NEW ringfencing regulations in the banking sector look set to create a two tier system of protection for peer-to-peer investors’ money before it is lent out.
P2P platforms can handle lender funds either by setting up separate client money accounts with a traditional bank or by outsourcing it to an e-money provider.
Government banking reforms, introduced in response to the financial crisis in 2008, mean that UK banks must separate their investment and retail banking activities by January 2019.
This means that money held in the retail bank is protected from the investment bank’s operations.
Technically, this means P2P funds held in a client money account with a bank are protected by the Financial Services Compensation Scheme (FSCS) until the money is invested but the same does not apply to P2P investor funds held by an e-money provider.
Furthermore, e-money providers can be based anywhere in the world, meaning that they may comply to a different regulatory framework entirely.
Neil Faulkner, managing director of P2P analysis firm 4th Way, said the distinction between platforms using client money or e-money accounts was a “long-tail risk” but one investors needed to understand.
“It is a small risk compared to others when choosing a platform, but they all add up,” he said.
“Provided you are spreading across lots of platforms there is no reason to worry why some are in e-wallets and some are ringfenced.”
Alison Donnelly, head of advisory at financial compliance firm FSCom, said the changes do upgrade the protection on offer where banks hold the client accounts, but said that doesn’t necessarily make e-money riskier.
“If you have a choice of credit institution or e-money, a credit institution has higher capital requirements and FSCS cover so in that sense it is more than likely always going to be safer on that whole ‘too big to fail’ point,” Donnelly said.
“That said, there is no e-money institution that has gone out of business and most will safeguard funds with a European Economic Area-regulated bank.”
Barclays has already been in contact with P2P lenders about the impact of ringfencing rules on their client accounts.
P2P bridging and buy-to-let mortgages provider JustUs has been told by Barclays that their client accounts will be in the retail part of the ringfenced bank.
Lee Birkett, founder of JustUs, told Peer2Peer Finance News he thought accounts held by ringfenced banks were safer for P2P investors.
“Ringfencing reduces the possibility that essential banking services used by ordinary depositors are put at risk by a failure in another part of the business or the global financial system,” he said.
However, other P2P platforms who use e-money providers insist investors should not be concerned. Business lender Growth Street uses e-money provider PrePay solutions, owned by Edenred and Mastercard.
Greg Carter, founder of Growth Street, believes that using an e-money provider is beneficial as activity is more automated compared with the way banks manage client cash accounts, so transactions can be completed faster.
“When we chose the e-money route we did lots of due diligence,” Carter said.
Some of the e-money providers they eschewed were very young and regulated overseas, he added.
While e-money providers do not offer FSCS protection or comply with ringfencing regulations, Carter points out that those in the EU still operate under the Payment Services Directive so similarly have to safeguard funds from their own balance sheets.
“The whole retail banking system will be less exposed to investment banking which is good for everyone whether on a client or e-money basis,” Carter said.
“It is to the benefit of all consumers; the differences between client money and e-money won’t change.”
It comes as HMRC is facing calls to clarify the rules regarding e-money accounts and ISA manager status. Current ISA rules say funds have to be held with a deposit-taking institution.
Many e-money providers do not have these permissions, yet it is believed some Innovative Finance ISA providers are still using them. Jake Wombwell-Povey, chief executive of P2P administrator Goji, said this was a “hangover” from the old ISA regime and that HMRC had not considered how P2P platforms operated before setting up the rules.
“The rules have no detriment to anyone in using the e-money institution,” he said.
“It would not be a good outcome for HMRC to be draconian on this. It is more that HMRC will say it needs sorting. “There is no detriment or tax avoidance or impact on competition.”
This article first appeared in the March issue of Peer2Peer Finance News, which is now available to read online.