Editor's PickAlternative Lending
Perhaps the key development is that equity crowdfunding promotions rules may soon be applied to P2P firms.
The FCA's review of crowdfunding rules - both loans and equity based - is finally here. We'll be reading and reacting live. More to follow...
Here's the link to the paper.
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The FCA is proposing that P2P promotions target exclusively the following groups: those certified or who self-certify as sophisticated investors, those certified as high net worth investors, those under advisement from an authorised person, or those who certify that they will not invest more than 10 per cent of their net investible portfolio in P2P agreements.
In other words, the regulator is looking to apply the same marketing rules to debt-based platforms (P2P) as apply to investment based platforms (equity crowdfunding). This must surely be seen as a blow to the industry.
The FCA last reviewed the sector in 2016. It is now inviting responses to proposals to change rules for loan-based platforms (peer-to-peer lenders). These cover, in the FCA’s words:
The regulator says it has observed poor practices in the sector, ‘particularly among loan-based platforms’. Here’s a quote from the FCA’s executive director of strategy and competition Christopher Woolard: “When we introduced new rules for crowdfunding, we said we’d review the market as it developed. We believe that loan-based crowdfunding can play a valuable role in providing finance to small businesses and individuals but it’s essential that regulation stays up to date as markets develop. The changes we’re proposing are about ensuring sustainable development of the market and appropriate consumer protections.”
Responses to the consultation are due by 27 October 2018.
More on the aforementioned 'poor practices': “For example, in relation to disclosure of information to clients, charging structures, wind-down arrangements and record keeping.”
P2P rule changes
See chapter 5 for full details of the proposed rule changes.
On timings: "To give P2P platforms time to make any necessary adjustments we propose a commencement period. We propose that these new rules should come into force six months from publication of the final rules and Policy Statement."
- The FCA will introduce minimum standards of disclosure. "To ensure investors are given clearer information about investments, charges and risk, we propose to set out the minimum information that P2P platforms need to provide to investors. We expect that many platforms already provide much of this under existing financial promotions and disclosure rules, but where they do not, improvements will be required to meet existing and proposed standards."
- The regulator is proposing 'more granular disclosure requirements'.
- Platforms must clearly describe their role. More detail about these requirements may be found on page 46. The FCA also wants to see investors given a fuller appraisal of what a P2P agreement entails (including terms, repayment structure, risks, etc.) prior to investing. Investors must be able to access information on their investments on an ongoing basis.
- The regulator is planning to enforce 'more explicit requirements to clarify what systems and controls platforms need to have in place to support the outcomes they advertise', in relation to advertised rates of return. These new rules will home in on credit risk assessment, risk management and fair valuation practices. As a minimum standard, the regulator will require that a P2P lender:
- "gathers sufficient information about the borrower to be able to competently assess the borrower’s credit risk"
- "categorises borrowers by their credit risk in a systematic and structured way (taking into account the probability of default and the loss given default)"
- "sets the price of the agreement so it is fair and appropriate, and reflects the risk profile of the borrower"
- The paper goes into more detail on each point, but it remains a little worrying that such standards have had to be enforced (in some cases, not all).
- For platforms that fall beneath the 'discretionary' tag (see below), the long and short of it is that they must keep their risk management framework under constant review to ensure that the advertised rate of return and the actual rate of return delivered do not 'diverge considerably'.
- Not all platforms are at risk. The regulator says some will have to do less to comply with its new rule changes. However, some platforms will need to make 'significant improvements to systems and controls' to meet with the new and existing standards.
- Wind-down rules are to be tightened, in part to ensure that complex IT systems continue to function in the event of a platform failure.
- "For platforms to have arrangements that are likely to be effective, we propose to require platforms to produce and keep up-to-date a manual containing information about their operations that would assist in resolving the platform in the event of its insolvency. We have called this a ‘P2P resolution manual’ in our proposed rules."
- This one's big: the FCA proposes 'to extend marketing restrictions that already apply to investment-based crowdfunding to P2P platforms'. That's perhaps unexpected for two distinct sets of platforms originating very different types of assets.
- Here it is: '... we propose to limit P2P platforms’ ability to market to certain investors'.
- The FCA is proposing that P2P promotions target exclusively the following groups: those certified or who self-certify as sophisticated investors, those certified as high net worth investors, those under advisement from an authorised person, or those who certify that they will not invest more than 10 per cent of their net investible portfolio in P2P agreements.
- One for the property peer-to-peer platforms: "In Chapter 7 of this CP, we set out proposals to apply Mortgage and Home Finance: Conduct of Business sourcebook (MCOB) and other Handbook requirements to P2P platforms that offer home finance products, where at least one of the investors is not an authorised home finance provider. This aims to address a potential gap in protections for home finance customers who undertake transactions through a P2P platform."
- More on transparency. The regulator is aiming for 'clearer and more meaningful data for investors on the range and performance of investments offered'.
- P2P platforms should be held to the sorts of standards that certain investment managers and investment businesses are. "We propose to bring P2P platforms more into line with the systems and controls requirements that apply to these types of firms."
The FCA has come up with a trio of new terms to categorise what it sees as an increasingly complex crowdfunding market. They are:
- Conduit platforms: "The investor picks the investment opportunities and the platform administers the loan or investment arrangements"
- Pricing platforms: "The platform sets the price, but the investor picks the underlying loan or investment"
- Discretionary platforms: "The platform sets the price and chooses the investor’s portfolio of loans to generate a target rate – this is only seen in the P2P sector"
But note that a single platform can operate in more than one way.
- The regulator is 'largely content' with its equity crowdfunding regime, but more to come around poor compliance giving rise to investor harm.
- Both P2P and equity crowdfunding platforms will be subject to the Senior Managers and Certification Regime (SM&CR) from 9 December 2019.
- On investor suitability: "During our PIR we have become aware that there may be some confusion amongst investment-based platforms in particular about the level of checks required in relation to an investor’s certification, particularly in relation to high net worth investors." More on this and on the definition of 'pooled investment vehicle' on pages 53-55.
- The regulator sees pensioners investing in P2P as a risk. It feels that low interest rates may drive them into alternative investments, taking 'inappropriate' levels of risk with their money. At the same time, the young are at risk due to the web-based, 'social networking nature' of crowdfunding, which might lure them into investments they do not fully understand.
- The FCA intends to keep the matter of whether P2P loans should fall within FSCS coverage 'under review', but won't be consulting on further changes for now.
- Wondering why the review took so long? The argument seems to be 'because we've done a good job'...? Judge for yourselves: "The next stage of the PIR process has taken longer than we originally expected. This is because our review has been wide in scope, taking into account the diversity and complexity of business models now present in the sector when considering the potential for harm and the case for intervening. It also reflects that, as we expected, the sector has evolved rapidly and we have continued to consider new developments as they have happened."
- Provision fund concerns remain: "We have observed that the contingency fund may be funded by borrowers, investors or in some cases using the platform’s own money (including money the platform would otherwise take as profit if no default occurs). We also have concerns about the operation, disclosure and resilience of these funds." Later, it is suggested that these mechanisms can give investors a false sense of security.
- The conflicts of interest section on pages 39 and 40 is pitched as a kind of reminder of the risks inherent to crowdfunding platforms... But it reads more like a thinly-veiled 'whodunnit'.
Reaction in from Funding Circle's co-founder and UK MD James Meekings: "Funding Circle has consistently campaigned for proportionate regulation that protects consumers, whilst allowing innovation to boost choice and competition in the lending and investment markets. We welcome today’s review as we believe it sets out to do that, and we look forward to continuing to work together to offer alternative and transparent investment opportunities for investors, and access to finance for small businesses."
And this from Julia Groves, partner and head of crowdfunding at Downing LLP: "It’s unsurprising to us that the FCA review is clearly focused more on the loan-based area of the market (P2P lending), given the lower levels of disclosure and the lack of transparency offered by some P2P platforms. By comparison, investment-based crowdfunding such as Downing’s asset-backed Crowd Bonds, automatically fall under higher regulations which rightly demand thorough due diligence and set out clear requirements for testing investor’s understanding of risk. We ensure our fees are as transparent as possible, for example, by setting them out clearly in the offer document for each of our Crowd Bonds."
Rupert Taylor, co-founder and CEO of AltFi data, also commented: "AltFi Data’s methodologies have always aligned with the FCA’s intention to make comparisons of the risk and return of platform lending as simple as possible. Our methodologies enable platforms to demonstrate that their return outcomes match their return expectations, based on a standardised methodology, thereby enabling originators to provide the FCA proposed ‘outcomes statment’ to a third party verified and like for like comparable standard."
Here's a section from the UK Crowdfunding Association's response: "We would still emphasise the need for the FCA to improve its use of technology to make monitoring an online sector more effective and efficient and not to rely on the sharp eyes of UKCFA members highlighting examples of poor or even illegal practice in the investment world. We welcome the FCA’s proposals for further alignment of the regulation of P2P Lending and Investment Crowdfunding."
Christian Faes, co-founder and CEO of LendInvest, welcomed the review: "It's good to see that the FCA is proposing a crackdown on the peer-to-peer industry. LendInvest made the decision some time ago, not to market to retail investors on its platform, and instead we launched a retail bond which we listed on the London Stock Exchange. We think this provides retail investors with a much better investment and significant protections over an investment in P2P. Investors, generally speaking, need a lot more transparency around what they are investing in, and the platform they are investing with."
Rhydian Lewis, co-founder and CEO of RateSetter, welcomed it for different reasons: “I believe peer-to-peer lending will become a part of every investor’s diversified portfolio and the proposals from the FCA do not change that belief. I welcome this consultation paper because the clearer the regulation, the better chance peer-to-peer lending has of becoming meaningful competition to the banks.”
The responses are still coming in. Here's Jaidev Janardana, CEO of Zopa: "As the founder of the P2P industry, we are always in favour of measures that move forward its maturity and allow responsible growth. We welcome the insight and recommendations that the FCA released today, as we believe it’ll provide more alignment of how customers should be treated within the industry."
"We operate with customer interest at the forefront of our business and as such the spirit of these regulations - which seek to ensure that customers are well informed and treated fairly - are in line with our own ethos. While we are still digesting the detail, we believe that the measures will not represent significant change from how we operate today."
"Following this review, we will continue to work collaboratively with the FCA and with our customers to ensure we provide the best possible services and products."
Peer-to-Peer Finance Association chair Paul Smee has also weighed in: "The Association has always maintained that all investors lending through a peer-to-peer lending platform need to be clear about the performance of the platforms on which they invest. That is why P2PFA members have set out and signed up to Operating Principles which give a gold standard for disclosure. We are pleased that the FCA’s proposals endorse the idea of full disclosure."
"There is a lot of detail in this document, and we will be working through its implications, to ensure that the eventual regime is practical, proportionate and allows for the development of a healthy and competitive market in peer-to-peer lending. Peer-to-peer lending needs to make its full contribution to the growth of the UK economy and we will be working to ensure that new regulatory requirements do not get in the way."
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