1 August, 2018

Taking the ‘Peer’ out of Peer to Peer Lending

Taking the ‘Peer’ out of Peer to Peer Lending

Last week, the FCA published feedback on their post-implementation review of Equity Crowdfunding and Peer to Peer Lending (P2P) regulation. Regulation within the P2P market was first introduced in 2014, and a review of the framework was announced back in 2016. This paper was therefore long awaited.

Although the review covers equity crowdfunding, it is the P2P sector which is the focus, with the FCA highlighting key risks and proposed regulatory changes. It’s a long paper, (61 pages + 95-page annex) which can be accessed here.

Below I’ve summarised the key proposed changes to the regulatory framework:

Increased risk management focuses on the assessment and pricing of loans, appropriate to the risk profile of the borrower. For “Autobid” platforms, such as Funding Circle and Zopa, the advertised rate of return must be reasonably achieved.

Increase in governance
o Platforms must operate at a standard similar to a firm who is ‘arranging deals in investments’.
o Platforms must establish and maintain risk management policies and procedures. Depending on their scale, platforms may be required to have an independent risk management function.
o Platforms must maintain a permanent compliance function.
o Depending on the scale of the platform, internal audit functions must be established and maintained.
o Platforms must take appropriate steps to identify and prevent conflicts of interest.

The FCA have stated the ‘role of the platforms in administrating, servicing and in some cases managing loans is complex. This makes it difficult for investors to assess investment risk properly.’ For this reason, they have proposed restricting the investor base, similar to equity crowdfunding.

– Marketing restrictions
o P2P platforms may only promote their offerings to self-certified sophisticated investors, certified HNW, advised clients or those who certify to not invest more than 10% of their net investible portfolio into P2P agreements.
o Investors are to be assessed on their knowledge and understanding of the risks involved before they can invest.

– Wind down arrangements
o Platforms are to keep an up-to-date manual containing information about their operations that would assist in resolving the platform in the event of its insolvency.

– Disclosure requirements
o Platforms will be required to disclose information, including how loans are assessed, the due diligence undertaken and default procedures. The aim of this increase in disclosures is to make the underlying risk easier to understand and to allow comparisons to be made.

It’s worth noting that this is a consultation period and the FCA have requested input from anyone that has the desire to do so. After this period, rules will be published and the platforms will have 6 months to adhere to the changes.

Clearly the FCA have spent considerable time understanding the wide range of business models in the market and, in particular, the changes relating to disclosure, wind down arrangements and risk management will benefit investors. This will hopefully create a standardised approach to offering P2P agreements.

The proposed marketing restrictions is where I feel the FCA have steered on the side of caution, citing that P2P investments are too complex for investors to understand the underlying risks.

Are P2P investments unsuitable for mainstream adoption?

No, definitely not. This is of course a biased opinion, however the FCA themselves have stated that losses and defaults across the P2P sector have been low. Peer to peer lending was created to provide reasonable returns to people wanting to lend their money and to provide access to capital for people wanting to borrow money. The industry has evolved, but largely it remains true to this ethos.

From my own experience, generally, investors understand the act of lending through P2P platforms, particularly in comparison to other mainstream investment products. Is P2P investing any more complex than ETFs, UCITS or investment trusts? Is Funding Circle’s listed SME Income Fund less complex than investing directly on their P2P platform?

As David Stephenson at Altfi reported earlier in the week, restricting the investor base ‘will chill growth in the market’. P2P investing has given access to investments that were previously only reserved for institutions and it now feels like the FCA have said that people can’t comprehend the risks involved and therefore need protected.

In reality, these restrictions don’t actually work. Those who want to invest – the risk takers that the FCA are trying to protect – lie to the platforms during the registration process and the platforms ignore these lies. It’s the mainstream investor who is cautious in his/her approach, but could benefit from P2P investments to balance his/her portfolio, that will now view P2P as too risky.

Stifling innovation

At the centre of the stated complexity are Autobid P2P platforms which have been newly defined as ‘discretionary platforms’. I thought this was interesting as typically this is the territory of the lower risk platforms like Zopa, Landbay and RateSetter.

The FCA concerns are as follows:

– The investor does not choose who they lend to.
– During a withdrawal, the user selects the monetary value that they want to withdraw, not the specific loans. It is the platform who decides what loans to sell, using automated software.
– The platform sets the price of loans and advertises a target rate of return
o As the investor’s funds are matched directly to different loans, different investors receive a different return which is likely to deviate from the target.
– ‘The platform effectively acts akin to a discretionary manager for the investor’.
– When loans mature, the platform invests the capital in a new loan, which is not chosen by the investor.

The FCA have suggested that some Autobid platforms may find it easier to opt for a Self-select model to simplify their model, rather than investing in upgrading their risk controls. It would seem that anything outside of pure P2P, where the lender selects a loan and builds a portfolio, has been deemed as complex. There is an array of products that deliver real value which will be difficult to deliver with new regulation. Assetz Capital’s Quick Access Account for example has a liquidity buffer, allowing people to withdraw early. Or, RateSettter’s provision fund, which dampens volatility, may come under closer scrutiny and be considered too complex. For some investors, these are great products.

Regulating how loans are assessed, categorised, priced and disclosed will increase investor protection, but stipulating how products are constructed will decrease the investor experience. If an investor was to self-select all loans themselves, yes, they might be closer to the actual risk, but they are more likely to build a poorly diversified portfolio. Either they wouldn’t invest or they would be left exposed.

The P2P market is fast becoming absorbed by three market leaders: Funding Circle, RateSetter and Zopa (the “Big Three”). With Wellesley & Co and LendInvest departing the P2P market, the “Big Three’s” market-share has increased to 78% of cumulative lending.

I’m sure the top three platforms will cope adequately with the increased regularly requirements, but challengers and innovators will need to navigate more complex regimes to compete. This is bad for a market still in its infancy and is likely to lead to poorer market competition.

Being regulated as a P2P platform is not always the favoured form of lending. Wellesley & Co and LendInvest, both considered P2P platforms, have now favoured Retail Bond and alternative investment fund structures. We’ve also counted 11 Crowd Bond structures which offer the IFISA.

There are other regulated structures which allow online platforms to raise capital from retail investors and lend capital. The P2P structure in some respects is the most transparent and is the fairest to consumers, but it’s difficult to see why an operator would pick this structure if it becomes overly cumbersome. For example, Crowd Bond structures are simple to set up, provide flexibly to the product provider and are IFISA eligible. Why would they pick a P2P structure?


The industry is now complex with a wide range of different business models and lending practices. The FCA have done well to highlight this and to provide a detailed overview of key investor risks, but in my opinion, they have not found a framework which fits this evolving industry. Although it’s taking time for this review to be released, I actually think the industry needs more time to innovate and evolve. Increasing risk management, disclosure and platform wind down plans will better protect investors, but restricting the investor base feels a step backwards for an industry which is generally delivering on its ethos of allowing people to earn returns by lending money to people who want to borrower money.