THE FINANCIAL Conduct Authority’s chief executive Andrew Bailey is still relatively new to the role but he’s already made waves in the peer-to-peer finance sector. He talks to Peer-to-Peer Finance News about managing innovation with regulation at a pivotal time for the industry
Andrew Bailey isn’t exactly a cheerleader of peer-to-peer lending. The Financial Conduct Authority (FCA) chief executive made numerous headlines this summer when he told the Treasury select committee that he was “pretty worried” about the way P2P is sold to consumers.
His comments were added to that now-infamous Lord Turner quote and some similarly cautious words from Treasury select committee chair Andrew Tyrie, to create an annus horribilis of mainstream media commentary that the sector is still trying to shake off.
But it would be inaccurate to describe Bailey as a critic of P2P, as much as it would be to describe him as a cheerleader. As the head of the City regulator, he has a delicate line to tread in supporting the sector while enforcing codes of conduct.
“It’s an industry which quite sensibly and quite understandably is rapidly evolving and innovating,” he tells Peer-to-Peer Finance News. “Some of the ways in which we’ve seen that innovation develop are quite sensible and others do create issues for us.”
Last month, the FCA released a surprisingly punchy interim feedback statement on its review into crowdfunding, which indicated it will implement tougher rules on the sector.
The watchdog said it would consider “setting investment limits to cap potential consumer harm” and suggested extending “mortgage-lending standards” to P2P platforms, amid concerns that consumers were not adequately informed about the risks.
One particular area of concern for Bailey is provision funds, which are held by a number of platforms including RateSetter and Zopa. The provision fund is a pot of money set aside to compensate lenders, if default rates increase more than expected.
“In an abstract way, the provision fund is perfectly sensible as it can buffer against losses, but it’s quite an innovation for P2P, which in its purest sense is connecting one lender to one borrower,” says Bailey.
“Lending with a provision fund, which generalises the use of reserves, is taking it in the direction of banking. Banking obviously has provisions of capital to protect depositors, but P2P isn’t a deposit contract in the same way.”
Bailey fears provision funds could give investors the false impression that their money is protected from losses like it would be in a bank deposit, which is covered by the financial services compensation scheme.
“The issue for us is how well investors understand the role of this provision fund,” continues the Bank of England veteran and former Prudential Regulation Authority chief.
“How is it marketed? Because we have seen examples where the presence of the provision fund goes with the marketing that nobody has lost money in the fund, but you can’t guarantee that.
“And thirdly how fairly is it used, bearing in mind the nature of P2P? Those raised some pretty big questions for us about how those funds operate, what role they play and how they’re marketed.”
December was certainly a busy month for the FCA. The crowdfunding feedback came hot on the heels of a separate crackdown on spread betting, which wiped around £1bn off the market value of the main players after the regulator proposed capping the amount of leverage that inexperienced retail clients can use for trading.
Less than a week later, the FCA announced a full review of competition in the UK’s mortgage market. Perhaps Bailey is keen to show that no stone will be left unturned, under his relatively new leadership.
“First of all, the P2P industry has both grown and evolved in terms of its nature and structure and form,” he asserts. “Secondly we have seen that some of the firms have come up against some natural growth limits in recent times. So all of those things are in play.
“But what we’re trying to do is balance innovation against ensuring firms are transparent about what model they’re operating in. It’s about a sensible interpretation of rules that are fair to investors, fair to borrowers, and transparent. But we don’t want to stifle innovation unreasonably.”
The Innovative Finance ISA
There appears to be a slight dislocation between the Treasury and the FCA in terms of their approach towards the sector. The Innovative Finance ISA, the tax-free wrapper around P2P investments, was first introduced by former Chancellor George Osborne in July 2015 and a number of smaller platforms have been offering the product since April this year. Yet the FCA is yet to approve the vast majority of larger platforms and clearly has a number of issues about the way the industry operates.
Bailey shrugs off the suggestion that the Treasury was a little hasty in launching the IFISA or that the FCA is playing catch-up.
“It’s perfectly sensible to want to extend the use of the ISA to more innovative forms of investments, there’s nothing wrong with that,” he explains. “Our point is this. The ISA comes out of a more traditional savings model – a banking model really – so it’s absolutely important that people using the IFISAS understand the risks embedded in it.”
Read more: Innovative Finance ISAs: The game changer
Jason Pope, technical specialist at the FCA who worked on the crowdfunding feedback, adds that there is no connection between the regulatory review and the IFISA. “We always committed to the post-implementation review for this year,” he says. “When the Treasury allowed the IFISA to operate, it was only the fully authorised firms, so there are possibly some firms that would like to offer the IFISA but can’t.
“I don’t think these things are all connected. There’s no focus on stopping any firms from offering it and we’re working as best we can to authorise the firms.”
Bank in sheep’s clothing
A key element of Bailey’s concerns around P2P is what the FCA calls “regulatory arbitrage”. In layman’s terms this means some firms are operating under relatively light P2P regulations when they are in fact closer to banks or collective investment schemes.
“P2P does serve a purpose in enabling investment in innovative sectors of the economy and we should not stand in the way of sensible innovation that allows investment in entrenching the economy,” says Bailey.
“However, there are two fixed points on our landscape. One is banking. The banking relationship is a deposit contract, where the deposit is held with the bank on the understanding that the customer will get it all back. The bank holds capital and reserves to buffer against the risk that they can’t repay it.
“The other point is the collective investment scheme, where you have many investors that put money into a fund that is then invested into many companies or investment opportunities, but there is no capital protection.
“Where P2P becomes slightly difficult is where it’s slightly muddying the waters between those two points in ways that lack transparency. If a firm is starting to innovate around those two points, but lacks transparency or appears to look like one of them, then we have to ask why that is and whether investors understand what they’re getting.”
Legal experts have already predicted that some of the larger platforms with more complicated business models may fall into one of the two categories, which may explain why some of their applications have been in process for more than a year. It is a tricky sticking point which is likely to have a major impact on the industry if the FCA rejects certain platforms’ applications.
Read more: P2P platforms heading for FCA rejection
For now, it’s business as usual for P2P lenders, although more regulatory hurdles loom on the horizon. The FCA will be completing its investigatory work next year and any changes will be come into effect in 2018.
In the meantime, Bailey will have to continue navigating that careful balance between supporting and reining in the sector.
Bailey is a busy man and the interview needs to be wrapped up. Does he agree with the line of thought that the true test of P2P will be whether it can survive a downturn?
“That’s a fair comment to make,” he says. “What would a downturn in a credit cycle test? It would test a number of things. It would test whether the sector was robust to making losses and whether investors understand the terms in which they put their money in, so it would in a sense test that relationship quite hard.
“If it came through that and investors said yes, I always understood the risks I was taking but I nevertheless valued the opportunity as part of my investment portfolio, then that would be a good assurance.”
This interview was published in the latest print edition of Peer-to-Peer Finance News. To request your monthly copy, complete with exclusive content, email firstname.lastname@example.org.