Tougher rules on wind-down plans should reassure investors in the wake of high-profile platform insolvencies, as Emily Perryman reports
HIGH-PROFILE insolvencies in the peer-to-peer lending sector have shone a light on the poor business practices being carried out by some of the industry’s less scrupulous platforms.
Business misconduct, poor governance and the substandard underwriting of loans are just some of the accusations made against the collapsed platforms.
With many investors still out of pocket, it’s no surprise that confidence in the sector has been knocked. Many industry onlookers are hopeful that new rules aiming to boost transparency and improve underwriting standards will raise the bar for platforms, thereby ensuring poor practices and messy insolvencies are a thing of the past.
So far there have been three insolvencies in the P2P lending sector: Lendy and FundingSecure in 2019 and Collateral in 2018. It’s a small number when compared with the number of platforms that have entered the market over the years, but because everyday investors have lost money the failures have garnered a lot of media and regulatory attention.
The reasons behind the insolvencies vary from one platform to another – Collateral was operating without the proper regulatory permissions; FundingSecure had deficiencies with its client accounts and a purported lack of management expertise; and Lendy suffered longstanding issues with borrowers falling into arrears or defaulting. There are, however, some common themes that unite the failures.
“I think it’s fair to say that some of the collapses have demonstrated that some platforms have been more accomplished in fintech than in loan underwriting,” says Lisa Best, head of financial services content at Intelligent Partnership.
“Despite recent strengthening of the regulations, the insolvencies don’t mean that Financial Conduct Authority (FCA) regulation hasn’t applied – it’s been in place since 2014.
But it does seem that the FCA finds the internet – the breeding ground for P2P – a difficult regulatory challenge.”
Negative publicity has also played a role in the demise of some platforms. MoneyThing cited the fall in investor confidence following the Lendy and FundingSecure insolvencies as one of the reasons for its decision to wind down in December.
Damian Webb, partner at RSM Restructuring Advisory, which is Lendy’s administrator, says poor publicity has meant the sector has struggled to attract new investors, which has subsequently undermined platforms’ growth and income.
“During a period in which their income has, in many cases, declined or stagnated, their costs have increased exponentially as they have had to invest in their infrastructure to meet the new regulatory requirements,” he says.
“Consequently, many platforms become uneconomic as they lack the income and scale to meet the required costs to comply with the current regulatory requirements.” Angus Dent, chief executive of P2P lender ArchOver, adds that lending money is a tough game with thin margins and lots of competition.
“I suspect that the businesses that failed tried to replicate what others had done before in a more efficient manner and this wasn’t sufficient,” he says.
“Other failures have exposed the myth that property – especially property development – represents good security for loans. We have seen that it isn’t and, furthermore, that it is often illiquid.”
The platform failures have brought to light the challenges and complexities involved when a P2P lender goes into administration. Many investors have found it difficult to collect what remains of their money – to the extent that some of Lendy’s investors plan to take legal action. Prior to December 2019, it wasn’t mandatory for platforms to have wind-down plans in place and, upon an insolvency event, the administrator would take control of the company’s business and assets.
“The way the loanbook would be dealt with would depend on whether or not there was a security trustee in place and contractual arrangements regarding the manner in which the loans would be administered,” explains Geoff Bouchier, managing director in the global restructuring advisory practice at Duff & Phelps.
“Recent developments in failed platforms have highlighted the challenges that can arise due to the differences in interpretation of insolvency legislation and investors’ understanding of the contractual arrangements in place with investors and borrowers. It is apparent that the structure and quality of agreements can vary significantly from platform to platform.”
This complexity means that years after an insolvency, administrators are still unpicking loanbooks and investors are out of pocket. In one instance, an administrator was accused of ignoring a third-party bid for the loanbook of a collapsed platform – another example of the often-contentious nature of insolvencies.
Sam McCollum, legal director at law firm TLT, says the reasons why an administrator might be unable to sell a loanbook can include issues over title to the assets and whether the administrator is contractually entitled to sell the loans.
“Administering a complex loanbook, with each loan potentially having multiple lenders, is not straightforward,” he says.
“Debt purchasers may also be put off by the resource required to do this – especially if they cannot get the firm’s IT platform to speak to their own systems – as well as by issues with the terms governing the loans.”
If the platform itself has poor record-keeping, it can make the process even more time-consuming, difficult and expensive.
Given the challenges involved, avoiding an insolvency is the best course of action – and this is where the FCA’s new rules on wind-downs could help. Since 9 December 2019, all P2P platforms must have arrangements in place to ensure the P2P agreements they facilitate will have a reasonable likelihood of being managed and administered, in accordance with the contract terms, if the platform fails.
Firms must also consider the cost of winding down the business and how those costs will be covered. Ben Arram, consultant at Bovill, says if wind-down plans do what they are meant to do, it should result in investors getting more of their money back and the industry as a whole becoming more robust.
However, he points out that the rules offer scope for interpretation and are yet to be tested.
“No one really wants to think about their firm failing so it’s easy to see why some businesses have shied away from writing wind-down plans,” says Arram.
“They are now being forced to put plans in place and disclose them to investors. Those not on board need to up their game a bit.”
The wind-down rules are part of a package of measures that provide for higher underwriting standards, more transparency about the information provided to potential investors and ensuring investors know the risks they are taking.
New marketing restrictions mean that new individual investors who don’t qualify as sophisticated or high-net-worth can only put 10 per cent of their overall portfolio into P2P.
December also saw the introduction of the Senior Managers & Certification Regime (SMCR), which makes senior managers personally accountable for business failings. Together with the P2P regulations, it is hoped this will improve governance, conduct and controls over time.
However, Symbat Tynshimova, compliance associate at FinTech Compliance, says the onus is on firms to change their culture and attitude to ensure continuity of business, which cannot be achieved by imposing stricter rules alone.
“The P2P providers who we have seen deliver target returns to their lenders and operate more efficiently in general are the businesses whose underwriting practices are very strict and credit risk assessments are robust,” she adds. “Hopefully, the new regulations combined with the recent developments in the industry can incentivise firms to review and improve their systems and controls.”
The new rules aren’t expected to prevent platforms from collapsing in the future – external events such as a major economic downturn will most likely result in firms failing in the P2P sector, as they will in any other industry. But it is hoped that some of the issues seen in previous cases – poor governance, allegations of misconduct and poor underwriting of loans – will become a thing of the past.
“The new regulations, combined with improved transparency and investor due diligence, should ensure that best practice is adopted and poor practices are eliminated,” says Webb.
At the same time, however, the new regulations will lead to an increase in costs which have to be absorbed by platforms in a period of tough competition and low investor confidence. This could result in short-term consolidation.
“The P2P industry is similar to any other in the sense that businesses that are not up to scratch, due to being badly run or weak business models, cannot continue for long,” a spokesperson for RateSetter says.
“But well-run businesses that put the customer at the heart of their model thrive. This is a Darwinian process that results in a stronger, better P2P sector.”