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FCA cites concerns in P2P review, regulatory arbitrage tops list

The FCA is taking another look at its approach to regulating both the peer-to-peer lending and crowdfunding sectors.

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The UK regulator, which implemented new rules for the regulation of “crowdfunding” in 2014, is making good on its commitment to review the market in 2016. The purpose of the review is to identify “whether further changes are needed”. A report from the regulator, which was published today, calls for input from a wide range of industry participants. A number of concerns are laid out within the report. The post-implementation review covers both loan-based and investment based crowdfunding. We’ll wrap up the highlights from the investment based segment of the review on Monday.

The review alludes to “some well-publicised problems in some crowdfunding platforms in other jurisdictions”, stressing that it is important to learn from these incidents. The regulator then reels off a number of potential concerns within the P2P sector.

The first is “a broader pooling of credit risk”, which is described as an emerging trend. This action, which often involves a provision fund mechanism, may have implications for how P2P is viewed in a regulatory sense. The review said that “pooling and other factors may mean that some firms operating loan-based crowdfunding platforms are also operating collective investment schemes”. In general, the regulatory status of peer-to-peer lending stands out as a concern. “There are potentially blurred lines between loan-based crowdfunding and other business models, such as asset management,” said the review. The FCA believes that this creates the risk of regulatory arbitrage.

It also states that some P2P products look increasingly like 30 day savings accounts. But though they may look something like a bank product, the FCA stresses that banks have “far higher prudential standards and must meet minimum liquidity reserves”. In practice, argues the regulator, P2P platforms cannot guarantee access to funds within 30 days, owing to fluctuating liquidity. The regulator says that this may result in the transferral of risk from exiting investors to those staying on, adding that this development “leads to questions over the extent to which loan-based crowdfunding platforms allow for regulatory arbitrage with banking business, without being subject to the same consumer protection requirements”.

Clearly the business of regulatory arbitrage is front and centre of the FCA’s thinking at present. This comes as no surprise. Rumours would suggest that incumbent financial services providers have been quietly lobbying the regulator to address what they see as imbalances in the regulatory system for some time.

The changing investor base in peer-to-peer lending was another point of concern, with the regulator determined to ensure that no conflicts of interest arise between institutional backers and individual investors.

The involvement of institutions is seen as all the more important in the context of the recently launched Innovative Finance ISA. Though the major P2P platforms continue to await full authorisation – and will not be able to accept IFISA money until fully authorised – the FCA has voiced concerns that a flood of less experienced, less knowledgeable investors will soon pile into the asset class, blindly trusting the ISA brand.

Whilst the review explicitly invites the feedback of industry participants, the regulator has taken decisive action on the capital requirements front. Minimum capital requirements for peer-to-peer lenders, which were set at £20k in 2014, will rise to £50k from 1 April 2017. Future applicants will be reviewed by the FCA in order to gauge their capacity to meet this requirement, significantly raising the barrier to entry for new platforms. 

The recent comments of Lord Turner, former boss of the City regulator, also appear to have weighed upon the minds of the FCA. Turner declared in February that “the losses which will emerge from peer-to-peer lending over the next five to 10 years will make the worst bankers look like lending geniuses”. The FCA’s review includes the following line: “In the coming months, we will work with firms to evaluate the quality of their creditworthiness assessments.”

Investment-based crowdfunding platforms are required to gauge the suitability of investors prior to allowing them to invest. The FCA’s review suggests that it may consider the implementation of a similar set of rules for peer-to-peer lenders.

You can access the full paper here. Those interested in submitting their feedback will need to have done so by 8 September 2016.

The full list of the peer-to-peer lending related questions that were posed by the review are available below. To reiterate, we’ll be covering the investment-based crowdfunding portion of the report on Monday.

Peer-to-Peer Finance Association Chair, Christine Farnish, CBE, commented on the review: ‘Peer-to-peer lending platforms have a proud record of embracing regulation. The Association’s platforms are committed to the highest standards of business practice – including ensuring that consumers and businesses considering investing or borrowing are fully aware of the risks and rewards of peer-to-peer lending – which are embodied in our Operating Principles."

Rhydian Lewis, CEO and co-founder at RateSetter, also weighed in: “We welcome the FCA’s announcement.  This review is a fantastic opportunity for our industry to put beyond doubt the case for opening up direct access to investment returns from the asset class of loans.  Peer-to-peer investing is becoming very popular and it makes sense for the FCA to ensure it is appropriately regulated.  We look forward to continuing our active and positive engagement with the FCA during the review process.”

James Meekings, co-founder of Funding Circle, said: "The FCA confirmed plans for a post-implementation review in 2014 and we welcome today's news that this consultation paper has now been launched. A review of the existing regulatory framework is a natural part of the evolution of all platforms and we look forward to being involved in the consultation process over the next few months."

Review Questions:

Q1. Do you consider that there is the potential for regulatory arbitrage with banking business? If so, what measures should be considered to address it?

Q2. Do you have any concerns about, or evidence of, differences in the treatment between retail and institutional investors?

Q3. Have you seen any initial evidence that the ISA wrapper has led to consumers not fully appreciating the risks involved in Innovative Finance ISA investments?

Q4. Are there differences in borrower protection between commercial and non-commercial agreements that would be best addressed by applying additional rules to P2P platforms, or are the existing rules adequate?

Q5. Do you agree with our analysis of the key developments in the loan-based crowdfunding sector over the last two years?

Q6. Are you aware of current or emerging risks that firms’ current infrastructure, systems and controls might not be adequate to deal with?

Q7. Do you have any comments on our concerns over the development of new loan-based crowdfunding business models? Have there been other specific developments that are relevant to the high-level standards summarised above?

Q8. Do you have any comments on the standards of disclosure on loan-based crowdfunding platforms?

Q9: Are our current financial promotion rules for loan-based crowdfunding promotions proportionate? If not, can you please provide examples?

Q10: Is our approach to online and social media promotions proportionate? Do you have any suggestions as to how to improve our rules or approach on promotions?

Q11: Should we require loan-based crowdfunding platforms to assess investor knowledge or experience of the risks involved? What would a proportionate requirement look like?

Q12: What effect do you think loan-based crowdfunding has had on competition in lending and investment/savings markets?

Q13: Where do you think regulations could be amended to increase confidence in loan-based crowdfunding markets, encourage the development of the markets in the interest of consumers or increase competition by removing uneven playing fields?

Q14: Do you have any comments on the resolution plans of firms operating loan-based crowdfunding platforms?

Q15: Are there any other matters we should take into account in the post-implementation review of loan-based crowdfunding?

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James Meekings

UK Managing Director and Co-Founder

Funding Circle

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