Moves by U.K. regulators to tighten peer-to-peer lending rules are proportionate and well-timed, as the larger end of the market evolves into something resembling asset management, according to market observers.
The U.K.'s Financial Conduct Authority updated its thinking in a document released Dec. 9, saying it now sees the need to modify certain rules. It can be difficult for investors to compare crowdfunding with other asset classes, and to assess risks and returns, the regulator said. Further, there appears to be increased pooling of credit risk for investors, "which has the potential to create a blurred line between loan-based crowdfunding and asset management."
At its most basic, peer-to-peer lending was a means to use technology to match those who needed to borrow, and who were being failed by the traditional banking market, with those with cash to put to work.
An increasingly sophisticated market
The market is swelling and becoming increasingly sophisticated. According to Liberum Capital Ltd.'s AltFi Index, P2P lenders have provided around £8.8 billion of credit in the U.K, with around £3.5 billion of that provided this year. Zopa, Europe's largest P2P firm, offers would-be retail lenders three sets of products with varied returns and access.
The rapid evolution of the marketplace means the move to update regulation is unsurprising, say industry watchers.
"This is the regulator being proactive," said Conrad Ford, CEO of business loan comparison service Funding Options, in an interview. "There are now a lot of models that look a lot less like P2P lending and more like a collective investment scheme or unit trust. If the industry is going to act like an investment scheme then the regulatory bar should be a bit higher."
The FCA highlighted the maturity mismatch in products. This is where borrowers take out loans for terms of, for example, five years, but investors can withdraw their money after an initial term or notice period. Industry sources say the FCA is not so much worried about systemic risk — the market isn't big enough for that — but rather how these products are starting to resemble savings accounts.
Unlike banks, P2P lenders do not benefit from any form of deposit insurance, though some platforms use provisioning funds to mutualize losses.
"Our focus is ensuring that investor protections are appropriate for the risks," said Andrew Bailey, CEO of the FCA.
A push for transparency
The regulator is consulting on various proposals, including more onerous requirements on the content and timing of disclosures by loan-based and investment-based crowdfunding platforms. For loan-based platforms, it will consult on strengthening rules around wind-down plans, restricting cross-platform investment and introducing mortgage-lending standards.
"There needs to be better reporting transparency on how defaults are managed," said Andrew Whelan, CEO of GLI Finance Ltd., an investor in alternative finance platforms for small and medium-sized enterprises.
"Definitions of defaults and delinquencies need to be hard-coded so they are standard across the industry," he said in an interview. These protections are especially important for retail investors who may lack the ability to process large amounts of complex information, Whelan said. Funding Options' Ford added that many of the larger platforms had made big strides in this area, adding that some mid-sized players "have opaque structures and it's not clear how they fit together."
As such, the FCA's move is seen as a step forward in the development of an industry that benefited from a softly-softly regulatory approach as it grew. In a statement, Christine Farnish, chair of the P2PFA, welcomed the review, noting that "in any dynamic market regulators need to keep the regulatory regime under close review."
A market lobbyist speaking to S&P Global Market Intelligence concurred, saying the FCA allowed the industry to get to the point where it could flourish.
"As it grows, so regulation must grow proportionately," the source added.
The FCA said its investigatory work should be completed in early 2017.