By Christian Faes on Thursday 20 February 2014
There is a lot of hype about the future potential of crowdfunding and peer-to-peer lending. The US has shown the huge potential with platforms such as Lending Club and Prosper lending billions of dollars a year.
The Financial Conduct Authority in the UK is about to set out its regulatory regime for crowdfunding (including peer-to-peer lending), which is set to come into force in April. Many in the industry have lauded the FCA for outlining a very sensible regime, however investors should still be very wary.
As the co-founder of one of the fastest growing peer-to-peer platforms in the world, you might be surprised to hear this from me. However, firm regulation of the UK peer-to-peer sector is not only important for investors, it is important for the sustainability of the peer-to-peer industry in the UK.
What would be the impact on this burgeoning industry, if it turned out that one of the UK platforms turned out to be nothing more than an online ponzi scheme? Already, some of the platforms on the market should certainly make investors scratch their heads and wonder what it is they are actually investing in.
The UK government is behind the broad concept of 'crowdfunding', as it has the potential to create desperately needed competition in the banking and financial services sector, and to get funding back into businesses. The government has actually invested tax payer's money directly on some of the more established UK peer-to-peer platforms. This provides a significant vote of confidence in the concept of lending to people and businesses online, although the amounts lent to date have been relatively puny (relative to the broader lending market).
In the industry we try and differentiate between crowdfunding and peer-to-peer lending. Crowdfunding is usually associated with equity fundraising (for start-up businesses etc); and peer-to-peer lending (also called P2P for short) is usually associated with straight forward lending.
The FCA uses the term 'crowdfunding' to refer to the broad umbrella of both equity investment and debt lending. Obviously, within this broad umbrella, there is a significantly different risk profile associated with the different forms of investment - 'investing' in a start up or an unsecured loan obviously carries a significantly different level of risk to lending to someone secured by a mortgage.
The FCA's proposed regulation provides a broad framework for platforms to adhere to, which is aimed at protecting investors. This includes the requirement for P2P platforms to hold certain capital on their balance sheet in case the platform itself comes under financial difficulty. However, there are also some seemingly glaring omissions.
The most obvious omission in the proposed regulation of P2P seems to be that there is no minimum threshold of due diligence that a platform must do, before it can effectively sell a loan to investors on their platform.
The proposed regime may create a very dangerous situation where a P2P website could essentially be started out of someone's bedroom, by someone that has absolutely no lending experience or understanding of loan underwriting. The proposed regulations do not even provide an obligation on a platform to do the most simple of checks, such as a credit check, nor use any sort of fraud detection system. The regulation effectively allows P2P lending platforms to 'outsource loan underwriting to the masses'.
Post April this year, peer-to-peer lending platforms will be able to operate in this way, and have the defacto stamp of approval from the FCA - and to provide these 'loans' to investors over the Internet.
Underwriting a loan requires skill and experience, and there should be minimum thresholds concerning this incorporated into P2P regulation.
If crowdfunding and P2P is to provide a sustainable alternative in the world of finance, the market - and investors - need to be confident that they can trust in the platform they are investing in.