Today is the day that the new crowdfunding rules for P2P lending platforms come into force. With great anticipation the industry has tried to prepare itself for the impact as the new rules seek to address a number of essential aspects of the business models of crowdfunding platforms. An increasingly complex sector, platforms making decisions their clients perhaps should, poor business practices with limited disclosures, obscure fee structures and increased fatalities among providers – when the FCA published the results of a review of the P2P sector it came with terrifying list referring to selling unsuitable products, poor customer treatment and an appalling price/quality ratio. Now that the new rules are here, the question is whether it is simply a storm in a water glass or a real game changer for the UK P2P Lending Rules?
Many jurisdictions are reviewing their crowdfunding rules, but the FCA continues to be a frontrunner in respect of FinTech regulation. Published in June 2019, the FCA has concluded its review and consultation of the P2P lending sector in the UK. This is the end point of a process that had started with a call for input for the UK’s crowdfunding rules years ago that sought to address gaps in the regulatory framework of P2P and Marketplace Lending. It also came with a number of new rules and amendments to the existing framework to better adapt the industry and increase investor protection. And despite the significant changes and heightened requirements for doing business, the industry seemed to be mostly in favour of the new rules. In fact, the FCA paper claimed that the industry was on the whole very supportive of the proposed changes, but an essential aspect caused quite a stir.
One of the FCA’s major observations of the crowdfunding sector was an apparent lack of risk perception on the side of investors. In its original consultation paper, the regulator therefore pointed out that it wants to ensure that only consumers capable of understanding the risk and bearing the consequences take these investment risks. This, so it said, was all the more important since the P2P sector consisted of “a wide range of borrowers and types of loans, from companies raising funds for property development, to consumers borrowing to pay for consumables”.
The FCA also highlighted that while for equity crowdfunding marketing restrictions were in place that tackled the issue, P2P lending was basically operating without such boundaries. Since crowdfunding investments are not covered by any form of investment protection scheme – an aspect investors often confuse with frameworks like the Financial Services Compensation Scheme that covers savings deposits, insurance policies, and investments up to £85,000 – makes it a rather risky business when they put their money into illiquid investment instruments like unlisted securities that are hard to value independently and cannot be sold easily.
The industry didn’t seem to be too happy with the idea though that asking prospective investors to classify themselves and reveal information about their wealth since it would be intrusive and off-putting in an online context. They further criticized the investment cap of 10% of investible assets for retail investors who are new to the asset class and other restricted investors as another element that could seriously limit the reach to both investors and P2P loans.
Finding an appropriate degree of protection for consumers and making sure that only consumers capable of understanding the risks and of bearing the consequences invest in P2P agreements was clearly marked as one of the FCA’s foremost objectives in the original consultation paper. This has remained a core concept in the new rules and the investor classes for P2P loans are now neatly set out in the updated COBS rules 4.7.7 to 4.7.10 differentiating between certified sophisticated investors, self-certified sophisticated investors, high net worth investors, and restricted investor.
But that, of course, is not all that has changed for the framework of UK P2P Lending Rules. The new regulation introduces additional requirements in respect of an appropriate assessment of investor, too.
The new rules also increase the requirements regarding governance and internal controls of platforms by a notch or two to make sure that there is a good chance that the advertised investment outcomes are actually reached. It means that firms will need to do more in terms of credit risk assessment, risk management and fair valuation practices, which is particularly true for those platforms with more complex business models as the FCA already pointed out in CP18/20 that the P2P sector had developed a wider, more complex, range of business models.
And extremely importantly, the FCA rules address the winding down of platforms as the industry has seen a number of cases that have left many investors out of their money.
Is it truly going to change the industry for the better? The new rules certainly raise the bar in terms of investor protection and should help restore trust in a sector that has tainted its reputation of recent at least to an extent. It will make it more difficult to act against the interest of investors and shorten the leash for those platforms that have shown poor judgement in the past. Whether it will be enough to draw new investments and, more importantly, new investors to P2P lending will remain to be seen though.