The letter of the law
Compliance is an essential component of the peer-to-peer lending sector, keeping platforms in check as they push at the boundaries of innovation. With new regulations looming, what should firms prepare for and should investors feel reassured that their money is in safe hands?
IT IS CLOSE TO FIVE YEARS since the Financial Conduct Authority (FCA) took over regulation of the peer-to-peer lending sector – a move that has coincided with a period of exponential growth for the industry.
This growth has presented the regulator with a number of challenges along the way: not least the task of regulating a sector that is home to constant innovation, as well as a diverse range of business models and lending types.
“There’s a myriad of business models and it took ages for the FCA to get their heads around this, so the authorisation process for many platforms was incredibly slow,” explains Michael Lynn, chief executive of P2P property platform Relendex.
Turnover at the FCA, a lack of resources and a lack of knowledge about the young sector are challenges that the regulator has grappled with over the past five years.
Andrew Holgate, founder of fintech consultancy Equitivo, notes that the FCA’s post-implementation review consultation, published last summer, shows how far the P2P market has come since the FCA took over as regulator.
“New models, innovation and a wider breadth of different loan types all pose problems for the FCA,” he says.
He notes that when the financial watchdog became responsible for regulating the consumer loans market, many platforms operated under a reverse auction model, where no interest rate was specified and the lenders were free to bid for the borrower’s loan proposal. They quickly moved to a fixedprice model, where an interest rate is determined by the platform’s assessment of how risky the loan is, and then to quasi-discretionary management of investor funds.
Dena Chadderton, senior adviser at regulatory consultancy BWB Compliance, was pleased that the FCA had considered the range of P2P platform models in its post-implementation review, grouping them into three categories: ‘conduit’, ‘pricing’ and ‘discretionary’.
“The FCA sees increased risk for the investor as the P2P platform’s role in the pricing and allocation of the loan increases,” she adds.
The regulator’s number one priority is to protect the interests of private investors – and this is evident in the post-implementation review. For example, the paper included a proposal to improve transparency to allow investors to gain a better understanding of the historic performance of the platform and the loan they are investing in.
The regulator also proposed restricting marketing to those who are certified as sophisticated or high-net-worth investors or those who promise to invest no more than 10 per cent of their net portfolio in P2P.
Finally, the FCA would like to see improved risk management at P2P platforms, including more formal wind-down plans. The financial watchdog is expected to publish its final thoughts during the second quarter of this year.
The proposals have so far received a mixed response from the industry. While many welcome greater transparency and the requirement to have more formal wind-down plans in place, the proposal to introduce marketing restrictions has attracted some criticism.
At a Peer-to-Peer Finance Association event late last year, industry stakeholders argued that marketing restrictions could dissuade everyday retail investors from putting money into the sector and may create onerous costs for platforms.
While those present at the event were broadly in support of appropriateness tests, they were concerned about how the tests would be implemented in practice.
It was suggested that different types of marketing restrictions would be suitable for different types of platforms depending on the risk profile of the loans.
“It seems like the FCA is focusing on this [higher risk loans] when the vast pot of investor money in the industry is with the lower risk options, where hardly any loans have lost them money overall and they have received plenty of interest for the risks,” says Neil Faulkner, founder of P2P analysis firm 4th Way.
With this in mind, he hopes the FCA is simply touting the idea of marketing restrictions to see how the industry responds.
However, Relendex’s Lynn suspects the regulator will put these proposals in place. If this is the case, his platform will need to respond to marketing restrictions by altering its technology, which will have operational repercussions.
“I think the FCA is minded to put all of this in place,” he says. “It is good, but it is a burden in terms of time and cost for small organisations like us.
“The big guys can absorb it as they have big departments dealing with this stuff but we haven’t – and we have got to comply with the same rules. This is quite tough but we will survive; our regulated status is very valuable to us.”
Lynn estimates that compliance costs equate to at least 10 per cent of Relendex’s revenues. Compliance also takes up a substantial amount of time internally: around 30 per cent of a senior director’s time, while two senior administrators spend 10 per cent of their time respectively on it, plus oversight from the management team.
“In a small organisation that is quite a lot of management time,” he adds. We have external consultants and internally we have got a lot of compliance knowledge going back 30 years.”
He adds that the company is set to spend tens of thousands of pounds on in-house training on compliance-related matters.
In Chadderton’s opinion, the biggest burden associated with compliance for all regulated P2P firms is time – particularly for senior staff, who may have multiple roles in a start-up.
“The obvious money-spent costs of being FCA regulated are the annual fees and the cost of any compliance support, but the true cost runs deeper at the cost of management time,” she says.
Once you factor in managing any complaints, client money oversight, reviewing and approving financial promotions, money laundering checks and the time spent staying up to date with FCA regulation, you can appreciate the effect this might have on a busy senior executive, she adds.
Stuart Law, chief executive of P2P platform Assetz Capital, estimates that between 15 per cent to 25 per cent of time spent by the company’s 100-strong team is on compliance-related matters. Assetz Capital has a compliance officer in-house, who also sits on the board, and the company does not use external compliance consultants. “
A lot of regulation is commercial common sense,” Law asserts. “It is about doing the right thing regardless of whether you are regulated or not. We just made sure we had our ducks in a row from the beginning and evolved from there.”
‘Big three’ P2P lender RateSetter has a long-standing internal compliance team.
“Our priorities include complying with relevant regulations; maintaining an open and positive relationship with the regulator; and helping to shape future regulation,” a spokesperson explains.
Five years since taking responsibility for regulating the sector, how should the FCA’s approach evolve?
While the approach so far has been relatively hands-off, Lynn would like to see greater dialogue between the FCA and the P2P sector in the future.
“A closer dialogue and more face-to-face meetings would resolve quite a lot of problems,” he says.
He adds that the FCA’s principles-based approach can also weigh heavily on platforms.
“The responsibility is on us to do the right thing at all times – and it is not always clear what the right thing is,” Lynn says.
This means that platforms can incur extra costs employing professionals, like lawyers and compliance consultants, in the quest to find the right answer.
Faulkner would like the regulator to set higher transparency standards in the future. He hopes this would allow consumers to spot the loans that are too risky and points out that collapsed platform Collateral did not offer enough transparency to investors.
With the regulator poised to take a tougher approach to regulating the sector, one important question remains: can P2P investors feel reassured that their interests are protected?
FCA regulations should help protect investors’ money from scams, frauds and back office incompetence, but there is always scope for things to go wrong.
“Being FCA approved is not a guarantee,” says Holgate. “Things can and will go wrong, but regulations should significantly reduce the risk of malpractice.”
Chadderton says that the FCA’s latest proposals seek to improve investor protections by ensuring they have all the information they need to make an investment decision that is right for them.
“But as always, it is worth noting that P2P loans are investments and the regulations are not able or designed to protect an investor from capital loss due to the performance of the investment itself,” she adds.
This article featured in the April issue of Peer2Peer Finance News, available to read online.