The FCA has indicated its intention to apply more stringent regulation to the UK's booming peer-to-peer lending sector, amid concerns that increasingly sophisticated lending platforms are outgrowing the current regulatory regime.
Following a consultation launched in July 2016, the FCA has now reported the interim findings from its 'post-implementation review' of the rules governing peer-to-peer (P2P) lending. The FCA's report identifies a number of risk factors associated with today's P2P platforms and confirms the regulator's intention to consult on future rule changes.
The FCA has regulated P2P lending – or 'loan-based crowdfunding' – since 1 April 2014. As such, P2P platforms must presently comply with core elements of the FCA Handbook, including the FCA Principles and relevant conduct of business rules.
However, current regulatory obligations upon P2P platforms are by design less stringent than those affecting other financial services firms. In particular, platforms active before April 2014 have been allowed to operate under interim FCA permissions, pending a successful application for full authorisation – and even fully authorised platforms need only meet limited minimum capital requirements. Unadvised investors also currently lack recourse to the FSCS.
This 'light touch' approach arguably suited the first generation of P2P platforms, which were essentially matchmakers between lenders and borrowers. Of concern to the FCA, however, is that some platforms' business models now increasingly resemble those of asset managers or collective investment schemes – creating a risk of 'regulatory arbitrage' where platforms operate like traditional financial institutions, but are not subject to the same controls.
In this respect, developments in the P2P lending sector identified by the FCA include:
- Pooling of credit risk – including through 'reserve' or 'provision' funds, where a proportion of investment return is set aside in order to reimburse investors following anticipated future defaults. In the FCA's view, this practice may blur the line between P2P lending and asset management, and can generate a false sense of security where the risks which remain are not adequately explained to investors.
- Maturity mismatches – where lenders can withdraw money more quickly than borrowers are required to repay loans. As the FCA observes, this bears some resemblance to traditional banking business, but is not subject to equivalent regulatory requirements (for example, regarding capital adequacy).
- Cross-investment – where one P2P platform facilitates investment in loans formed on other platforms, creating an increasing degree of interconnectivity between P2P platforms (and therefore systemic risk).
Whilst the FCA's review continues, last month's report highlights several areas where the regulator has already identified sufficient potential for consumer detriment to warrant possible rule changes. Subject to further consultation, the FCA proposes to introduce restrictions on cross-investment and, given the increasing complexity of P2P lending, to strengthen the rules requiring firms to implement 'wind-down plans' in case platforms fail. The regulator also proposes to introduce more prescriptive rules regarding the content and timing of risk disclosures to potential investors, in response to concerns that some investors are not sufficiently aware of the risk factors associated with P2P lending.
The FCA aims to consult on these issues now and to publish final rules in the summer. This may not, however, mark the end of the FCA's post-implementation review – the regulator observes that, if necessary, it will propose further rule changes to be implemented in 2018. With many P2P platforms already working closely with the FCA in the course of their applications for full authorisation, the FCA's report suggests that further change in the regulatory climate can also be expected.