Nicola Horlick, chief executive of Money&Co and Lauren Lee, managing associate on the finance litigation team at law firm Addleshaw Goddard, assess the future of peer-to-peer lending
Prior to the economic crash in 2008, the vast majority (estimated at 91 per cent) of funding to small- and medium-sized enterprises (SMEs) was provided by the big traditional banks. However, following the crash, SMEs have found it much more difficult to obtain finance. The introduction of alternative finance including peer-to-peer lending has brought choice and competition to the banking market and has increased rapidly in popularity over the past few years. According to the third European Alternative Finance Industry Report, the alternative finance market across Europe grew by 41 per cent from €5.431bn in 2015 to €7.671bn in 2016.
P2P lending is an alternative way of raising finance and allows investors to provide loans (secured and unsecured) to companies looking for finance, with the loan being organised through a lending platform. P2P lenders claim that they can provide loans very efficiently and offer better interest rates for investors.
However, with the limited protection currently afforded to P2P investors leading to the spectre of more regulation by the FCA and with some P2P lenders applying for banking licences, is P2P lending here to stay or are P2P lenders just traditional bankers in disguise?
Regulation of P2P Lenders
The Financial Conduct Authority (FCA) began regulating the P2P lending industry from 1 April 2014 and required P2P lenders to apply for full authorisation with interim permissions being granted in the meantime. The definition of what constitutes P2P lending is found in article 36H of the Regulated Activities Order. It is noted that invoice finance platforms do not fall within the definition.
The FCA rules include prudential requirements, protections in case of firm failure, client money rules, disclosure rules and dispute resolution and reporting requirements. Whilst it is widely regarded that regulation in this area is a positive thing, most people believe that the rules are a little too relaxed and, as such, the FCA is due to produce a consultation on new rules at some point in the near future. It should be noted that P2P lending platforms are not currently covered by the Financial Services Compensation Scheme (FSCS). It could be argued that more regulation will bring P2P lending more into the mainstream of investment and the larger P2P platforms appear to be relatively relaxed about the prospect of more stringent regulation.
Internationally, the regulation of P2P Lenders is extremely varied. It is prohibited in Japan and Israel. It is unregulated in Brazil, China, Egypt and South Korea and there is intermediary regulation in Australia, Argentina and Canada. The UK and the US have their own specific models of regulation whereas France, Germany and Italy regulate P2P platforms as banks.
Read more: Nicola Horlick’s Brave New World
Why are some P2P lenders looking to obtain a banking licence?
Whilst P2P lenders are still receiving a high number of applications from potential borrowers, the difficulty is in finding quality borrowers. P2P lenders are judged by the level of bad debts that they have incurred and so the emphasis has to be on finding quality borrowers with a lower likelihood of defaulting. Most P2P lenders are also now looking for better security than in the early days of the sector’s existence. They will generally look to take a debenture and, if the company is light on assets, they will also look for personal guarantees from directors. In addition, there are now frequently covenants in loan agreements with P2P lenders.
More and more, the bigger platforms are beginning to act more like banks and some P2P lenders have applied for or are looking to apply for a banking licence so that they can provide an even wider range of products. In particular, P2P lenders with a banking licence will be able to offer deposits protected by the FSCS and provide credit cards and overdrafts. However, regulatory obligations will, of course, increase.
Notwithstanding the above, there are some P2P lenders that have confirmed that they have no intention of applying for a banking licence and that the P2P model works and is scaleable.
Read more: P2P lending set to pass £9bn milestone
P2P lending and the ISA market
The ISA market could prove to be a very substantial provider of money to lend for the P2P lending sector. On 6 April 2016, the government introduced a third type of ISA to sit alongside the cash ISA and the stocks and shares ISA. This was the Innovative Finance ISA. This allows investors to wrap their P2P loans in an ISA wrapper and receive the income completely tax free each year.
According to the HMRC statistics for the ISA market for the tax year to 5 April 2017, there is £270bn sitting in cash ISAs in the UK. Money&Co., a P2P business lending platform, recently did a survey of 233 ISA providers and found that the average yield being offered to cash ISA investors was only 1.03 per cent. Amongst the major banks, the yield was only 0.5 per cent. The Innovative Finance ISAs that are on offer are yielding six to seven per cent per annum. It should be noted, however, that P2P loans can fail and investors can suffer bad debts.
Will Brexit impact upon P2P lending?
The majority of P2P lenders have seen lending continue to increase since the referendum in June 2016 but there is a concern that if the cost of importing goods and services increases upon leaving the EU, then SMEs may require additional funding or may struggle to service the finance they already have in place. Those SMEs that export to the EU may also be negatively impacted by Brexit post the transition period. P2P lenders are very aware of these issues and they are taking the likely effects of Brexit into account when making credit assessments.
Whilst traditional banks may be slightly nervous about lending money in this period of uncertainty, arguably, it is a time for P2P lenders to fund the growth of SMEs and drive the economy forward.
What effect will PSD2 have on P2P lenders?
PSD2 incorporates and repeals the Payment Services Directive (the main piece of legislation governing payment services in the EU) and focuses on – amongst other things – improving consumer protection and making payments safer and secure. PSD2 allows non-banks to use banks’ APIs and non-banks can enter the financial market without the heavy compliance and infrastructure which banks are required to maintain.
Overall, PSD2 is beneficial to P2P lenders. It will allow access to banking customers’ data and allows them to offer services to those customers who are not being ‘serviced’ by the standard high street bank i.e. SMEs who are trying to obtain a loan.
P2P lending has provided SMEs (and others) who often struggle to obtain finance through more traditional channels with an alternative means of obtaining funding. The Department for Business Innovation and Skills confirmed in 2016 that SMEs accounted for 99.9 per cent of all private sector business, 60 per cent of all private sector employment and contributed 47 per cent of all private sector turnover in the UK. Given the importance of SMEs to the future of the economy, there is no doubt that P2P lending will continue to be a welcome addition to the banking world for the foreseeable future.
Furthermore, with the emergence of the ever-evolving fintech and crypto-currency market, the opportunities for P2P lending may well increase and, whilst Brexit may lead to some challenges in the future, the indication thus far is that foreign investors and, indeed the UK government, feel that the long-term future of P2P lending is very positive and a viable and sustainable alternative to the traditional banks and banking. P2P lending is most definitely here to stay!