Are approved at an appropriate level in the business
    • Are considered in the light of any potential risks, impacts and consequences of the proposed changes
    • Appropriately take into account the needs of and risks to clients and relevant consumers

 

 

Application form

 

An application form and accompanying documents must be submitted to the FCA. Detailed below is an outline of the information required and the fees.

 

How to apply and the fee

 

All firms apply online using Connect which is the FCA’s online application system.

 

The fee payable depends on whether the application is straightforward (£1,500), moderately complex (£5,000) or complex (£25,000).

 

The fee is payable once the application has been submitted and is non-refundable. This is done online with a credit or debit card.

 

Applicant contact details form

 

You must detail the full name, contact number, email address and full address of the person associated with the application. You must also detail whether or not there has been a pre-application meeting with the FCA.

 

Corporate controller form

 

This asks for information about the corporate entity such as the name, legal status, registration number and registered office. It also requests the company’s latest financial statements, details of any litigation (past or present), details of any complaints, director details and a structure chart.

 

Firms selling investments form

 

This application form requests the following details:

 

Regulatory business plan: this should include a background to the business, why the firm wishes to carry out the activity, whether a business opportunity or customer base has been identified, long term strategy and expansion plans, where the customers will be sourced, current business lines, details of the services, past employment history of advisers and experience of the firm.

 

Scope of permission required: what type of clients the firm will have, what permission is sought, what legislation applies.

 

Financial resources: The FCA will need to be satisfied that the firm meets its financial requirements. They will want details relating to: whether or not the firm will hold client money, 12 month financial projections, which prudential category applies, shareholdings in the firm, sources of external funding, insurance details, opening balance sheet, forecast balance sheet and monthly cashflow forecast.

 

Personnel: The FCA will want to be satisfied that the firm has staff that have adequate skills and experience. They will want details as to who will hold these roles.

 

Compliance arrangements: Please see below for information relating to compliance and financial crime. The FCA will also want to know the method of sale (i.e. internet, face to face and/or telephone). 

 

Owners and influencers

 

Information relating to who owns and controls the firm must be disclosed. The information required includes, how many controllers there are (shareholders and % shareholding) and a structure chart.

 

Also, information about any close links the firms has with any other companies which can include subsidiary companies must be provided.

 

Disclosure of significant events

 

This relates to information relating to bankruptcy, criminal investigations and civil proceedings.

 

Detailed IT controls form

 

This is an IT self-assessment questionnaire to work out whether to complete the detailed IT controls form, an IT controls form, or neither form.

 

The information required includes: the nature and scale of the operations, details about the complexity of the IT systems and the features of the IT systems.

 

Compliance procedures

 

You are not required to send compliance procedures with the application, but must be able to produce a copy at any time while the FCA are assessing the application or in the future. The FCA states the following in respect of a compliance monitoring programme:

 

You must establish, maintain and carry out a programme of actions to check that it complies and continues to comply with the compliance procedures. This is called a compliance monitoring programme, which must be sent with the application.

 

The compliance monitoring programme must be relevant to the regulated activities so the compliance monitoring programme must be tailored.

 

A compliance monitoring programme must describe the action that will be taken to ensure compliance with the FCA's rules and guidance at all times, in particular:

  • What checks will take place
  • How often the checks will take place, as appropriate to the procedure being checked - this might be daily, weekly, monthly, quarterly, annually or another period specified by the FCA
  • Who will carry out the checks - this is the role of the person who will make the check, such as the compliance officer, training and competence officer, money laundering reporting officer
  • What records of the checks will be kept to confirm they have taken place

 

Financial crime procedures

 

In respect of financial crime, you must have in place procedures to counter the risks that it might be used by third parties to further financial crime. This includes any offence involving:

 

  • fraud or dishonesty,
  • misconduct in, or misuse of information relating to, financial markets or
  • handling the proceeds of crime.

 

The FCA details that the financial crime procedures will include the following:

  • The steps taken to ensure its Money Laundering Reporting Officer (MLRO) knows their duties and is able to perform their controlled function effectively
  • The procedures that will be in place to ensure that the applicant will obtain sufficient evidence of the identity of and undertake all necessary due diligence exercises in relation all its clients
  • The systems and controls that will be in place to ensure that know your business information is made available to the applicant firm's MLRO
  • The anti-money laundering training that will be provided for all relevant staff; and
  • The disciplinary procedures for any member of staff who fails to report promptly to the MLRO any suspicions or belief that money laundering is occurring

 

Timescales

 

The FCA on receipt of your application may ask for further information and may even arrange a meeting.

 

The FCA will make a decision on completed applications within 6 months. If the application us incomplete, it may take 12 months.

 

Review of regulatory framework   

 

The FCA’s rules on crowdfunding were introduced in 2014 and the FCA committed to carrying out a full post-implementation review of the crowdfunding market and regulatory framework in 2016 to identify whether further changes are required. The FCA have invited readers to engage with the review, to offer feedback about the areas FCA should consider and thoughts on the sector by 8 September 2016. [5]

 

Areas of concern for the FCA include the standards of disclosure. The FCA have stated:

 

We have some potential concerns about how firms are presenting information to investors. It is, for example, quite difficult to find clear information on default rates on platform websites or to understand how the likelihood of default differs depending on when a loan was originated (i.e. default rates by vintage). Such disclosures could make trends in underwriting standards more transparent to investors. We plan to do additional work in the coming months to review disclosure standards, increasing our supervisory focus on standards of promotion and disclosure by firms operating loan-based crowdfunding platforms. If necessary, we could consider whether to mandate in detail the disclosures we expect and the time that those disclosures must be provided. [6]

 

An outcome of the review will determine what changes the crowdfunding sector faces. The FCA have said following the review, they will take into consideration:

 

  • Whether to mandate additional disclosures, to help potential investors better understand the risks. For example, by setting out how many businesses that raised funds have since failed and how many have had successful pay-outs
  • Whether to require firms, when setting out the money raised, to only include money contributed on the platform from persons unconnected to the business
  • Whether to subject investment-based crowdfunding platforms to new due diligence standards[7]

 

In terms of how much change there will be, according to Forbes, “it may well find areas where rules need tweaking, because the marketplace looks very different today than when regulation first came into force. However, there is no reason to think, in the absence of any evidence to the contrary, that crowdfunding platforms have done anything other than introduce a welcome dose of innovation in financial services”. [8]

 

 

Contacts:

 

                                       

Peter Howitt                                Sheena Subherwal Patel                 John Pauley

Director                                         Associate                                           Associate

peterhowitt@ramparts.eu             sheenapatel@ramparts.eu                 johnpauley@ramparts.eu

 

2nd Floor, 3 Hardman Square, Spinningfields, Manchester, M3 3EB

Tel: +44 161 914 9785

 

DISCLAIMER

We are qualified to provide legal advice on English, Gibraltar and European law. Any opinion, statement or information relating to any other law expressed above or in our correspondence are not intended as legal advice and should not be relied upon as such, and no liability will be accepted in this respect.

 

 

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