For most start-ups, regulation is a dirty word. In the “fintech” sector – the nickname for the burgeoning collection of peer-to-peer lenders, online currency exchanges and crowdfunding sites outside the mainstream financial sector – regulation is the main obstacle between remaining a niche activity and becoming the norm.
“We’ve been lobbying all of the various stakeholders – the Treasury, politicians and the Financial Services Authority – to get us regulated because it would be a good thing for what we do,” says Giles Andrews, who heads Zopa, a peer-to-peer lending service, which has lent more than £200m since it was founded in 2005.
“I don’t think the man on the street thinks financial regulators did an amazing job in the recent past,” concedes Mr Andrews. “But there is still faith that regulated industries are more trustworthy than unregulated industry.”
With banks reluctant to lend, a host of new financial companies have emerged in the past two years to plug some of the gap. “Fintech” start-ups have also sprung up as entrepreneurs use technology and data analysis to try to disrupt bigger, more established players.
But unclear regulation, combined with a lengthy and costly approval process, has meant that many start-ups have employed a shoot-first, field-questions-from-regulators-later approach that risks confusing consumers and drawing harsher regulatory scrutiny down the road.
Darren Westlake, chief executive of Crowdcube, which offers equity-based crowdfunding platforms for small companies, said this was the only way to launch his company.
The crowdfunding group has raised nearly £5m for small companies in the UK since its launch in 2011. Investors range from standard angel investors – who have pumped in as much as £100,000 in a single investment – and regular punters, who are able to throw in as little as £10.
“We couldn’t find a way to do it [with FSA approval], really. We looked at the procedures and processes that we needed to have in place. If you were to do all of the processes that a stock broker would do for a £10 investment, you’d spend more than £10. It was about finding the best way to do this.”
Instead, Crowdcube took another route. When a company tries to raise money through Crowdcube, the company becomes a subsidiary of Crowdcube. Companies are allowed to issue shares in subsidiaries without FSA approval.
Crowdcube’s website states that it has been approved as a “financial promotion” by Bishop Fleming, the accountancy firm, in its capacity as an FSA-authorised company. “We don’t push that in people’s faces,” said Mr Westlake. “We’re not using it as a selling point. We have to say that for regulatory reasons. We don’t think it confuses anyone.”
By contrast, Seedrs, another crowdfunding site, spent 18 months preparing its application to the FSA, which took 13 months for the regulator to process: a long time for any company – particularly a start-up.
“FSA authorisation is simpler than people make it out to be: you’re either authorised, or you’re not,” says Jeff Lynn, co-founder of Seedrs. “There’s no halfway ground.”
Crowdcube has also applied for FSA approval, which it hopes to have secured in early 2013.
The FSA raised concerns about the absence of regulated crowdfunding companies last summer, pointing out that they “may not have adequate protection in place for investors”.
“The crucial point for investors to understand is that the FSA firm’s ‘approval’, and the regulatory protections that go with that, only cover the marketing side,” says Clive Cunningham, a partner at Herbert Smith Freehills, a law firm. “There is no ‘approval’ of the investment itself or the investee company or what happens to investors’ money.”
Simon Dixon, founder of crowdfunding site Bank to the Future, says reputation, rather than rules, is driving his company to look at regulation. “It is confusing for the industry,” says Mr Dixon. “We are one of the only industries lobbying for regulation.”
Calls for regulation from established players in the market, however, are met with cynicism by some rivals. “No real entrepreneur wants to be regulated,” said the head of one non-FSA regulated financial start-up. “It’s political or tactical when they call for regulation. If you regulate too much, it just protects the incumbents.”
With the FSA set to morph into the Financial Conduct Authority this year, the sector’s wishes for more regulation could come true. “It is too early to say, but it would not be surprising if the new conduct regulator, the Financial Conduct Authority, with its statutory responsibility for ‘consumer protection’, takes a more proactive – and possibly more intrusive – interest in protecting crowdfunding investors,” says Mr Cunningham.
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