P2P lending connects one borrower with a host of lenders without going through an intermediary such as a bank. At the outset, the theory is that P2P lending has fewer overheads; they’re just the ‘dating agency’ matching up lenders and borrowers with equal and opposite requirements – the lending equivalent of both parties saying they have a GSOH!
The allure of alternative finance is heightened by low interest rates as lenders chase returns. However, there is little evidence that many P2P platforms are actually turning a profit. And crucially, regulation is in its relative infancy. The P2P industry is, from a regulatory perspective in a somewhat unpredictable space at the moment. Whilst recent high profile authorisations suggest a positive view from the FCA in terms of this sector, we know from the FCA’s Interim Feedback on its current crowdfunding rules that they intend to increase the regulatory burden on P2P firms.
A key theme from this Interim Feedback relates to the disclosures and transparency of platforms. Do investors really understand what they’re getting into and could platforms do more to address this? The regulator’s position would seem to suggest that there is a raft of information being misrepresented by some platforms, potentially exposing investors to unnecessary and therefore unacceptable levels of risk. There’s an additional concern that investors, particularly unsophisticated ones, do not have sufficient appreciation of the risks. That is not to say that all platforms are at fault or that there is even intent behind the issues causing the regulator concern, rather there is simply a lot more that can and probably should be done in this area by the platforms. A regulatory risk framework that allows for greater transparency will be essential to tackling this issue and ensuring growth in the P2P space.
The regulator has also expressed concern that P2P firms’ wind-down plans may not be adequate and is planning to strengthen the rules around this. Firms should therefore expect to see an increase in capital requirements.
Another cause of concern, which requires further exploration, is around potential conflicts of interest. There’s a risk that large investors will have greater access to preferential deals, over small investors, which creates problems for effective competition within the sector. Given the regulator’s mandate to promote competition more generally across financial services, it will be interesting to see how this gets applied to the new rules. There is also a risk that platforms will be driven by the strong commercial imperative to quickly start turning a profit, which could lead to a relaxing of lending standards. Another area of concern across the industry is how firms achieve a balance in their duty of care to both lenders and borrowers with the former potentially receiving preferential treatment to the detriment of the latter.
Commercial opportunities could come from the FCA consulting on expanding the scope of the existing rules to allow, for example, residential mortgage lending via P2P platforms. There appears to be a lot of demand for this, which may well lead to disruption to traditional mortgage lenders. In response to this, the regulator is looking to consult on applying existing mortgage lending standards to the P2P sector. Firms currently operating on interim permissions or that are seeking first time authorisations should be prepared to react quickly to the new rules, in order to avoid authorisation delays, allowing competitors to beat them to the market. It is paramount that platforms keep abreast of the conversations taking place around P2P lending in order to understand the direction of travel and plan ahead.
Getting to grips with compliance can be complex. However, new entrants should not be put off by tighter regulation. This regulatory environment will enable the sector to grow in a controlled, sustainable manner whilst championing transparency, disclosure and a customer focused approach leading to better commercial outcomes. Despite the uncertainty around incoming rules, firms should not be complacent. Those operating within the P2P sector must keep up to date with emerging news, rules and guidance to mitigate risks and maximise success by upholding regulatory standards.
The FCA is poised to consult on a number of enhancements and additional requirements in a bid to increase consumer protection and the general standards by which P2P platforms will be expected to operate. This will undoubtedly shape the future of the sector. The forthcoming consultation papers will obviously present compliance challenges for some firms, but those that are early adopters will no doubt gain a competitive advantage.
Ben Arram is a Consultant at Bovill, the international financial services regulation consultancy.