The regulatory landscape of peer-to-peer lending has evolved considerably in recent years. Now that the new rules are in place, what can the industry – and its customers – expect? Frank Brown of regulatory consultancy Bovill talks to Andrew Saunders
FIVE YEARS IN TO THE Financial Conduct Authority’s (FCA) reign, is the peer-to-peer lending industry’s regulatory honeymoon period drawing to a close? Frank Brown, managing consultant of financial services regulatory consultancy Bovill, thinks that it might be.
“The regulator has absolutely changed its focus,” he asserts. “Look at authorisations for example, often a good yardstick. A couple of years ago they were going through fairly quickly and fairly easily. Now they are slower and more challenging, with more questions on the business model.” The arrival in early December of more stringent legislation – particularly around marketing, investor appropriateness and the ’10 per cent rule’ – plus the fallout from platform failures like Lendy and FundingSecure, certainly suggest a sea-change in regulatory attitude towards the sector.
Established platforms which grew up under the ‘old regime’ might not have felt like they were receiving special treatment at the time, but they will notice – if they haven’t already – a change in terms of both tougher language and action, Brown says. Take the policy statements now emerging from the FCA. “In terms of regulation, it’s quite prescriptive and there is more control than there was previously,” he adds.
It’s a shift that is driven, he says, by the FCA’s need to balance its two overarching obligations – to foster competition and good customer outcomes on the one hand, whilst simultaneously maintaining market integrity on the other. The FCA took over regulation of P2P from the Office of Fair Trading in 2014. Having initially approached the sector more as a tender young plant that needed to be encouraged in order to promote competition in the lending market, the FCA now seems to have decided that it is mature and competitive enough to cope with a more robust approach. Attention is thus moving towards the business of maintaining market integrity in the wake of those aforementioned high profile collapses.
“Embarrassing headlines about P2P firms falling over don’t do much to help market integrity,” Brown comments. The stage of the economic cycle is another major influence. “I think there is a recognition that [the P2P platforms] have grown up in incredibly benign economic circumstances – you could not wish for a better place to be launching products,” he states.
Persistently low interest rates have created demand for better returns for investors on the one hand, whilst also making it easy for borrowers to budget for repayments on the other. But Brown cautions, such unusually-favourable conditions cannot last forever and a slowdown is widely believed to be on the way. “Bad debt on lending is quite stable at the moment, but you know economic cycles,” he says. “We are already over 10 years out from our last recession in this country.”
It all adds up, he says, to one unavoidable conclusion: “There is quite clearly a view from the regulator that this is a market that needs tightening up.” Not that this comes as too much of a surprise to anyone who read the FCA’s 2018 consultation paper on P2P, or its response to industry feedback on the paper which followed in the summer of this year.
But we’re now getting the first real taste of what it all really means, in the form of the package of legislation which came into force on 9 December. The new tougher requirements include marketing restrictions for everyday investors and much more stringent requirements for wind-down preparations in the event of a platform failure, as well as higher standards on the information that must be provided to investors.
Some industry figures worry that the FCA crackdown is going a bit too far, a bit too fast and risks killing the goose that lays the golden egg. Particularly when it comes to the 10 per cent rule: in a sector whose roots lay in democratising returns for smaller investors, this restriction will mean that someone with £20,000 to invest can put a maximum of just £2,000 into P2P.
It may have the unintended consequence of pushing platforms away from retail funding and towards institutional money – a trend that was already in train anyway – but overall Brown is sanguine and thinks that the impact of the legislation will be less dramatic than feared.
“People often look at new regulation like this, the marketing restrictions and appropriateness tests, and think that it is going to be the end of the world,” he says. “But generally speaking, it doesn’t turn out like that.” For Brown, the wind-down rules are perhaps more structurally significant. Partly because they make it clear the regulator is prepared to let platforms fail – in as orderly a manner as possible – and partly because they emphasise that platforms have a duty of care towards investors, even though they don’t actually hold funds in the way that traditional investment companies do.
“Wind-down is incredibly important from a maturity, good practice and consumer information perspective,” explains Brown.
“It’s being able to demonstrate that you have thought about end-of-life and you have a credible solution for keeping the lights on during the time it takes to find somebody else [to take on the loanbook].” At least one platform’s wind-down plans are being tested for real right now – on 6 December, P2P lender MoneyThing announced its closure, citing economic uncertainty and diminishing returns on lending.
Unlike Lendy or FundingSecure, MoneyThing is not in administration and has shut down voluntarily. According to a statement on its website, it plans to “exit the market quietly and with minimum disruption to our customers and the industry as a whole”.
Another new regulatory change worth thinking about is the Senior Managers Certification Regime – the requirement for firms to have named individuals who are responsible for regulatory compliance. It was introduced to the banking sector in the light of Libor manipulation and other misconduct scandals and is now being applied to consumer finance – including P2P – as well.
In banking, SMCR hasn’t resulted in much in the way of enforcement to date; Brown reckons the FCA may be looking to this wider rollout for an opportunity to prove that the rules do have teeth after all. “It will give them a chance to put some metaphorical heads on poles,” he asserts. “I think there are some areas of P2P – high-cost, short-term lending, perhaps some aspects of motor finance – where the regulator has a view that things are not as they should be.”
You have been warned. P2P platforms also need to start thinking about how all the new regulations might impact their business plan, and growth forecasts in particular “I do advise people to have a look at their business strategy and their three-year plans, because [the new regulation] is going to make some difference,” Brown says. In other words, best to dial down your growth targets now to avoid the temptation to lower your lending standards and pile on risk later.
“The worst thing you can do is strive to meet a target that is unobtainable,” he states. “Targets that are unobtainable are the root cause of poor customer outcomes.” Brown himself comes from a Big Four consultancy background, before which he had stints at Home Retail Group and Santander. He moved to his current role in March 2017 from PwC and enjoys the contrast that Bovill’s more entrepreneurial culture provides.
“There are short reporting lines and quick decisions, which is helpful,” he explains. “You can have an idea and pursue it, rather than being constrained by a large bureaucracy. It’s horses for courses, but for me personally it has been a positive change.” That culture helps Bovill identify more strongly with the similarly entrepreneurial P2P platforms it advises, says Brown, and also influences the nature of the advice given.
“Bovill’s USP has always been around giving clear advice that answers the client’s questions – we tend to be quite practical. ‘You have a risk here and this is what you should do about it’. We don’t produce large reports that don’t say anything.” In his view, it’s decision time for the industry. “There is a fork in the road,” Brown says. “Does P2P want to be a boring – in a good way – mainstream product, or does it want to be a sort of fast and loose piece of niche investment exotica?” The most benefit will accrue to the greatest number if it chooses the mainstream fork, he argues.
“That’s where the money from investors is and it’s where the stability is, without question. If it goes the other way it becomes much smaller and the number of players that could make money in that space also becomes small.” While going mainstream inevitably involves greater regulatory scrutiny, nipping bad practice in the bud now is good for the industry as a whole. The quid pro quo is enhanced consumer confidence and more consistent and more sustainable growth, says Brown.
“A few more platform failures could see the Daily Mail’s and Martin Lewis’s of the world get very vocal about P2P,” he warns. “It would be relatively easy for it to become seen as risky and for people to turn against the sector.” So the honeymoon may be over, but now it’s up to both industry and regulator to make sure that a long, happy and profitable marriage ensues.