The peer-to-peer (P2P) lending market is a young phenomenon. So young, in fact, that the Financial Conduct Authority (FCA) is still working out how best to regulate it. This week Lawyer monthly benefits from expert analysis by Angus Dent, CEO at ArchOver, who delves into the potential for consensus on this complex discussion.
With the authority playing catch-up, many P2P companies have waited months for their full permissions. Twelve years after the first P2P platforms launched, there is still no unifying regulatory manifesto for P2P.
At the same time, the FCA is trying to protect investors and borrowers and ensure that companies adhere to client money regulations. The P2P market needs to have security models in place to mitigate the risks associated with lending in the space.
This is still a work in progress, so many companies represent their own island of regulation at present, distinct from their peers. Best practice directives are handed out on a case-by-case basis. Running a business in these conditions is hard - you never know when the hammer may fall, or when you may suddenly be given your wings.
That makes it extremely difficult to plan for the future and build security into your business model. Many of the sector’s key players are running at a loss as they try to stabilise their costs against seasonal fluctuations in income. Patchy regulation only adds to those challenges - how can you stabilise if you don’t know whether your services will be deemed appropriate in six months’ time?
In short, uncertainty is the enemy of profitability. To counter that, robust investment in security is essential to keep users’ confidence high.
The rulebook
A large part of the problem facing the industry is that you can’t play the game if you don’t know the rules. The rules we do have are being made up as we go along. Instead, the FCA needs to start doing its job and build a proper framework if it is to fulfil its primary purpose - to stimulate competition in the sector while protecting borrowers and investors.
The FCA is due to release a new set of regulations this summer, which should in theory lay out a unifying set of best practices for the whole sector. This is a great opportunity to put into writing the original founding principles of peer-to-peer lending - namely, innovation, a reduction in red tape, a more transparent approach to lending and borrowing and a steadier, less market-linked rate of ROI.
The FCA should be looking to incorporate the successful elements of P2P lending into its plans and strategy. Ultimately, the best practices that become enshrined in regulation should be set out by the industry, not the regulator. Importantly, the FCA should also keep in mind that P2P lenders operate under a very different set of principles to that employed by the banks. It should encourage the flexible and straightforward approach that has helped companies like Zopa and Funding Circle pass the £2bn lending mark, helping the P2P sector reach the next level of success, with healthy competition rules and firmly established best practices.
At the same time, it’s important to ensure that that flexibility is backed up with security. The FCA needs to focus on building lender assurance into its regulation - P2P’s viability in the future will rely on proving to investors that their money is secure and carefully looked after.
Current obstacles
There are several roadblocks in the way of that ideal scenario. First, the lobbying power of the established banks. P2P lending is still an unpredictable factor in the market. If it grows fast enough and builds a solid reputation, it could pose a serious challenge to the high street banks’ low-cost capital, targeting money that’s currently running at extremely low interest in deposit accounts. Until the banks can be certain of the competition posed by P2P, they will always have a certain amount of resistance to full regulatory acknowledgement. Again, the FCA needs to counter that instinct by treating P2P platforms as a different beast with different goals.
There’s also a temptation for regulators to lean too far towards a box-ticking mentality. This means laying out a set of specific regulations and not asking too many questions so long as the appropriate tests and measures are met. Although this approach seems orderly on the surface, it can also lead to a patchy mess if you don’t give enough thought to whether the boxes are worth ticking in the first place.
Instead, the P2P market would benefit from a new set of broad regulations that acknowledge the scope and breadth of the services it offers and place security at the heart of the industry. These practices should then be applied rigorously in spirit, allowing for multiple interpretations while also keeping the brake on unethical practice and keeping.
This is how a lot of British law works - it relies on the common sense of its interpreters rather than presuming their imbecility. The FCA needs to do the same with regard to P2P regulation. The new rules published in the summer should allow P2P companies to maintain their rapid fulfilment model, whilst always remaining vigilant against malpractice and ensuring funds can be recouped in the case of a loan default.
Can we reach consensus?
Ultimately, peer-to-peer lending provides a unique and much-needed service in a time of extremely low interest rates and tight banking purse-strings. It helps investors build their portfolio, whether it be to increase the size of their pensions pot or get closer to house deposits, and it provides the ready cash to help small and medium-sized businesses grow.
That role will be best served by a comprehensive review of regulations, providing a single basis for the industry to work from and a solid security stance to mitigate risk for investors and borrowers.
It’s time to end the confusion - 2017 must be the year that P2P gets the regulation it deserves.
