In the second of a two-part series, Chris Maule, CEO and founder of UK Bond Network, discusses the why misleading information can be an issue for investors in the peer2peer sector.
In my last article, I explained why insufficient information was a problem among crowdfunders. But as importantly, the Financial Conduct Authority(FCA) has also expressed concern about the misleading nature of the information available.
The FCA found that many platforms downplay the level of risk for investors by claiming that no capital has been lost, or by positioning risk warnings below more attractive performance information on their websites.
Another problem that is likely to come to light in future is the quoting of forecast default rates. If the actual default rate turns out to be lower than that forecast, then that’s great and shows a platform is doing a good job. If the actual rate turns out to be higher however, and an investor would be justified in stating that a platform mislead them at the point of investment, they would have right to recourse for the difference in losses – that between the forecast and actual default rates.
The credit ratings that many crowdfunders use to judge a business’ investment rating can also be questionable, and are sometimes based on no more than an online credit check. The risk is that these systems can be ‘gamed’ and consequently platforms may inadvertently be providing misleading information to investors. Even more of a concern to platforms is that providing a credit rating could be perceived as providing advice – something platforms do not necessarily have the appropriate regulatory cover to do – exposing them to yet more regulatory risk.
The FCA also expressed concern over some platforms’ claims that they place retail investors on an equal footing with venture capitalists. This is misleading as, in exchange for the high risk that venture capitalists assume by investing in smaller and less mature companies, they usually get extensive control over company decisions (including often a board seat), in addition to a significant portion of the company’s ownership and value. This isn’t a benefit that retail investors operating via crowdfunding platforms receive and, as the FCA notes, even when a crowdfunded business succeeds, often“equity dilution means that they do not share in the profits to same extent.”
A“lack of balance”in the information provided to investors by equity crowdfunders was also noted by the FCA. Here, benefits are emphasised and risks downplayed. Most products offered on crowdfunding platforms are unsecured, being either equity or unsecured debt, so investors have little or no protection in the event that the company defaults or becomes insolvent. At UK Bond Network, we ensure all details about the investment are transparent, including general risks in the sector and also those specific to the transaction. In addition bonds offered via the platform are secured.
The report also reviewed the financial promotions of a number of mini-bonds, considering both those available on crowdfunding platforms and through direct marketing. They found that firms are often failing to make clear that mini-bonds are investments that place investors’ capital at risk, and are not deposit-based or capital-protected products. Because of this it is misleading to compare the operation of and returns available through mini-bonds with more traditional and familiar financial products, such as savings accounts. At UK Bond Network, we accept that higher risks are involved in lending money compared to holding it in a savings account, which is why we take significant steps to assess our investors’ financial understanding and recognise the risks inherent in any investment made through our platform.
Despite initial growing pains for some crowdfunders, the industry and its investors should be reassured by this review, as increased scrutiny will only improve transparency in the sector. With a wider FCA review due to take place next year, it’s now within alternative finance platforms’ best interests to take a mature, responsible approach to communicating the realities of their offerings to businesses and investors.