IT’S OFFICIAL – the Financial Conduct Authority (FCA) will soon make it mandatory for all peer-to-peer platforms to introduce an “appropriateness test” for new investors.
The purpose of the test will be to weed out any unsuitable lenders, and any potential lenders who do not fully understand the risks associated with P2P. However, opinions differ on what this test will actually look like.
According to FCA guidelines, the appropriateness test should include a range of questions which will assess the investor’s understanding of the relationship between the borrower and the platform, and their exposure to the risks of P2P lending. It should also confirm that there is no Financial Services Compensation Scheme (FSCS) protection, that returns may vary and that P2P investments are not comparable with a savings account.
The test should also ensure that investors are aware of the risk that they may be unable to exit a P2P agreement before maturity, even where the platform operates a secondary market.
However, while this test can be presented in multiple choice format, the regulator has warned that platforms must avoid a “tick-box approach.” This suggests that each platform will have to get creative when designing their questions. The test should be hard enough to dissuade unsuitable investors and detailed enough to ensure that those investors who are deemed suitable are truly aware of the risks involved.
Wellesley is one of the few platforms to already have an appropriateness test in place, due to its status as a mini-bond provider. If a new investor fails the test twice, they are unable to take it again for 60 days.
“The most important thing about the appropriateness test is that the consumer understands the risk and rewards associated with the investment decision,” says Luke Madden, managing director at Wellesley. “The whole point of the test is if we feel the investor doesn’t understand the risks they are taking then the test identifies that and they’re prevented from investing.
“We should remind ourselves that these products do not have FSCS protection and therefore an investor should educate themselves about all the risk and rewards before the investment decision. And if the appropriateness test helps them do that then it’s a good thing.” Within the wider P2P community, the appropriateness test is being viewed as an extension of existing investor protections. Several platforms already ask new investors to disclose their annual earnings and net worth.
At Zopa, where the minimum investment is £1,000, investors are told at every point during the sign-up process that “it’s important you’re comfortable with P2P’s risks”, and Funding Circle advises all new investors to read not only its terms and conditions, but its loan conditions as well. Every platform tells investors that they are not FSCS protected. The appropriateness tests must be ready to go by 9 December 2019, and some platforms are already working on the finer details.
“We have always been very supportive of the idea of an appropriateness test and over recent months we’ve led work with the Tax Incentivised Savings Association to create a framework for effective appropriateness tests,” said Mario Lupori, chief investments officer at RateSetter. “The P2P sector is very diverse, so a test which is bespoke to the platform will help investors understand the specific product that they are looking to invest in.”
Other P2P executives have identified the test as an opportunity which could offer a “competitive advantage” and put P2P on a par with other mainstream savings and investment choices.
The challenge for platforms will be to create a test that meets the high expectations of the FCA, without alienating prospective investors. If they can get that balance right, they could end up in a much stronger position.
This story first appeared in the print issue of Peer2Peer Finance News, which can be read in full here.