The number of crowdfunded loans originating from online platforms has grown at an exponential rate in recent years. This increasingly emerging and important financial sector has been subject to a FCA Consultation Paper issued earlier this week. Does the Paper endorse those eye-catching comments made by Lord Adair a couple of years ago?
Predictably, it does not. Nor does the Paper, which appears to commend the 'innovation' associated with the sector, draw such a conclusion. The FCA do, however, identify areas of concern. They recommend a series of changes which will bring loan-based crowdfunding platforms increasingly under their microscope.
The Paper and its conclusions are unlikely to come as a surprise to those operating in the sector. Since the publication of its Policy Statement of March 2014 the FCA have been keen not to be perceived as stifling this technology-led sector but to, instead, flag it as a developing area under review. That approach was formalised by the commissioning of a 2016 post implementation review. This flagged the FCA's concerns of potential investor detriment and its aim to propose new rules. From these beginnings the recent consultation paper was born.
The Paper concentrates on two forms of internet based crowdfunding. Internet platforms which facilitate investors investing directly in businesses are not considered to be in need of any significant regulatory change. The Paper asserts that the FCA are "largely content" that the regulatory framework for these is "adequate". In contrast, the FCA recommends that more rigorous regulation should be introduced and apply to those platforms that act to facilitate loans between lenders and borrowers.
The FCA recognises that some P2P platforms already have robust systems and controls in place and says that these platforms will have the easier task of complying with any recommendations that are implemented. However, the backdrop is of an industry where it has identified cases of "actual or potential harm to investors" which it says should be addressed by tighter regulation applicable to all.
The Paper identifies that investors in some P2P crowdfunding may not:
- Be given clear or accurate information, leading to the purchase of unsuitable financial products
- Understand or be aware of the true investment risk they are exposed to
- Be remunerated fairly for the risks they are taking
- Understand what might happen if the P2P platform administering their loan(s) fails
- Understand the costs they are paying for the services the platform provides, or
- May pay excessive costs for a platform's services.
It proposes a raft of regulatory changes. Amongst these it proposes:
- Prescriptive rules be introduced concerning the risk management framework applicable (a) when a platform assesses a borrower's credit risk and (b) when it reflects that in the price of the agreement.
- New governance rules to bring platforms into line with certain types of investment businesses
- Marketing restrictions
- Steps to ensure appropriate 'wind-down' arrangements to protect investors when a platform ceases to operate
- Requirements to increase the level of disclosure that a platform should provide to its investors as including (a) the nature and extent of due diligence completed in relation to borrowers and (b) an explanation of the procedure for dealing with loans in late payment or default together with (c) other wide ranging requirements.
Further proposals include a suggestion that home finance loans made by P2P platforms should be subject to parts of the FCA's Mortgage and Home Finance: Conduct of Business sourcebook (MCOB) rules.
The FCA recognises that losses and defaults across the P2P sector have been low. However it strikes a cautionary note- as relative newcomers to the market the platforms have not been stress tested by a full economic cycle and the increase of losses on loans and investments that may follow.
When the FCA's 2016 review was carried out it recorded a concern within the industry that the failure of a high profile platform was one of the biggest risks to the ongoing viability of the sector. The consultation gives the industry a chance to consider whether greater regulation could reduce that risk.
With the economic uncertainty associated with Brexit on the horizon the consultation is well timed.