The FCA has published a long-anticipated consultation paper setting out proposals to update the regulations for peer-to-peer lending.
The consultation is open until 27 October, after which the regulator will consider the responses and publish its conclusions. Any new rules would typically be introduced around six months later.
We have always advocated that to operate effectively all markets require a clear, fair and proportionate framework of rules. We were therefore amongst those in our sector who very early on called for proportionate regulation of P2P lending, which came into effect in 2014.
The FCA sets the scene for its proposals by saying that peer-to-peer lending “can be an important alternative source of finance for companies and consumers” and an “alternative investment opportunity for investors”. It describes how the most prevalent model in P2P lending is where the platform prices the risk and chooses the investor’s portfolio of loans to generate a target rate (the FCA call this the ‘discretionary’ model).
RateSetter has been a pioneer of this model since we launched in 2010 because we believe it is the best way to make the exciting innovation of P2P lending simple, efficient and sustainable. It makes P2P a useful product for a wide audience. It is the best route to having a product that can compete – albeit with some fundamental differences – with the banking model, which has traditionally dominated lending and borrowing with mixed results.
We welcome the bulk of the proposals as they will raise standards and drive out bad actors. We have the odd quibble on some detail here and there but we agree with the overarching objectives. We do, however, fundamentally disagree with one proposal around marketing restrictions.
What we agree with
In the regulator’s own words, the proposals seek to ensure “investors receive clear and accurate information about a potential investment and understand the risks involved” and are “adequately remunerated for the risk they are taking”. They call for “transparent and robust systems for assessing the risk, value and price of loans, and fair/transparent charges to investors” and for “good governance and orderly business practices”. We agree with these aims and with the practical steps proposed to deliver them: risk management frameworks, governance, wind-down arrangements and disclosure requirements.
What we do not agree with
The regulator is proposing to introduce “marketing restrictions”. While the proposed application is unclear, this is essentially a form of categorisation. It means treating normal investors differently to ‘sophisticated’ and ‘high net worth’ or ‘advised’ investors or requiring them to certify to only invest 10% of their ‘net investible portfolio’ in P2P. We do not agree with this proposal. Having to categorise and treat people differently feels like a failure, not a control. While advice is valuable in many situations, it is unnecessary to insist on it. As for a limit, it makes sense to diversify your investments but we think this is a clunky and restrictive mechanic.
Introducing marketing restrictions not only raises questions around personal freedom, fair competition and financial exclusion, but would be disproportionate given the risk profile of P2P. It would be a mis-categorisation of the asset class, as well as a backward step for competition and financial inclusion.
We appreciate that the regulator is seeking to protect investors from harm. That is why we support those of its proposals that will manage risk such as risk management frameworks, governance and platform wind-down arrangements; what we don’t support is blocking access. We say: eliminate the high-risk elements of P2P lending and you can keep it accessible.
A middle ground?
As well as marketing restrictions, the regulator proposes ‘appropriateness’ tests. These tests seek to ensure that those signing up understand the risks. We do not oppose these tests because we do not want anybody to invest on RateSetter who does not understand the risk or is vulnerable.
I am confident all of you reading this blog will know that RateSetter does not shy away from explaining the risks of investing on our platform: capital is at risk; instant access is not guaranteed. I am equally confident that these risks are well managed and low relative to other asset classes and that investors are fairly rewarded for taking on these risks in the form of healthy rates of interest.
The filter of a test, for every investor, could be highly effective and obviate the need for other restrictions. It would ensure investors understand the risk, while not restricting access.
Our view is that provided investors understand and accept the risk they should be able to use P2P lending and all be treated the same way. We think a reasonable case can be made for appropriateness tests but we do not think a reasonable case can be made for marketing restrictions. We shall be making this case, supported by evidence, in our response and asking the regulator to reconsider or refine its proposals.
We hope this blog is clear and helpful. This is a live topic and it was interesting to see the Financial Times cover the subject this morning. P2P lending remains a new concept for lots of people but as its scale and track record grows and as its regulation becomes clearer, it has the potential to be a mainstream investment and a truly competitive alternative model for lending and borrowing.