If this sector fails, it won't be the fault of regulation
"The social investment sector does not have a regulatory barrier to it for crowdfunding, it has a market infrastructure problem." Theresa Burton, co-founder of Buzzbnk and CEO Trillion Fund, responds to the Financial Conduct Authority's (FCA) call for views on regulation of the social investment market.
The Financial Conduct Authority (FCA) have recently put out a “Call for input: Regulatory Barriers to Social Investment" and Big Society Capital have responded.
I have a bit of experience in this area, having co-founded Buzzbnk.org in 2009 exactly to help raise loans for social enterprises and charities from the public at large via crowdfunding. With over six years of experience in both the social enterprise sector as well as crowdfunding I have some strong views on the challenges and issues facing the social investment sector.
I was a founding director of the UK Crowdfunding Association (UK CFA) for two years and helped structure the UK CFA response to the FCA and government consultations on crowdfunding and peer-to-peer lending (P2P). I know P2P lending extremely well, both from a hands-on, day to day perspective, but also the market, what's next (P2P ISAs), and how the regulations work. I spent a year understanding and building the technology for investment-based crowdfunding with Trillion and am very aware, and supportive, of the important financial promotion protections in place for investors.
I have just finished a full FCA application for loans-based crowdfunding (also called P2P) and know every detail and line and what the FCA handbook looks like for a regulated business. In short, I know pretty much every aspect of the business of regulated crowdfunding.
My conclusion? The social investment sector does not have a regulatory barrier to it for crowdfunding, it has a market infrastructure problem. The retail social investment sector (investments by individuals, and not institutions, in charities and social enterprises) is so early stage, so nascent, so small, so risky that there are very few providers – also known as social investment finance intermediaries (SIFIs) – operating.
Why would we not want regulated protections for retail investors as with any other investment?
What the retail social investment sector needs is significant investment and perhaps also subsidy, in strengthening the existing SIFIs and investing in new ones. It certainly needs subsidy for transactions sizes less than £500,000 until the market is bigger and more investment readiness programmes for these smaller raises.
Where could these funds for investments in SIFIs come from? The usual suspects, Big Society Capital, Big Lottery, major foundations and some new ones such as Access Foundation. What is clear to me, after trying to raise capital from over 40 private sector VCs and Angels for Trillion/Buzzbnk, is the market is still way too small and risky for them to be interested to invest.
Reducing the investor protections because the sector can't or won't invest in building the market infrastructure, or because they want to pass on the subsidy needed for much of the investment on offer today, is woefully passing the buck to the public.
Why would we not want regulated protections for retail investors as with any other investment? Regulations ensure that the material presented for investment is fair, clear and not misleading. That all claims are substantiated. That all customers are treated fairly. That the FCA authorised crowdfunding firm presenting the investment have a strong set of systems, controls and procedures. That the firm has capital adequacy and provisions in place to ensure continued service is in place for the investors. That IT systems are tested for security and backup and restore procedures are in place. That any money is protected in a client money account. That the investor has recourse to the Financial Services Ombudsman. Regulation means fees and commissions must be fair and transparent. That key persons are fit and proper, hold the experience and skills necessary with honesty and integrity.
No regulation or regulator is perfect, but why would we not want the above protections for the social investment sector? For the sake of short term gain to grow it more quickly? At the moral hazard of real misuse and misrepresentation?
The scenario of reduced protection and the application of a generous tax incentive, Social Investment Tax Relief (SITR), is a recipe for disaster – would we see hard sales processes, un-transparent fees, misuse, fraud? This would destroy trust in the retail social investment sector.
Lets do this right and not take short cuts at the expense of the public.
We mustn't ask the retail investor to accept any less dignity in treatment than any other kind of investment. They deserve full rights to know the facts and make their own decision if they want to invest based on that. I have no problem with an investor choosing to trade off risk for impact, but it needs to be transparent and clearly explicit. Not hidden in a fuzzy sense of "goodwill".
In the post from Simon Rowell at Big Society Capital he calls for a “modernising” of the regulations – what does this mean? The UK has one of the leading regulatory frameworks for crowdfunding in the world, ahead of the US, balancing the protection of the retail investors to growing the equity and debt crowdfunding market, providing much need capital to business and creating jobs.
Rowell notes that the FCA have to explain “over six separate powerpoint presentations demonstrates how complex this area really is” and that “this call is needed” – but this is counter to the evidence presented further on in the blog that the UK has billions of pounds of direct investment flow from interested individuals to SMEs through peer-to-peer and crowdfunding, thus showing that, in fact, the UK regulatory framework is fit for purpose and crowdfunding is growing rapidly to scale.
And it is not true that investors can’t choose to trade off impact for risk or return, that “this route is often closed off”. There is nothing in the regulations that prohibit an explicit, transparent offering of a lower interest rate or return on a regulated crowdfunding platform. The point is that the investor must be given fair, clear and not misleading information and that claims are verified by a third party.
He also writes that “charities and social enterprises are missing out” on the billion pound crowdfunding market. They are missing out not because regulations are not fit for purpose, but because the sector is so small and early stage.
All regulated crowdfunding platforms know this is a go big or go home game. They need massive volume to get to economy of scale to get to break-even and beyond to profits. Being a “FinTech” company (just had to fit that buzzword of the day in at least once) requires significant upfront investment, which is why the big players are generic or focusing on large asset classes like property. They have to demonstrate a large enough market to off-set the risk of investment. We simply don’t have that in the retail social investment sector. Not now. And not for a very long time.
It is time the leading social sector bodies get together and tackle the tough problem in front of it. No foundation or fund can do it on its own, it needs a joint effort to spread the risk and have a program of significant investment in SIFIs focusing on growing retail investment.
Passing this off as a problem of regulation is, simply, not fair. Social investors who are individuals (retail) should not have to compromise on any of the protections I have outlined above. We need to build and keep their trust and this is not achieved overnight. This is a long-term game and none of us, I am sure, want to see a massive mis-selling scandal, or worse, at the end of it, tarnishing the social enterprise sector by reducing or removing regulation.
Lets do this right and not take short cuts at the expense of the public.
Photo credit: Alexandre Perotto