* Growing market raised 1.2 bln euros in 2011
* Lack of tailored regulation viewed as obstacle
* Regulators have highlighted risks
By Kylie MacLellan
LONDON, Dec 7 (Reuters) - The peer-to-peer lending industry has welcomed a commitment by the British government to regulate the internet-based financiers, describing it as a "watershed moment".
So-called crowdfunding providers and peer-to-peer lenders, which help businesses and individuals to raise cash from members of the public, had said that rules tailored to more traditional markets were holding back development of a vital source of finance.
But from April 2014 peer-to-peer lenders, such as Zopa and Funding Circle, will be regulated by the new Financial Conduct Authority (FCA) and consultation will begin early next year to decide how the new rules will work, the Treasury reiterated on Friday after an announcement in parliament last month.
"We have always strongly believed that introducing proportionate regulation was necessary to enable the sector to continue to flourish," the Peer-to-Peer Finance Association said.
"We are committed to working closely with the government and the Financial Conduct Authority over the coming months to build the right framework for our future."
The crowdfunding industry has developed in response to reduced bank lending to small and medium-sized businesses because of tougher capital rules and greater regulatory scrutiny.
A host of alternative financing models have cropped up online, many allowing individuals to lend to, or invest in, companies with sums from as little as 10 pounds ($16). Massolution, a research and advisory firm specialising in the sector, says that 1.2 billion euros ($1.6 billion) was raised globally from crowdfunding last year.
Though some websites have tried to fit their operations within existing regulation, most remain largely outside it.
Part of the problem in drawing up appropriate regulation is the wide range of activities involved. Some offer debt, some equity, while others seek donations for charity or funding for creative projects in return for some non-financial reward.
With little or no expected returns from the latter, the main focus on the need for regulation has been around equity crowdfunding and peer-to-peer lending.
The government, keen to improve the flow of finance to small businesses to boost the sluggish economy, has also set up a working group to look at all aspects of policy on such websites.
As well as making sure that individuals are aware of the inherent risk involved with putting money in start-ups, the industry wants to ensure that platforms vet businesses adequately to avoid scams.
"Regulation is on its way," Susan Kramer, a Liberal Democrat member of the British parliament's upper house, said at an industry summit on Friday. "It is not a question of 'will there be regulation?', it is a question of 'will it be the right regulation?'"
Britain's Financial Services Authority (FSA) warned in August that inexperienced investors should be aware of the risks when using crowdfunding websites. A few days later United States securities regulators put crowdfunding at the top of their annual investment scams list.
At the moment, the FSA considers authorisation of equity crowdfunding schemes case by case, it said.
Views differ about how to tackle these risks without stifling an increasingly important source of funding, and the matter is complicated by the varying rules already in place in different countries across Europe.
Measures taken by Seedrs, the only crowdfunding website to have received FSA approval, include the requirement for investors to pass a test to show that they understand the risks.
"It is hard to come up with a whole securities regulation; sometimes it does have to be a bit incremental and adaptive," Seedrs founder Jeff Lynn said. "There is no question at all that this is going to be a space that will continue to move."
Some would like the operation of such platforms to be a distinct regulated activity, but others argue for smaller steps, such as a cap on the sums that people can invest or lend.
Though the introduction of a separate regulated activity could still be some way off, lawyer and co-founder of peer-to-peer site Zopa, Simon Deane-Johns, said that increased engagement with government and regulators was encouraging.
"Over the next year or two it should become progressively easier to set up a platform," he said.