The FCA has published new rules for loan-based (P2P) and investment-based crowdfunding platforms.
The new rules are timely, with increased scrutiny on the sector following the recent collapse of Lendy.
In this insight, we summarise the main changes for P2P platforms and provide our views on what this means for the industry. Many of the changes will be welcomed by the sector, although the new marketing restrictions and investment cap will be the most controversial.
- Since April 2014, operating an electronic system in relation to lending (ie what P2P platforms generally do) has been subject to regulation by the FCA under article 36H of the Financial Services and Markets Act 2000 (Regulated Activities Order) 2001. Prior to this, P2P firms were typically licensed by the OFT for activities such as debt administration.
- In 2016, the FCA launched its post-implementation review into the sector.
- In July 2018, the FCA consulted on changes to the rules governing P2P platforms. Its proposals sought to prevent harm to investors, by providing for a proportionate regulatory framework that would not stifle innovation in the P2P sector.
Following the feedback received, the FCA set out its final policy position in PS 19/14. It has implemented most of its proposals (albeit with some modifications and more clarity).
The key changes
Marketing to retail customers will be restricted to sophisticated or high net worth investors, or those who receive regulated advice from an authorised person, or 'restricted investors' who agree not to invest more than 10% of their portfolio in P2P investments.
P2P platforms will need to carry out an appropriateness assessment that considers a client's knowledge and experience of the investment before the platform can accept their instruction to invest (where regulated advice is not provided).
Risk management framework
P2P platforms must understand and be able to price the credit risk of the P2P loans they facilitate – at origination and over time. This requires them to have an appropriate risk management system in place. The new rules:
- Set out the minimum requirements for platforms. This includes gathering sufficient information to assess a borrower's credit risk, categorising that risk and setting the price fairly to reflect that risk (where applicable).
- Set out when a loan has to be revalued (such as at origination, default, transfer and when the platform thinks a borrower might be unable to pay).
- Require platforms which set the price of loans and choose the investor's portfolio to generate a target rate of return (Discretionary Platforms) to have a risk management function which enables them, in practice, to achieve the stated target rate of return with a reasonable degree of confidence. If platforms cannot demonstrate this, they should not be offering the target rate.
Amongst other things (and in summary), platforms will need to:
- establish, implement and maintain adequate policies and procedures designed to detect any risk of failure by the firm, as well as associated risks, and have adequate measures and procedures to minimise such risks; and
- maintain permanent and effective compliance functions which are independent. This requirement will apply on a proportionate basis. If a platform can demonstrate that it would be disproportionate, it will not need a compliance function which is independent. Whilst there's no fixed threshold, Discretionary Platforms will need independent compliance functions.
This is also linked to the Senior Managers and Certification Regime, which will apply to platforms from December 2019.
Wind down arrangements
Platforms must have in place arrangements to ensure that, if at any time they cease to manage and administer their lending agreements, those agreements will have a reasonable likelihood of being managed and administered, in accordance with the contract terms between the firm and its relevant borrower and lender customers. Platforms must also keep an up to date resolution manual which would assist in resolving the platform's business management and administration of P2P agreements in the event of its insolvency.
Platforms will need to comply with detailed disclosure requirements including relating to the role of the platform, the investment and the practical impact of providing a direct loan (eg if the platform were to cease operating). In particular, amongst other things, a prescribed risk warning is required where the platform offers a contingency fund.
Finally, the FCA notes there is currently no market for regulated home finance, although it understands that some firms are considering moving into this space. To address a potential regulatory gap, certain MCOB rules will apply to P2P platforms which facilitate home finance products (where at least one of the investors is not required to be authorised for this purpose).
When do the changes take effect?
The new rules will come into force on 9 December 2019, so platforms have some time to make the necessary changes. The exception is that the MCOB changes will apply from 4 June 2019.
What does this mean for the industry?
Retail investors may be reassured that the FCA is monitoring and regulating this developing area. This is especially important following the high profile collapses of Lendy and Collateral and the problems experienced in the USA with Lending Club.
Platforms may be frustrated with the FCA's rules on marketing restrictions, along with the 10% cap for non-sophisticated or advised investors. The FCA has emphasised the importance of the cap but it has clarified that investors can re-classify as sophisticated investors when they have more experience (ie two or more investments in the last two years).
Some platforms may also be concerned that these restrictions are not targeted based on the varying risk profiles presented by the different platforms.
On the whole, the majority of the new rules will be welcomed by the industry. The rules strike a difficult balance between seeking to prevent harm for investors, and in particular retail investors, all the while ensuring the continued use and take-up of P2P lending and the benefits the P2P sector can offer to both investors and borrowers.