The peer-to-peer lending industry is waiting with baited breath for the regulator’s full report from its review into the sector. Will its outcome herald a new era for P2P, or just new hurdles to overcome?
It is often said that a week is a long time in politics and the same can be said for peer-to-peer lending regulation.
It is just over a year since the Financial Conduct Authority (FCA) first announced a call for input on the P2P sector as part of a post-implementation review that it promised when the industry came under its regulatory scope in 2014.
We had a glimpse of the FCA’s thinking with an interim statement in December that showed that the City watchdog is worried that consumers aren’t aware of the risks, with suggestions that investment limits may be introduced and some concerns about provision funds.
At the time of the call for input in July 2016 the Peer-to-Peer Finance Association’s members had a cumulative loan book of £5.8bn.
Since then, originations have grown to £8.4bn as of the end of the first quarter of 2017 and this corner of the alternative finance market has moved from technology entrepreneurs to ISA managers and even, in the case of Zopa, a future bank.
It’s a long way from the Office of Fair Trading (OFT) regulation in the days before 2014.
P2P firms that had launched before April 2014 were given interim permissions when regulation transferred to the FCA and have had to apply for full authorisation.
“Comparing the two is like chalk and cheese,” says Julian Cork, chief operating officer of P2P property lender Landbay.
“The OFT was focused on making sure you were fully registered as a company and people knowing you were on their list.
“There wasn’t the full detailed due diligence.
“As soon as the FCA created the regulatory regime there was a lot of work to do.”
Landbay gained authorisation in December last year but the process took 15 months.
“There was a lot of talking to our case manager and interpretations of evolving rules,” Cork adds.
“Regulation has created a bigger barrier for entry but it was the right thing to do in terms of making sure the market balances innovation and growth with consumer protection.”
Other platforms who worked under the OFT regime, such as Zopa and Funding Circle, have only received full FCA authorisation in recent months, while others such as The House Crowd, formed in 2012, are still waiting.
So, is the FCA up to the challenge of regulating the industry and will its full review, due to be published over the summer, be out of date before it reaches the printer?
Emily Reid, partner at law firm Hogan Lovells, says the FCA could easily translate protections across to borrowers in similar ways to retail banks, but there is no direct comparison for lenders.
“The focus will therefore continue to be on whether retail lenders are adequately protected and what more needs to be done,” Reid asserts.
“The introduction of the Innovative Finance ISA (IFISA) has increased the tempo, especially as most of the bigger platforms have now received full permission and are able to market the IFISA to their customers.
“Apart from retail lender protections, the FCA may well decide to focus on ensuring business continuity in the event of a platform or servicer failure, on systems and controls around client money and on any areas of perceived or actual conflict of interest that work to the detriment of the retail lenders.”
The industry saw some signs of the FCA’s teeth when it wrote to platform bosses in February to stop wholesale lending where it is in breach of regulations.
So what other aspects of the sector could the FCA focus on?
One area of concern in the FCA’s interim statement was provision funds.
“Certain features introduce risks to investors that are not adequately disclosed and may not be sufficiently understood by investors,” the report said.
“For example, the use of provision funds may obscure the underlying risk to investors, which may result in investors believing that platforms are providing an implicit guarantee of the loans they facilitate.”
Stephen Findlay, chief executive of P2P investment manager BondMason, is a vocal opponent of these types of perceived safety nets. He argued in a report earlier this year that provision funds “do little (nothing) to improve returns for well-diversified investors” and provide an “illusion of protection.”
“I’m not sure the FCA is comfortable with the regulatory position or nature of permissions required to operate a new provision fund,” he told Peer2Peer Finance News.
“I can see these being phased out, perhaps replaced with insurance contacts instead. “
Provision funds have been used by some of the best-known platforms.
Zopa is currently in the process of retiring its SafeGuard Fund, something a spokesperson said is unrelated to the FCA review.
“The FCA has created a purpose-built regulatory framework for P2P business,” a spokesperson for Zopa says.
“This framework is based on the different activities that P2P lenders perform.
“It has ensured that customers get the appropriate information and rights while providing regulatory clarity for the platforms.
“We believe that the certainty afforded by the framework has played a significant role in both improving practices across the industry and supporting sustainable growth.”
Another platform, RateSetter, also has its own provision fund, but there is no sign of it being scrapped. A spokesperson declined to comment.
The P2P sector also has its own ideas of what it would like to see in the report.
Cork says the final report will create an opportunity to mandate best practices on loan book transparency, something members of the P2PFA, such as Landbay, have done.
“Doing that more widely across the whole industry could help in letting people understand the underlying rate and the returns,” he explains.
“They will be able to see the margin and understand the risk.”
Findlay goes further, suggesting a specific chief credit officer role for each platform.
“Their role will be to be responsible for the performance of the loan book and returns and they should have to demonstrate requisite experience before they can take such a job,” he says.
“They should also be required to report the actual performance versus the expected performance each year, either reporting publicly, or to the regulator, or to an appropriate industry body.”
Findlay also says clearer messaging would be helpful, as would a worked example of the fee model over the life of a loan for each platform so clients can understand where fees arise, and how the platforms are remunerated.
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But Reid says there are so many different business models that it would be hard for the City watchdog to be too prescriptive.
“Every platform has a different focus, so coming up with a set of rules that works across the board will be challenging,” she says.
“Because change is so rapid, the FCA should try to adopt a firm but flexible approach to make sure the regime doesn’t become out of date too quickly.”
Getting the right balance for the actual business and protecting customers is also top of the list for the platforms.
Frazer Fernhead, founder of P2P property platform The House Crowd, warns the regulator must let the consumer make their own choices.
He cites one example of the FCA’s policy on internet marketing where he questions the need for a risk statement on pay-per- click adverts on Google, which take up space and cost more, when the link will go through to a page saying the same thing.
“The FCA provides an important function, and being FCA regulated helps companies build consumer trust,” he says.
“However, as we have seen with banks, it cannot prevent bad practice all the time.
“P2P by its very nature is self-regulating, as everything is transparent and subject to online reviews. I would urge the FCA to adopt a lighter regulatory approach, giving people the choice between heavily regulated industries with lower returns and ones perceived as higher risk but with better returns. Let consumers decide for themselves.”
Similarly, Bruce Davis, co-founder of renewable energy P2P platform Abundance, says the FCA must recognise how willingly the industry has accepted regulation.
“This sector supports regulation, we are not given credit for that,” Davis says.
“We are seen as outsiders, but we are not the new kids on the block anymore.
“Our data is at a level the banks would give their high teeth for.”
Read more: Hogan Lovells analysis on P2P regulation
Others believe that rather than the full FCA report being the end of the review, it could just be the beginning.
“It would be a mistake to view the development of regulation for marketplace lending or crowdfunding as a completed exercise,” Karteek Patel, chief executive of Crowdstacker, adds.
“The industry is constantly innovating and [it is important to] make sure regulation is keeping pace with the innovation.
“New issues will inevitably arise all the time so our approach is to focus on consumer protection and try and stay several steps ahead.
“We believe that one of the areas the FCA will focus on will be to improve transparency so that investors can better assess risks and returns. We, for example, make investors carry out a test so they better understand the key risks.”
The FCA declined to comment on when the review will be released, so P2P platforms will have to wait to see whether the new era of regulation will welcome them into financial services or keep them on the outside.