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What the new P2P rules mean

The collapse of two peer-to-peer (P2P) lending platforms in the last year has seen the financial regulator step up regulation of the sector.

Whilst the sector can still thrive in the longer term, the industry must act to restore confidence before it is overtaken by events.

P2P lending has grown rapidly in the last decade.

Allowing retail investors to invest as little as £1 to individuals and businesses, P2P platforms commonly offer much higher returns than those available in the traditional savings market.

P2P lending has proved extremely popular, offering investors better returns than they get on cash savings
Many platforms promise instant access when individuals want their money back.

P2P businesses typically source the loans, check the borrowers, collect repayments and chase defaults – in many ways, much like a traditional bank.

P2P lending has proved extremely popular, offering investors better returns than they get on cash savings – to which P2P platforms have compared themselves in the past – and borrowers potentially cheaper funding, or funding that they might simply have not been able to access.

Last year, according to the industry’s trade body, P2P platforms facilitated loans worth almost £3bn.

With strong lending in the first half of 2019, the total since the first loan was made in 2005 has passed £10bn.

The returns are not without risk, though – and not just that the advertised rate will not be realised or that money will take longer to be repaid than planned.

The Financial Services Compensation Scheme that protects bank and building savings up to £85,000 does not apply to P2P loans, so your capital is at risk.

As “Money Saving Expert” Martin Lewis puts it: “Peer-to-peer lending looks like savings… acts like savings, but smells like investing.”

There have been a small number of high-profile collapses in the sector recently, with investors still waiting to see how much they will get back.

Earlier this month, the administrators of one recently failed firm announced that only those who invested through the platform in the past four years would even be considered peer-to-peer investors; before that they were lending money to the P2P firm itself, and so join its list of unsecured creditors.

Even those with an interest in the loans still do not know how much they will see, however.

Upping the ante

The Financial Conduct Authority (FCA), which has regulated the sector since 2014, had concerns since the start.

Its investigations launched in 2016 found poor practice among some P2P platforms in relation to information disclosure, charging structures, wind-down arrangements and record keeping.

The continued growth and failures have only added to the calls for change.

Consequently, new rules drawn up in the wake of recent collapses came into force on Monday, 9 December.

When considering the new regulations, it is worth remembering what the FCA is seeking to achieve.

This, according to its policy statement published in June, is that investors in P2P platforms can make informed decisions, setting out the minimum information that P2P platforms need to provide; that they have clear and accurate information about the investment risk; that they are appropriately rewarded for this; and that they understand their capital is at risk and may suffer losses.

A glance at the online consumer reviews of some P2P lending firms suggests that these objectives may have not always been met in the past.

It is hard to argue that the changes the FCA is bringing in will not help in addressing some the concerns aimed at the sector.

P2P platforms must now clarify governance arrangements and controls, particularly around credit risk assessment, risk management and valuation (with regards to the loans and borrowers); there are new rules around the wind-down of the platforms, so that the loans can still be managed and administered even if the platform fails; and new details on the minimum information given to investors, with greater transparency around the role of the platform, fees and the arrangements for winding down.

For many established P2P platforms doing much of this already, the requirements will present few difficulties.

For others, they do not seem unreasonable.

More importantly, there are also a number of changes specifically designed to protect less experienced investors, particularly those not taking advice. (Those poorly advised already have some protection and potential means of redress through the Financial Services Compensation Scheme.)

These inexperienced investors will be limited to putting in 10 per cent of their investible assets in P2P, and they will have to be evaluated by the platform operator for appropriateness, assessing their knowledge and experience of this type of investment.

Moreover, there will be restrictions on marketing, so that financial promotions can only be sent to sophisticated or high net worth investors, for example.

Overall, the reforms try to ensure that firms are well run, that investors understand the risks and that those putting money in do not lose more than they can afford to, even if the firm itself goes under.

Has the horse already bolted?

Despite the new controls restrictions, the FCA has chosen not to heed those calling for a ban on sales without advice or even to ban sales to the public entirely.

Moreover, it has yet to be seen how the controls for non-advised sales will work.

On the 10 per cent restriction, investors will be able to self-certify, for example.

It will probably be some time and perhaps another review before we know how well this works in practice.

And the same is true of firms’ checks on appropriateness.

You could make a similar criticism of the requirements around management structures and governance.

One of the complaints from investors about the failed firms to-date has been the quality and expertise of those operating them.

Simply rebadging an existing employee as a compliance officer or internal auditor is not going to significantly transform the levels of competence in a sector that is still relatively young.

Some firms may need to invest in these functions to facilitate meaningful change, for example through training or bringing in new expertise.

Perhaps the biggest criticism, however, is that the changes are much better at providing protections for future investors than existing ones.

Under the rules, those who have invested in P2P twice or more in the last two years can be reclassified by firms as sophisticated investors – removing the restrictions on investment amounts and marketing.

An individual who puts in even £10 twice over the two-year period could therefore, in theory, then be allowed to invest a big chunk of their life savings or cashed-in pension pot in P2P.

In such scenarios the FCA will expect firms to adopt a sensible approach, which should also be beneficial for the reputation of the sector.

Striking the balance

The FCA has to consider how it protects investors while at the same time not being seen to stand in the way of innovation.

Take no action and investors with too little understanding of the risks stand to lose more than they can afford; but come down too hard on P2P platforms and it risks stifling a sector that can provide opportunities for investors looking for yields and is proving popular not just in the UK but across Europe.

(While the UK market continues to be most active, France and Germany also have dozens of P2P platforms.)

It could even have panicked investors into withdrawing money en masse, potentially leading to a run on the sector which is unlikely to be a good outcome for anyone.

Overall, the new rules appear to strike this balance fairly well.

They should enable the continued development of the UK’s P2P sector and help keep it competitive in line with its view that the sector offers “valuable choices, particularly for SME lending and investors,” as the policy statement puts it.

The FCA acknowledges the challenge: “We have sought to find an appropriate balance between advancing our policy objectives and enabling future innovation in products and services.”

The rest will be down to the sector itself.

The new rules are likely to mean some investors are better informed and could reduce the amount some put into the platforms.

They are not likely to put many existing investors off the sector entirely, however.

What might do so are more high-profile collapses.

The higher returns may not look quite so attractive if the sector as whole starts to be seen as a high-risk gamble.

The P2P sector still has huge capacity for growth and can continue to play an important part in providing an increasing source of funding for British businesses and individuals, whilst offering attractive returns to investors.

But to do so long-term, it needs to put the right governance, controls and care for customers in place.

It has great potential; whether that is realised is in firms’ own hands, or that of their peers.

By Mark Turner

Source: FT Adviser