Advising on Peer to Peer Lending: Barriers to Entry
We’ve been speaking with financial advisers* for over a year, trying to understand why they struggle to get to grips with peer to peer lending (P2P). The feedback has been enlightening with most claiming there’s just too much risk and too many barriers involved to formally advise on P2P. But, we believe many of the barriers intermediaries face can be overcome, and should be overcome, to ensure their clients are offered the best choices in the market.
*Typically ‘independent advisers’ who can offer the full range of financial products and providers available.
Here are some of the barriers we’ve recorded from conversations with several intermediaries.
1. Difficult to place P2P on a standard risk scale
Advisers will use a scale to determine the riskiness of an asset class (or investment sector), evaluating its characteristics and producing a score which can be measured relative to other asset classes. The scale is typically 1-10: cash and government bonds will sit at the lower end of the risk scale, while equities will sit at the higher end of the scale.
As P2P lending is broadly considered to be a new asset class by advisers, it’s hard for them to place P2P on a scale and measure against other asset classes, particularly when it’s not weathered multiple economic cycles and been robustly tested.
In our opinion, P2P can be viewed alongside other asset classes in a typical multi-asset class portfolio as illustrated below.
Figure 1: Multi-asset-class portfolio. Source: Orca
Placing P2P on a risk scale is reliant on the adviser evaluating the characteristics of the investment, which is not impossible.
2. Difficult to compare the whole market
There are many providers operating in the P2P lending market, offering varied types of lending; unsecured consumer loans versus secured property, for example. For an adviser, evaluating risk can be complex and time-consuming.
There are solutions available which alleviate this burden, such as Orca, which conducts due diligence on providers and their products, before building and executing a portfolio on behalf of the investor.
3. Client suitability assessment concerns
As with placing P2P on a risk scale, advisers have found it difficult to perform their client suitability obligations as no standard template has existed to help them assess their clients’ suitability relative to P2P.
The FCA outlines key factors to consider when assessing suitability. As well, some compliance support services have created P2P suitability templates. Ask your adviser if their compliance regime has such a template.
4. Professional indemnity insurance concerns
Professional indemnity insurance (PII) is considered a “grey area” by many advisers. According to an article published by Peer2Peer Finance News, ‘some independent financial advisers assume it is covered under the general advice section of their policy, whereas others do not think it is covered at all.’
While talking with some of the more forward-thinking advisers, their understanding is that they’d simply have to contact their insurance provider and potentially pay a premium to gain coverage.
This is of course a cost which would only be justifiable if the adviser began recommending P2P.
5. Regulatory concerns
Many advisers we spoke with thought peer to peer lending was unregulated. Since 2014, the FCA has mandated that all P2P lending platforms operating in accordance with article 36H of the Regulated Activities Order must be fully regulated. Virtually all of the major players in the market are fully regulated at the time of writing.
This should not detract from the fact that peer to peer lending is not covered by the Financial Services Compensation Scheme (FSCS), meaning an investor’s funds are not covered in the event of loss due to borrower default.
6. Simple and efficient solutions are hard to find
For the progressive advisers who see value in allocating 5-10% of their clients’ portfolios to P2P, they still face the problem of evaluating the market and building a diversified portfolio of P2P investments.
Aggregators, like ours at Orca, offer advisers and their client-base access to the market without the requisite due diligence of each underlying P2P platform and the administrative burden of building a portfolio of multiple P2P investment providers.
7. Tax efficient product providers low in supply
P2P investments can be held within a tax-efficient ISA, the Innovative Finance ISA (IFISA). There are dozens of IFISA providers on the market.
There are a few SIPP operators who have partnered with P2P platforms to offer more bespoke SIPP schemes, but no major operators have adopted P2P as yet.
The issue for advisers may be that their clients’ annual ISA subscription allowances are fully apportioned to other investments each tax-year, and, there are no major SIPP operators who have overcome the challenge of P2P being a non-standard investment or the issue of connected parties.
Financial advisers - specifically independent advisers - have a responsibility to evaluate the whole retail market when advising clients on investments. Peer to peer lending provides stable, uncorrelated and attractive returns and should be viewed as an effective tool to diversify clients’ portfolios. There are solutions available which remove the complexity of evaluating the market and the burden of building portfolios of P2P investments. Take Orca, for example.
The question is: Are advisers shunning P2P because they’re concerned with their own reputational (business) risk or their clients’ risk?
If you’re an adviser, get in touch to hear more [email protected]