The FCA has published its final rules and feedback (PS19/14) resulting from its consultation into reform of the loan and investment-based crowdfunding platforms market.
In an increasingly dynamic market of new and innovative investment products, loan-based (“P2P”) and investment-based (“IB”) crowdfunding platforms have emerged as an exciting, but challenging regulatory landscape. In July 2018 the FCA published their consultation (CP 18/20) requesting feedback on its ongoing assessment of the market and on its proposed reforms to its regulation.
Having received feedback from across the sector, including from 44 published non-confidential respondents, the FCA has now published its final response to the consultation, focussing on its revised rules for the P2P sector. In doing so it has sought to strike a balance between providing sufficient flexibility for the sector to develop, whilst providing protection for consumers in a novel and potentially risky market. The rules introduce some fundamental provisions of which market participants should be aware – aimed at ensuring the sound structure and efficiency of platforms, and providing clear information and balanced risk for investors.
Amongst its targeted outcomes for the industry, the FCA noted a desire to ensure P2P platforms were well governed and competitive, with business structures that ensure appropriate risk management frameworks and allocate governance responsibilities.
Many P2P platforms take it upon themselves to price potential loan opportunities on behalf of investors – the FCA has concluded that transparency and disclosure are not sufficient to negate the resulting risk for consumers. Instead, the new rules establish a broad “minimum common standard” in credit risk analysis, whilst encouraging innovation in analytical techniques. Under the rules, platforms must ensure its prices are “fair and appropriate”, considering several factors including the risk profile of the loan.
Some platforms go further and in addition to pricing loans, they assemble investors’ portfolios to match their target rate of return. For these platforms the FCA has introduced rules requiring the platform to develop a resilient risk-management framework to include the frequent repricing of loans, the use of robust modelling capabilities and the allocation of loans only if they meet the relevant risk-profile at the time of investment.
Platforms’ internal systems to protect consumers are to be bolstered further by a strong set of wind-down arrangements to be utilised in the event of the platform ceasing to operate. Firms are required to establish robust, unbiased arrangements, with all necessary prior consents already in place, to ensure the orderly wind-down of the platform and safe administration of existing loans. These arrangements should be detailed in an internal resolution manual, which should be available to the FCA on request.
The new rules also address internal responsibility for risk management. There is now a requirement for P2P platforms to establish internal audit and independent compliance functions if judged proportionate to their business structure. In addition, responsibility for the development and oversight of the risk management framework is to be a specific responsibility to be allocated under the incoming Senior Managers and Certification Regime (“SMCR”) to a person approved for a significant influence controlled function.
As well as their internal policies, the FCA’s new rules address platforms’ relationships with their investors.
Amongst the most controversial rules consulted on were proposed marketing restrictions and suitability assessments to be required of platforms. Following its consultation, the FCA has concluded that platforms should only be permitted to make direct financial promotions to sophisticated investors, those receiving independent financial advice, or “restricted investors” who confirm they will not invest more than 10% of their net investable assets in P2P agreements in the following 12 months. These measures are designed to ensure that P2P investing is available only to those who understand the risks, and can withstand potential losses.
Platforms will also now be required to conduct an assessment of a prospective client’s knowledge and experience of the P2P market before accepting their instruction to invest. Under the FCA’s new guidance, this assessment should avoid binary answers and should cover a variety of areas, including the contractual relationship between borrower and lender, the associated risks, differing returns, lack of coverage by the Financial Services Compensation Scheme and potential illiquidity in any secondary market.
The FCA’s new rules have also expanded the disclosure requirements on P2P platforms. Platforms are now required to disclose to potential investors:
- The role of the platform and the service provided;
- The potential implications of the platform’s insolvency or wind-down; and
- Information about investments, including accurate historical performance and loss data.
This disclosed loss data should accurately reflect genuine defaults by borrowers, regardless of whether the relevant investor was protected at the time by the use of the platform’s contingency funds. This disclosure is to be further standardised by the FCA publishing a single definition of “default” to uniform data across the industry.
The new rules are to come into force on 9 December 2019, coinciding with the extension of the SMCR to investment firms. In addition to these rules for P2P platforms, the FCA has also applied various rules under the Mortgage (Conduct of Business) Sourcebook to platforms when facilitating home finance products, and is conducting a more thorough consultation on proposed rules to reform the investment-based crowdfunding market.