Stricter rules for the peer-to-peer lending sector were introduced last December, but have they had their desired effect? Michael Lloyd investigates…
With the Covid-19 outbreak and the subsequent national lockdown this year, it is easy to forget that it has only been 11 months since a raft of new regulations for the peer-to-peer lending industry were introduced.
Arguably, the current economic environment means that rules governing how platforms operate – and how they wind down – are more important than ever. In a ‘normal’ year, we would be looking back at the impact of these rules and asking if there was room for improvement.
But this is 2020, so the regulations have already been tested again and again thanks to an unprecedented economic crisis. And according to most industry stakeholders, despite initial frustration at the speed and scope of the regulations, they have already proved to be a success.
On 9 December 2019, the Financial Conduct Authority (FCA) outlined its tougher regulations for the sector, including the requirements for more detailed wind-down plans and appropriateness tests for investors. The regulator also introduced the so-called 10 per cent rule – mandating everyday investors to put no more than 10 per cent of their portfolio in P2P loans. Industry onlookers generally agree that the appropriateness tests have made the risks clearer to investors, allowing them to make much more informed decisions on where and how to invest.
“The rules were introduced to improve and standardise best practice,” says Kylie-Jo Greeff, compliance manager at Rebuildingsociety. “I think they have worked to make platforms more aware of what is required of them and I think by and large most platforms have added more protection and information for consumer investors.”
In particular, the appropriateness test has been singled out as making the biggest difference to platform engagement.
Rishi Zaveri, co-founder and chief executive of Lendwise, says that over the past year, he has seen some consumers confused by his platform’s test, which shows that P2P is not right for them.
“It clearly tells you they shouldn’t be investing in P2P,” he says. “If it stops unsuspecting people who really aren’t able to understand the essentials from investing in P2P, it’s not a bad thing.”
He goes onto say that wind-down rules are more important than ever in the current Covid-19 induced high-stress environment.
“The wind-down rules are important for anyone dealing with retail money,” Zaveri says.
“I think Covid-19 has reminded everyone that something can come out of the blue and it’s important to have a plan to deal with the unexpected. Forcing everyone to have a plan, so that if they need to close they can wind down in an orderly manner, is good.”
However, it is no secret that some platforms were initially unsure about December’s rules, and not everyone believes that the regulations have been a net good for the industry, one year on.
Stuart Law, chief executive of Assetz Capital, says that even though the rules have ensured most platforms operate a well-run ship, he hasn’t seen any evidence of people being challenged on how well they have implemented the regulations.
“For us it’s a significant difference,” he says. “But I can’t see how other platforms have worked and the impact on the industry is not very visible.”
There have even been some suggestions that the FCA should conduct a follow-up exercise to see how well the new regulatory framework has worked and should publish their findings to give guidance and reassurance to the sector.
Mike Bristow, chief executive of CrowdProperty, supports the new rules but believes that the FCA could go further in enforcing what data platforms have to disclose.
“I think it’s good to have increased regulation in the sector and I think it’s upped operating practices on average across all platforms which can only be a good thing,” he says. “But I think the regulation could go further and might do in the future.
“I don’t think data transparency is sufficient in the sector – some platforms do it well, some don’t. I think that it’s important to building trust and confidence in P2P so investors can make better informed decisions.”
One of December’s rules involved marketing restrictions which mean that P2P platforms can now only market to high-net-worth or qualified investors and can no longer do so to restricted retail investors.
Although platforms agree that fair, clear marketing under these rules protects investors, they were initially split on whether December’s regulation, including these communication restrictions and the appropriateness test, would lead to a fall in the number of P2P investors in the sector.
But a year on, and the investor landscape has been transformed – perhaps permanently. As a result of the government-backed loan schemes and liquidity concerns among some platforms, more institutional money has been flowing into P2P of late.
This has changed the focus of the industry somewhat and led to less of a reliance on new retail money.
“I think there is less retail involvement now, but there are a lot fewer platforms that people trust,” says Law.
Bristow disagrees, and says there may not necessarily be fewer retail investors in P2P as the sector is experiencing a growth phase.
“Maybe the growth rate is slightly slower as a result of marketing restrictions but that’s not our only acquisition channel,” he says. “Lenders find us through word of mouth too.”
The Senior Managers and Certification Regime (SMCR) also came into force in December, as part of the regulator’s drive to improve culture, governance and accountability within financial services firms. As the P2P industry is fully regulated by the FCA now, platforms have to ensure they comply with these new rules.
While some believe it’s too early to tell the success of SMCR, the overwhelming majority of industry onlookers have welcomed the rules as a force for good, helping platforms articulate their management and governance processes.
“SMCR has certainly been effective in focusing the minds of senior management within the industry,” says Jonathan Segal, partner and head of fintech and alternative finance at law firm Fox Williams.
“We are yet to see many examples of the FCA using SMCR in enforcement action against senior managers and firms in the market, but in my opinion, this is just a matter of time.”
When SMCR and the new regulations were introduced last year, there were fears that these new standards would create huge compliance bills for P2P lending platforms pushing up the barriers to entry and causing smaller firms to leave the sector. But has this happened?
“The compliance costs won’t help smaller firms trading on margins, raising money every year to survive, especially if they’re operating in the market for £50,000 loans to small- and medium-sized enterprises and unable to compete with the bounce back loan scheme,” says David Bradley-Ward, chief executive of Ablrate.
“If you’re not in the right business model you need to pivot and consider your options.”
However, others have noted that it was already becoming more challenging for small players to operate in this space, even without the new regulations. And, once again, the impact is difficult to unpack. Who knows how many people have thought of launching a P2P platform but were deterred by compliance costs?
“I think that there should be a fairly high barrier to entry and, in the past, maybe there hasn’t been and that has meant that too many platforms were not of high enough quality,” says Bristow.
“There is a regulatory and compliance responsibility for every platform and there’s a cost associated but it’s a necessity to channel investor lending capital into lending capabilities.
“Barriers to entry shouldn’t be too low. Not everyone should start to lend and advertise.”
The regulatory landscape is changing quickly and it can be challenging for platforms to keep up, especially given the belief that the regulator is looking more closely at the sector. Platforms have praised the regulator for meeting the difficult balance between protecting consumers and not stifling innovation.
Industry onlookers believe the FCA is cautiously supportive of P2P, as it is a regulated sector it wants to see thrive. However, it was not long ago that the regulator came under fire from the industry for implying that all P2P investments are high risk. In February, the FCA ran a Google adverts campaign, which resulted in a Google search of the term ‘ISA’ leading to an FCA webpage entitled “high-return investments”.
The regulator listed P2P as an example on the website, alongside other types of investments such as cryptoassets, mini-bonds and land banking.
“To list P2P alongside land banking and other mostly unregulated sectors is utterly wrong and a bit scandalous because P2P is regulated,” says Law. “The FCA is doing a good job and is supportive of the industry but I think they’re not enthusiastic about it.”
Less than a year into the new rules – amid extraordinary macroeconomic circumstances – it is difficult to judge whether they have been a complete success, but feedback from platforms has been mostly positive. Stricter rules lead to greater governance and more confidence among customers.
There may be fewer retail investors in the sector and higher barriers to entry, but that is not necessarily a bad thing. A consolidated industry with the highest quality players is what will ensure P2P’s future in the alternative investment landscape.