Jonathan Segal’s first feature in a new series for Business Money is now live.
The P2P business lending market has undoubtedly been making small, but strongly felt, inroads into the business finance market over the last few years. It will come as no surprise that the industry’s regulator, the Financial Conduct Authority, has begun to make its presence felt in this nascent market.
On 9 December, the FCA published a statement – FS16/13 – setting out interim feedback to its call for input on crowdfunding rules. It will, I believe, be of interest to regulated and non-regulated lenders alike. Here are the FCA’s primary concerns.
The FCA has identified a risk of regulatory arbitrage in the P2P sector, and potential for investors to misunderstand the nature of the products offered.
Some firms are adopting business models which include aspects that are the same or similar to those in the investment management and banking sectors. The FCA expects firms applying for authorisation to go some way to ensuring their activities fall within the scope of the permissions for which they have applied. This should address some of the concerns more traditional lenders and banks have about the industry.
The FCA intends to reduce the risks for investors concerning the administration of existing loans following the failure of a firm. The authority is concerned that the plans some firms have for wind-down in the event of their failure are inadequate to successfully run-off loan books to maturity and adequately protect investors. This has implications for more traditional lenders too, in that there may be loan books for sale in the not too distant future in the event of platform insolvencies.
It is also a timely reminder to banks and other financiers providing credit to traditional lenders that they need to have plans in place if the lender of record fails. For instance, are the loans assignable and is the underlying security held by a security trustee?
Mortgage lending standards
The FCA’s proposal is to extend mortgage-lending standards to loan-based crowdfunding platforms where the investor or lender is not acting by way of business.
The authority intends to put some thought into implementing these standards but is wary of introducing any measures that would add burdensome administrative costs to platforms. Is this a move towards a stricter lending code in the UK?
Conflicts of interest
The FCA has stated its concern about conflicts of interest, in particular arising due to preferential treatment of institutional investors. The authority states in its report that it is important for crowdfunding platforms to treat those on both sides of the transactions they facilitate as clients.
Once conflicts of interest have been identified, firms must seek to manage them. Avoiding a conflict is one way to manage it. Disclosure of a conflict may only be considered if the firm cannot manage it in order to avoid consumer detriment. The disclosure should make clear that the firm cannot manage the conflict and that investors are likely to suffer detriment. How these thoughts will be implemented by the FCA remain to be seen, but firms should certainly prevent institutional investors from cherry-picking loans.
The FCA also intends to consult on more prescriptive rules on the content and timing of disclosures by requiring a consistent minimum basis for investor disclosures. As a general point, the FCA has concerns about the quality of communications between firms and potential investors, so I expect to see greater and more prescriptive disclosure requirements in the coming months.
The FCA’s aim is to publish a consultation paper in Q1 2017, and to publish the final rules in the summer. The authority is also continuing its consumer and market research into crowdfunding; this should be completed early this year, and the FCA may publish a second consultation paper on rule changes in mid-2017, with any rules coming into force next year. I look forward to dissecting these new rules when the proposals are published!