The peer-to-peer lending sector is anticipating a regulatory clampdown on appropriateness tests and investor categorisation after a swathe of warnings from the City watchdog in recent months.
In April, the Financial Conduct Authority (FCA) said it was considering toughening up its rules on the promotion of “high-risk” investments, including P2P lending.
The regulator then wrote to the boards of P2P lenders in May, urging them to ensure their secondary markets, wind-down plans, loan disclosure and fees were fair and clear for consumers.
And last month, the FCA published a letter it sent to bosses of equity crowdfunding platforms in July, warning that “too many” consumers are still investing in inappropriate, high-risk investments that do not meet their needs.
The FCA expressed concerns that investors may be holding more than 10 per cent of their portfolio in investments that “could pose a significant risk of harm”.
Investor marketing restrictions have been in place within the equity crowdfunding space for a number of years and similar rules were subsequently introduced for P2P lending platforms in 2019.
Platforms are currently restricted to marketing to sophisticated or high-net-worth investors, those receiving regulated financial advice, and those who certify that they will not invest more than 10 per cent of their net investible portfolio in P2P agreements – known as restricted investors.
This means users have to select one of the categories to describe themselves before investing.
Jatin Ondhia, founder of Shojin Property Partners, said the FCA’s approach suggests that it does not believe restricted investors understand the risks of alternative lending.
“It is wrong that restricted investors should be prevented from investing in equity crowdfunding projects and the further restrictions being considered by the FCA take us back many years by enabling only wealthy investors to take advantage of the new fractional investment models in this space,” he said.
“The whole intention was that the market should be opened up to everyone.”
He said the majority of operators in the P2P lending market are looking after investor interests and want to build a sustainable alternative investment marketplace to spread wealth across all sectors.
“The FCA risks throwing out the baby with the bath water,” he added.
“In the long run this market will prevail and if the FCA doesn’t get a handle on this it will lose its crown to one of the many other competing regulated markets such as Singapore, the USA or Europe.”
David Bradley-Ward, chief executive of Ablrate, agreed that the trajectory of the regulations seems to be to restrict access further for retail investors.
“What effect this will have on the industry is a matter of how those restrictions are implemented by the FCA and whether certain models are given a different categorisation within those restrictions,” he said.
“We have seen this coming for years.
“I cannot count the number of times I have talked about liquidity being the key. If the industry in general had addressed these concerns in the past few years we would not be at this stage.”
Compliance specialists are picking up similar sentiments from the regulator.
“The general feeling is the FCA is seeking to ensure the industry is more robust when it comes to failures and where firms do fail there is an adequate and reasonable wind-down plan in place,” said Gilbert van Roon, managing director of Fintech Compliance.
“It won’t ban restricted investors outright but they could face further restrictions on the amount they can invest or the proportion.
“I know there are already restrictions in place, but I think they could become tighter in future, or the regulator could say that retail investors can only get involved if advised by an independent financial adviser.
“That would be a very strong call to make by the FCA.”
He said it would be complex to strengthen the current investor categorisations as you would need a lot of paperwork to prove you are sophisticated or high net worth, whereas currently investors just select a box to self-certify.
Mark Turner, managing director in Kroll’s financial services compliance and regulation practice, said the key thing is for platforms to keep an eye on their user base to make sure investors are choosing the right category to describe themselves.
“I’m not expecting changes to the appropriateness test, those doing it correctly don’t have a lot to worry about,” he said.
“We have seen particularly during lockdown that more interactions are online.
“The FCA will expect firms to look at their data and if the percentage of people who are eligible has changed materially pre-lockdown to now, is this because the number of clients has grown or because people are clicking through quickly who maybe shouldn’t be qualifying?”
In response to the regulatory direction of travel, Bruce Davis of the UK Crowdfunding Association (UKCFA) highlighted the trade body’s recent survey of investors which found a high level of understanding of the risks involved.
He added that the FCA has since been in touch directly with a sample of platforms to say that it will be carrying out further data collection and analysis to follow up on the evidence provided by the UKCFA and better understand investors’ perceptions and experience of the sector.
The FCA has been contacted for comment.