Britain’s financial watchdog has proposed new regulations designed to offer a greater degree of protection to investors who lend money to individuals and businesses via Peer to Peer (P2P) platforms
P2P lending as we know it today was in many respects a product of the great financial crisis and the recession that followed. As banks reduced their lending to companies and consumers, the vacuum was at least partially filled by online markets that connected a community of lenders to a pool of prospective borrowers. For lenders, the sites offered a means to secure returns that were significantly higher than the interest rates on offer from savings accounts. Meanwhile, borrowers had an alternative to the High Street Banks.
And the sector has flourished. The P2P Finance Association (P2PFA) says its member platforms have been responsible for a cumulative £9bn in lending to date – £660m of that in the first quarter of 2018 – with the money coming from more than 150,000 investors.
It’s not hard to see the attraction. At a time when bank savings accounts are typically paying less than 0.5% in interest, P2P platform lenders can secure returns of between 4% to 7%. But there are risks. For instance, the borrower may default or the platform itself could become insolvent.
Regulation in the sector has been relatively light touch, with the Financial Conduct Authority (FCA)taking the view that it was important to let innovation flourish in what has become a hugely important segment of the financial services market. But times are changing. Last week, theFCA signalled that oversight of sector is to be tightened in order to keep pace with developments of in the market.
Announcing the watchdog’s proposals, Director of Strategy Christopher Woolard, said that while “loan-based crowdfunding” was playing an important role in the UK financial services market, regulation had to evolve.
“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,” he said.
Letting the Light In
Essentially the FCA’s plans aim to eradicate what it sees as poor practices on the part of some platforms and ensure that lenders will be given clear and accurate information about the nature of the investment and the degree of risk involved. In other words, lenders should be in a position to fully understand the relationship between the risk and the return on the investment. In addition, the FCA says investors should be remunerated in accordance with the risk.
In addition, the FCA is seeking to ensure that platforms take a conservative approach to promoting themselves. For instance, any returns predicted by the platform operators should be achievable. All this is to be set out in a new code following a consultation with the industry.
But is further regulation really required? According to Frazer Fearnhead, founder of P2P lending and property crowdfunding platform The House Crowd, the industry is already upfront with investors.
“We and other P2P companies make it clear that there are risks involved and people are very happy to accept those risks in exchange for a decent return,” he says.
Fearnhead is concerned that over-regulation could effectively stifle activity.
“If P2P companies are to be regulated in the same way as the banks, the red tape and cost would be so burdensome there would be no advantage to retail investors and they would be stuck with the same sorts of paltry returns the banks offer,” he argues. “ It would kill off innovation in the sector to the detriment of both investors and the business community and leave just a handful of large companies who are able to absorb the costs and operate on extremely narrow margins.”
In contrast, Max Lehrain, Chief Operating Officer of Relendex – a P2P platform specialising in property – is relaxed about the impending regulation. He argues that the proposals set out by the FCA simply reflect the reality of building a sustainable business in a market where real people are lending their own hard-earned cash.
“Although there is an element of the P2P environment that presents itself as new and exciting, what you have to do as a platform is ensure that you are building a long-term business,” he says. “If your business is compliant you are better able to build it for the long term.”
To protect its lenders, Lehrain says Relendex takes a conservative approach to underwriting loans and applies a rigorous risk assessment process. The majority of loan applications are turned away. This is not dissimilar to what is happening in the high cost payday loan industry.
Risks and Rewards
As Frazer Fearnhead points out, the term P2P lending covers numerous business models.
“It should be noted that there are different types,” he says. “There is unsecured and secured. Unsecured is clearly riskier; if the borrower defaults you have a very difficult time recovering the debt. “
And there is also considerable variation in the returns that can be achieved – which range from about 3.0% to 10%, depending on the platform and the nature of the loan. Generally speaking, the higher the return, the riskier the loan.
Fernhead points out that platforms already comply with current FCA regulation by posting information about risk.
“All platforms publish details on their defaults and bad debts – anyone investing should look at these before making a decision as to whether to invest,” he says, adding that his company seeks to educate their audience through blogs covering different types of lending and the risks associated with them.
There is, however, no industry-wide code of practice laying down standards of transparency. In theory, then, tighter FCA regulation should simply mean that the communication practices of the best in the industry will become the norm for all. Everyone will go the extra mile to educate investors.
But Fearnhead has another worry – namely that ordinary investors will be prevented from using P2P platforms because the process of qualifying as a lender will become too stringent.
“Further regulation, which is intended to prevent them offering investments to retail investors, would defy the very purpose of P2P lending which is there to enable retail investors to get a better return on their money that they can achieve from savings accounts or other traditional institutional investments,” he warns.
If his fears are justified while becoming safer, lending through a P2P could also be more difficult.