PEER-TO-PEER lending platforms are gearing up for the introduction of appropriateness tests, in anticipation of the outcome of the Financial Conduct Authority’s (FCA) review into the sector.
The City watchdog is expected to release final rules on reform of the P2P sector this summer, following controversial proposals released last year which mooted the introduction of categorisation and appropriateness tests for P2P investors.
The industry on the whole has supported the introduction of appropriateness tests but expressed concerns about the way they would be implement¬ed and resulting costs. Firms are now working together on solutions.
The Tax Incentivised Savings Association (Tisa) has established a working group to create a standard approach for appropriateness tests, which it will present to the FCA.
The investments trade body created a similar framework in response to the revised Markets in Financial Instruments Directive (MiFID II) – EU regulations that mandated a greater breadth of investment firms to implement appropriateness tests, although this did not include P2P platforms.
“The guide will help firms and their customers determine whether and to what extent P2P is appropriate for non-advised customers,” Jeffrey Mushens, technical policy director at Tisa, said.
“This would provide an alternative to the approach of restricting investment in P2P to investors who can demonstrate that no more than 10 per cent of their investable assets could be invested in P2P.
“The working group is made up of representative industry members and we are aiming to publish a draft guide in June.”
There are 15 P2P platforms in the group including ‘big three’ lender RateSetter.
Mario Lupori, chief investments officer at RateSetter – who chairs the group – said an appropriateness test can be “very effective in ensuring that investors understand the nature of P2P investments, while not restricting access.”
Jake Wombwell-Povey, founder of direct lending investment manager Goji, has also been involved in meetings.
“We want to have an actionable guide so firms can implement the test,” Wombwell-Povey said.
“The FCA will not endorse anything but have engaged with Tisa in the past.
“We hope by developing a best practice guide, they will engage in a similarly constructive manner. Clearly some platforms will have more resources to introduce this than others.
“The objective of the working group is not to lower costs but to develop a best practice guide.”
Crowd bond platforms such as Downing and Abundance already require investors to pass appropriateness tests as they fall under the MiFID regime.
The tests aim to ascertain investors’ knowledge on a range of issues, such as whether they understand their capital is at risk or the lack of Financial Services Compensation Scheme protection.
Julia Groves, partner and head of crowdfunding at Downing, said the implementation costs should be in the thousands rather than tens of thousands.
“The implementation cost will vary depending on how each platform is designed, and whether you have development in house, but it should be thousands rather than tens of thousands of pounds, and certainly not six figures,” Groves said.
“We have set the tech up to be able to apply a different set of questions to different bonds, so that we can double check that our members understand any changes or new features.
“Most consumers pass the test, we have a failure rate of about 11 per cent.
“If they have read and understood the risk warnings and the offer document, they will find it easy to pass the test. If they haven’t and they don’t understand, then we don’t want their money.”
The Peer-to-Peer Finance Association is in discussions with Tisa about its best practice guide. The trade body said that its platform members supported the idea of bespoke appropriateness tests, adding that “a standardised approach could fail to reflect the characteristics of the wide variety of markets served by different platforms.”
Some industry commentators have suggested that appropriateness tests could have the additional benefit of protecting platforms from mis-selling complaints.
“The test can also potentially be used as a shield for mis-selling cases, as the investor will have a hard time saying they didn’t understand the product when they have taken a test implying that they did understand the risks involved,” Jonathan Segal, head of fintech at law firm Fox Williams, said.
However, Emily Morton, an associate at law firm TLT, highlighted that appropriateness tests do not result in blanket approval from the regulator. She cited the FCA’s criticism of contracts for difference platforms in 2017, regarding the way tests were implemented.
“I wouldn’t expect appropriateness tests to have too much of a negative impact in the P2P lending space, but it will be important for firms to get this right,” she said.
This article appeared in the June issue of Peer2Peer Finance News.
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