Overregulation has been blamed for a number of high-profile exits from the peer-to-peer lending space. Michael Lloyd asks if regulation is having an undue influence on the future of P2P…
When Funding Circle announced last month that it was closing its peer-to-peer lending business, it offered a number of reasons. But the one that really resonated with the wider P2P lending community was regulation.
Lisa Jacobs, chief executive of Funding Circle UK, told Peer2Peer Finance News that while regulation was “not the leading factor” behind the platform’s P2P exit, “it was one of the many things that went into our decision making”.
This will be a familiar refrain to regular readers of this magazine.
Over the past few years, P2P lenders have been hit with a raft of different regulatory proposals which have changed the face of the sector forever. Several platforms have already left the space due to the cost and limitations of ongoing regulation, while others have spoken out about the sheer volume of compliance work that is now required of all platforms, regardless of their size.
There are the Financial Conduct Authority’s (FCA) proposals for a new consumer duty, tougher rules for appointed representatives (ARs), strengthening financial promotion rules for high-risk investments and the Treasury’s consultation on the financial promotion exemptions for certified high-net-worth individuals, sophisticated investors and self-certified sophisticated investors.
Last summer, P2P property lending platform FutureBricks left the retail P2P space in favour of unregulated corporate lending because of the regulatory burden impacting the “potential commercial viability of P2P”.
And earlier this year, P2P pawnbroking platform Connective Lending wound down stating that compliance with regulation had made the business “uneconomical in the P2P sphere”.
Even more regulation is on the horizon for P2P platforms and other industry stakeholders.
The City regulator has set out its proposals on strengthening financial promotion rules for high-risk investments, including P2P lending. It is planning to ban the promotion of investor incentives, such as new joiner or refer-a-friend bonuses, improve risk warnings on ads and strengthen appropriateness tests.
The FCA has also proposed changes that would improve principals’ oversight of appointed representatives (ARs) and plans to introduce a new consumer duty for all regulated firms, including P2P lending platforms, which will force firms to test and show that consumers are receiving good outcomes.
The Treasury has also suggested amending the criteria for self-certification, with alternative tests placing a greater degree of responsibility on firms to ensure that individuals meet the criteria to be deemed either high-net-worth or sophisticated.
For some, the content is not necessarily the problem, but the pace of change.
“There have been an unprecedented number of changes and consultations to the regulations governing both P2P and crowdfunding over the last few years and the pace in 2022 hasn’t shown much sign of slowing,” says Bruce Davis, co-founder of crowd bonds platform Abundance and director of the UK Crowdfunding Association.
“Such a pace of change is unsettling for businesses and introduces the risk of unintended consequences as rules are being brought in simultaneously from both government and regulators.”
Out of all these changes, the regulator has been paying particular attention to the issue of ARs.
Principals have historically been able to offer an easier route to market for smaller P2P platforms which are unable or unwilling to become directly authorised. In March 2022, the regulator revealed it stopped one in four firms from entering the consumer investments market between April and September last year, up from one in five the year before, demonstrating how difficult it can be to become directly authorised.
But now the regulator is making it more difficult for principals to operate.
In December, the FCA proposed tougher rules for the oversight of ARs after finding that there are “real risks of consumers being misled and mis-sold”.
The regulator said that its proposed changes would improve principals’ oversight of ARs and require principals to provide it with more information on their ARs, allowing the watchdog to spot risks quicker.
Daniel Rajkumar, managing director of P2P platform and principal Rebuildingsociety, which since 26 February 2021 has been subject to an FCA lending restriction on its ARs, says he has replied to the FCA’s consultation and hopes to have the ban removed once the watchdog has seen evidence that the company has the appropriate resources.
“It’s a bit of a shame the regulator was uncomfortable with principal firms and P2P lending firms acting as principals,” he says.
“Hopefully this policy statement that comes from the policy paper will pave the way for better collaboration between industry and the regulator.”
Rajkumar says that he agrees with most of the points from the consultation.
However, he believes that regulatory hosting, in which the principal oversees the AR but does not necessarily use the permissions themselves, is harder to operate successfully within innovative financial services such as P2P lending, as the principal should have a good understanding of how the AR operates.
He also criticises the FCA for proposing more data gathering without knowing what it wants it for, as this would create further costs and more work for the AR and principal.
“I can understand how the regulator in the past has had some concerns about where the risks lie,” Rajkumar says.
“I hope they give us another chance at operating a P2P network. I hope this consultation paper is the beginning of this opportunity to enable us to do that.”
Neil Faulkner, managing director of P2P ratings and research firm 4th Way, believes that new rules for ARs and principals would make it more difficult for new platforms to launch in this space. Instead, he hopes for a tiered strengthening of the rules for each asset class, based on historical risk levels.
“The FCA is estimating very high costs of its interventions, but has been unable to estimate the benefits, which can potentially lead to dubious results, so I hope it treads very carefully,” Faulkner says.
“I think possibly the biggest cost will be a hidden one in that it will make it harder for new P2P lending platforms to start up. I hope that the FCA cares about that cost to the overall P2P lending ecosystem.”
Long-time principal ShareIn stopped offering AR services to new clients in 2020 due to regulatory expectations.
ShareIn’s chief executive Jude Cook told Peer2Peer Finance News that “the FCA’s expectations on a principal are so onerous it doesn’t stack up for us financially anymore”. Instead it will retain just five of its existing clients as ARs.
Regulation doesn’t just stop with principals and ARs. Going forward all platforms will have plenty to deal with.
Some industry stakeholders are worried that the FCA’s proposals for strengthening financial promotion rules for high-risk investments will lead to more retail investors being blocked out of the sector.
And others are worried that the Treasury’s proposals for financial promotion exemptions will harm platforms when they look to crowdfund.
“Some of the proposals may potentially reduce the availability of the exemptions for early financing rounds and impact the ability for early-stage companies to grow,” says Sam Robinson, a financial services partner with law firm CMS.
However, it’s not all doom and gloom. The sector has welcomed the FCA’s apparent willingness to take on feedback in its high-risk investments consultation. For example, P2P property lending platforms have praised the regulator for shelving a proposed ban on the marketing of P2P property development loans for the time being.
The FCA has also been engaging with the sector on its high-risk investments consultation through a series of roundtables, which P2P industry stakeholders have seen as a positive exercise.
“The rules we introduced in 2019 were necessary to enhance protection for investors while allowing them to take up innovative investment opportunities and supporting the P2P market,” said an FCA spokesperson. “It was, and remains, vital that investors receive the right level of protection.
“Our more recent work on strengthening the financial promotion rules for high-risk investments aims to see a market in which consumers can invest with confidence, understanding the risks they are taking and the regulatory protections provided. We do not want to restrict consumers if they want to invest, but we do want them to be able to access and identify investments that suit their circumstances and attitude to risk.”
As well as absorbing industry feedback, Peer2Peer Finance News understands that the P2P sector may have a secret ally in the Treasury. Although unconfirmed by the Treasury, two P2P platforms have revealed that industry leaders have been in talks with Treasury officials about the direction of travel for regulation in the sector.
“I think we are seeing a more balanced and evidence led approach now compared to a couple of years ago at the height of the London Capital & Finance scandal,” one industry stakeholder says.
Mark Turner, managing director in Kroll’s financial services compliance and regulation practice, says although new proposals will mean the cost of compliance will rise, most will be able to adapt and comply.
“I don’t think there’s anything in there to threaten the sector as a whole,” he says.
P2P platforms and industry stakeholders have their concerns over new regulation for the sector, but there is some evidence that the FCA is listening.
By entering into discussions with the regulator, responding to public consultations, and showing a willingness to invest in best practice, P2P platforms are proving their ability to adapt and thrive –whatever is thrown their way.