Response to EC Consultation on Crowdfunding

New Years' Eve marks the deadline for responding to the European Commission consultation on crowdfunding. 

The response page is here (scroll to "How to Submit..."). You can respond as either a citizen or an organisation. I chose the citizen option as I was responding in a personal capacity rather than on behalf of any client. The compulsory questionnaire (embedded below) took about 20 mins to complete. It gave me the option to upload a document and I chose yesterday's response to the FCA consultation.

Have your say! ;-)

Response to EC crowdfunding consultation Dec 2013 from Simon Deane-Johns

Response to FCA Crowdfunding Consultation

I have embedded below my personal response to the UK Financial Conduct Authority's consultation on rules for regulating peer-to-peer lending and crowd-investment platforms, submitted today.

Interested in any thoughts or feedback you may have.

Response to FCA crowdfunding consultation simon deane-johns - final from Simon Deane-Johns

A PSD Passport For P2P Lending?

I was interested to read the overview of European national laws that might apply to various types of peer-to-peer finance ('crowdfunding'), published this week by the European Crowdfunding Network (ECN). It's fair to say that the UK is somewhat more advanced in its decision to specifically regulate, but it's proving fairly easy for other member states to catch up - principally via payment services regulation.

While self-regulation of the peer-to-peer lending in the UK borrowed heavily from the UK's implementation of the Payment Services Directive, no one suggested that a peer-to-peer lending platform was actually a payment service (in my view, it's out of scope, or otherwise exempt in several respects). Whereas, the peer-to-peer foreign exhange platforms, such as Kantox (in the UK) and Currency Fair (in Ireland) did take advantage of the PSD as a regulatory basis for their activities.

The EU passport rights that authorised payment institutions enjoy are obviously important for a foreign exchange platform, but less so for lending - due to the challenges in establishing a cross-border market for consumer credit.

Until now, that is.

Unfortunately, the FCA has been rather heavy-handed in its approach to the regulation of peer-to-peer lending, particularly in terms of financial promotions, client money rules and the red tape deterrent requirement for anyone 'lending [to consumers] in the course of a business' (whatever that means) to hold their own consumer credit authorisation, in addition to the platform. In other words, the FCA ignored pan-European calls for a PSD-like approach and has instead opted to import the activity into its investment regime. The French, on the other hand, are consulting on a PSD-based approach, although they have proposed some ridiculously low limits and appear to restrict the volume to the €3m per month to stay below the threshold for fully authorised payment institution status (where a passport would be available), which need to be lifted if it is genuinely going to enable P2P lending, especially to SMEs. 

The ECN overview reveals that other member states appear to be all over the place on the question of whether platforms fall within the scope of the PSD. Some commentators suggest the payment element of P2P lending is in scope, in which case that aspect should be outsourced, or that the platform operator become registered as a small payment institution or fully authorised as a payment institution (or become appointment as a PSD agent). Others suggest that P2P lending may be in scope but exempt under the commercial agents exemption.

Interestingly, however, the European Commission has proposed a new Payment Services Directive (PSD2), which it would like to finalise by Spring 2014. PSD2 is still somewhat flawed, sure, but even in its current form it would seem more proportionate than what the UK is proposing in relation to P2P lending. Including P2P lending within its scope would also provide the Commission with an opportunity to clarify that, so long as the platform is authorised, lenders (payers) should not also need to be authorised under the Consumer Credit Directive - to enable businesses to lend to consumers and other businesses.

Any port in a storm...

French Crowdfunding Proposals

French officials are consulting on their own crowdfunding proposals until 15 November. These appear to be more consistent with the industry recommendations made last December, and seem somewhat more proportionate than the FCA's proposals for the UK.

Unfortunately, no official English version has been made available but Frederic Baud has kindly pointed me to an article by Aurélie Daniel on the proposals.

Frederic has explained that the intention is to use the transposition of the small payment institution provisions of the Payment Services Directive to require registration by donation-based and loan-based crowdfunding platforms. As a small payment institution, platforms would need capital of €40K, and be subject to a rolling 12 month average limit of €3 million transaction per month (that could be lowered to €1 million under proposals for PSD2). Above that threshold, platforms would need to be fully authorised as a payment institution, with minimum capital of €125K and higher amounts based on various optional calculations.

So far, that is completely consistent with the regulatory approach that the industry called for at the Peer-to-Peer Finance Policy Summit in London last December (which the FCA has ignored), and would represent a far lighter regime than the FCA has proposed for UK loan-based platforms. Regulating loan-based crowdfunding via payment services regulation is also consistent with the traditional view that simple loans are not 'debt securities' and therefore do not properly fall within the scope of specified investments currently regulated by the FCA.

But Aurélie points out that the French proposal contains controversial "upper limits for loan-based crowdfunding... [namely] a maximum loan amount around €250 per individual per project and a global maximum loan amount around €300,000 per project." While this might not trouble consumer loan-based platforms, it would negatively impact platforms that facilitate loans to businesses and for the purchase or development of larger assets such as commercial property. Ironically, the French appear to have reserved such loans for banks, and in this respect the FCA's proposals are of course more helpful. The limits apparently do not apply in relation to investment-based crowdfunding.
 

FCA Crowdfunding Consultation

The FCA has today published its crowdfunding consultation, covering both crowd investment in equities and debt securities (which the FCA calls 'investment-based crowdfunding'), as well as the lender side of peer-to-peer lending ('loan-based crowdfunding'). The borrower side of loan-based crowdfunding was covered in the FCA's consumer credit consultation earlier this month. The consultation paper will be of interest not only to platform operators, but also to those looking to raise or contribute funds in a bid to escape bank products, in particular.

The FCA is clearly aware of the general anxiety that any rules it makes should not exclude the 'crowd'. But based on the FCA's summary of its proposals, in my view it has not struck the right balance (called for by the industry last December) for the reasons below. In summary:

• The proposals seem to land quite heavily on peer-to-peer lending (perhaps partly because investment-based platforms are already subject to the investment regime). While in principle the FCA has followed the thrust of the P2PFA's Operating Principles (which was based on payments regulation) the decision to bring simple P2P loans into the investment regime will make it substantially more expensive in time and money to establish a platform. The costs of ongoing compliance will also increase, though largely through the undue complexity of the investment regime, rather than any substantive change in how operational risks are managed. In addition to potentially discouraging entrepreneurs from establishing a platform, the red tape requirement for a lender to be authorised, in addition to the platform, where 'lending in the course of a business' on a platform may discourage business and institutional participation, especially without clarity on where compliance responsibilities lie given that the lender's own operational systems aren't involved at all. There is little proportionality according to the relative risks associated with different types of loan (e.g. unsecured prime, secured, short term high rate and so on). However, there is some good news in that the FCA seems to advocate the introduction of a 'secondary market', where platforms don't already operate one, without apparent restrictions on how these should operate or whether one could participate without first lending into the 'primary market'.

• The proposals for investment-based crowdfunding do at least allow for wider 'retail' participation than the FCA has seemed to support to date. However, people will be asked to certify that they will not invest more than 10% of their 'net investible portfolio' in unlisted shares or unlisted debt securities (excluding their primary residence, pensions and life cover), and they face an 'appropriateness test' if they aren't investing on advice. So it will still be much easier to stick a tenner on a pony, where the house always wins, rather than to back a local business in support of the economy. The risks that the FCA points to in justification for this can all be explained transparently on websites. But who in government will take responsibility for the strange inconsistencies in the way we are allowed to use our money?

Comments are due by 19 December, and it would be best to get involved. The FCA plans to review the overall crowdfunding regime again in 2016, so it could be a long wait before any problems missed will be rectified...

Loan-based crowdfunding

Firms operating loan-based crowdfunding platfroms are to be regulated from 1 April 2014 as ‘operating an electronic system in relation to lending’ (under article 36H of the Regulated Activities Order). The FCA is aware of about 25 firms in this category.

The FCA sees loan-based crowdfunding as "generally of lower risk than that made via investment-based platforms" although it sees the potential for innovation that may bring higher risks, so will keep the sector under review. For the time being, however, the FCA is consulting on:

• minimum prudential requirements that firms must meet in order to ensure their ongoing viability (£20,000 to £50,000 minimum capital and a further 0.3% to 0.1% of volumes on a scale of £50m to £500m);
• the requirement for firms to take reasonable steps to ensure existing loans continue to be managed in the event of platform failure;
• rules that firms must follow when holding client money, to minimise the risk of loss due to fraud, misuse, poor record-keeping and in the event of a firm's failure;
• rules on the resolution of disputes, and
• reporting requirements for firms to the FCA in relation to their financial position, client money holdings, complaints and loans arranged.

It is reassuring that all these issues (other than FCA reporting obligations), have long been addressed by the Peer-to-Peer Finance Association in its Operating Principles. However, those were modelled on payment services regulation (under the Payment Services Regulations 2009), whereas the FCA proposes to apply more or less the full weight of its retail investment regulation on the sector for little real benefit. For instance, the effect of the voluminous client money 'sourcebook' ('CASS') is not terribly different to payment services segregation requirements that would only need to be tweaked slightly). Firms might decide to outsource the handling of client money to other authorised firms, rather than accept the additional red tape that CASS creates (as investment-based platforms tend to do).

Unfortunately, too, the FCA interprets the Consumer Credit Directive to mean that any person or firm lending in the course of business via loan-based crowdfunding platforms will need to be authorised as they are carrying on a regulated activity. That interpretation is inconsistent with the FCA's view that such a person is actually an investor in loans, rather than a lender, but may be driven by the use of the word 'creditor' in the Directive. Moreover, such dual authorisation makes no sense, given that all the operational activities associated with the marketing, creation and servicing of the loans takes place in the platform operator's systems, rather than the lender (even where that lender is, say, a bank). In other words, the lending is being done in the course of the platform operator's business, not any business being run by the lender. Responsibility for compliance in such circumstances is not clear. How is a business lender supposed to comply with consumer credit rules when it is not directly advertising, processing loan applications or servicing the loans? Further, the FCA (like the OFT) declines to give any guidance on what it means to be 'lending in the course of a business', other than to refer to its existing guidance around the 'business test'. Early case law cited in HMRC guidance on this topic, however, requires an assessment of the operational reality which in this case suggests lenders on loan-based crowfunding platforms are not lending in the course of a business operated by them but in the course of a business of the platform operator.

In my view, the FCA's interpretation of the Consumer Credit Directive is another example of UK officials failing to take a purposive approach to interpreting EU law and needlessly creating a rod for our own backs. I doubt very much whether the purpose of the Directive was to ensure dual regulation in the context of loan-based crowdfunding.

Notwithstanding the 'low risk' classification, the FCA plans to treat investments on loan-based crowdfunding platforms largely as it does other designated investments (though there is no guidance on what distinguishes a 'loan' from 'debt securities' in the FCA's view). So rules that apply to firms arranging transactions in designated investments will therefore also apply to firms running loan-based crowdfunding platforms. As a result, such firms will have to comply with two separate FCA rule books - one for borrowers ("CONC"), and one for lenders (now to be called 'investors') ("COBS"), including rules applicable to 'financial promotions'. 

Finally, the FCA seems to advocate the inclusion of a 'secondary market' on loan-based platforms, in the context of a discussion on cancellation rights. The FCA does not explain its view as to whether or how certain exemptions to the right to cancel apply, for instance, where the lender is not acting in a commercial or professional capacity, the main service contract is not a 'distance contract' so the loan can't be a 'secondary contract' for cancellation purposes or the lender makes an irrevocable offer to lend within the cancellation period.

As to the nature of the 'secondary market itself', in its cost benefit analysis, the FCA also points to the fact that most of the main platforms have one and states:

"we estimate a one-off cost of 20 days of web programming to add secondary market functionality to platforms. We assume a cost per day of web programmer time of £200.29 This would mean that adding a secondary market to a platform could create a one-off cost of around £4,000. We also estimate ongoing costs of four hours per day to oversee the functioning of the secondary market. We estimate a cost per hour of £10 for administration work in small to medium firms, so the annual ongoing cost per firm of this option would be £10,000. It appears that, as platforms mature, they prefer to offer a secondary market, so in the long term most platforms are likely to aim to introduce a secondary market."

At last, a little ray of pragmatism, perhaps. But on what functional specification was this estimate based?

Left unanswered are a bunch of awkward issues, such as the distinction between loans and debt securities (now that both seem to be specified investments), how 'hybrid' loan-based and investment-based crowdfunding platforms should be treated, how a platform might facilitate loans above and below the £25k per loan cap, that some types of loan-based platform are lower risk than others and should receive more proportionate treatment (e.g. secured vs unsecured, or smaller numbers of customers) and confirmation that platforms do not qualify as certain other forms of investment activity (as well as others identified in Annex 2 of a submission on the Financial Services Bill in June 2012).

The new rules will take effect from 1 April 2014, but firms with 'interim permission' will have until 1 October 2014 to comply.

Investment-based crowdfunding

A crowd-funding platform needs to be authorised if it carries out the regulated activity of enabling a business to raise money by arranging the sale of unlisted equity or debt securities, or units in an unregulated collective investment scheme. The FCA is aware of about 10 authorised firms and 11 appointed representatives of authorised firms in this sector. However, exemptions may be available. For example if the firm operating the crowdfunding platform is an appointed representative of an authorised person or an Enterprise Scheme they will not need to be directly authorised.  

While the FCA already authorises investment-based platforms under existing investment regulation, the FCA concedes that the current rules don't really fit. The FCA has imposed restrictions on the authorised platforms on a case-by-case basis, which "restrict firms to dealing with professional clients and retail clients who are either sophisticated or high net worth." However, the FCA believes that its new proposals "should mean crowdfunding investment opportunities are available to more retail investors than currently, but with appropriate safeguards to check that investors are able to understand and bear the risks involved." The FCA also intends "to provide adequate consumer protections that do not create too many barriers to entry or significant regulatory burdens for firms." The new rules will take effect from 1 April 2014, but firms will have until 1 October 2014 to comply.

The FCA is proposing to limit the direct offer financial promotion of unlisted shares or debt securities (including websites) by firms to one or more of the following types of client:

• retail clients who are certified or self-certify as sophisticated investors, or
• retail clients who are certified as high net worth investors, or
• retail clients who confirm that, in relation to the investment promoted, they will receive regulated investment advice or investment management services from an authorised person, or
• retail clients who certify that they will not invest more than 10% of their net investible portfolio in unlisted shares or unlisted debt securities (i.e. excluding their primary residence, pensions and life cover).

Where advice is not provided, firms will need to apply an appropriateness test before selling them promotions for unlisted equity or debt securities.

Where crowdfunding platforms allow investment in units in unregulated collective investment schemes, the existing marketing restrictions will apply. These can only be promoted to certain types of customer, and changes to those restrictions were also recently consulted on and were made here.

Left unanswered are a bunch of awkward issues, such as the distinction between loans and debt securities (now that both seem to be specified investments), how the financial promotion rules actually apply, how 'hybrid' loan-based and investment-based platforms should be treated, and confirmation that platforms do not qualify as certain other forms of investment activity (as well as those identified in Annex 2 of a submission on the Financial Services Bill in June 2012).

The FCA considers investment-based crowdfunding to be high risk, owing to the the high rate of start-up business failures, the possibility of unauthorised advice, professionals picking the best offers, lack of dividends, equity dilution and the lack of a secondary market.

It seems bold to assume that professionals are any better than others at 'picking the best offers'. Research reveals that no one can predict which businesses will be successful. However, these risks can all be explained. What the FCA proposals views don't account for is the ability for people to lose unlimited amounts by betting on the ponies without going through any hoops at all. The FCA states that it has "no evidence to show that the wrong type of investor is investing in unlisted shares or debt securities" but concedes that "it is possible our current regulatory approach is effectively preventing this." Why is someone who bets on the ponies, for example, the 'wrong type' to be investing in a start-up?

From a policy standpoint, if it's ok for somebody to stick a tenner on the next race, when the betting shop is the real winner, then surely, so as long as the risks are clearly explained, the same person should be able to back a small business, where the economy is the winner. 

But who in government will take responsibility for this inconsistency?

SEC Crowd Investment Rules

Today, the US Securities Exchange Commission (SEC) finally published its rules to enable securities-based crowdfunding (or 'crowd investing') under certain exemptions from Federal securities registration requirements (Title III of the JOBS Act). 

The proposal document is some 585 pages long, so it may take some time to fully digest the proposals. Comments are open for 90 days. That review is complicated by various State laws that are being rushed through to permit intra-state crowd investing out of frustration at what is perceived as SEC foot-dragging. And, on this side of the Pond, the FCA's own consultation on crowdfunding, due out this week. A lawyer's work is never done [sighs].

As a reminder, the JOBS Act exemptions apply to transactions by an issuer that meet requirements which include:

• the amount raised must not exceed $1 million in a 12 month period (adjusted for inflation at least every five years); 
• individual investments in a 12 month period are limited to the greater of: 

• $2,000 or 5 percent of annual income or net worth, if annual income or net worth of the investor is less than $100,000; and 

• 10 percent of annual income or net worth (not to exceed an amount sold of $100,000), if annual income or net worth of the investor is $100,000 or more (adjusted for inflation at least every five years); and 

• transactions must be conducted through an intermediary that is either registered as a broker, or is registered as a new type of entity called a “funding portal” that is exempt from broker/dealer registration;
• issuers and the intermediaries must provide certain information to investors and potential investors, take certain other actions and provide notices and other information to the Commission;
• the securities acquired through this exemption are also to be exempt from registration requirements.

Happy reading!

Will EU Red Tape Kill Store Cards And Loyalty Schemes?

Following my earlier SCL article on PSD2, I've had a few more thoughts on the European Commission's proposals aimed at ‘limited network’ services, such as retail store cards, gift cards, fuel cards and loyalty programmes. Remember, the Commission wants the changes agreed by Spring 2014, and Member states will have two years to implement them. It will be another five years before the Commission revies the effect of the changes, so this is the last chance to rectify the mistakes in PSD1 and avoid more in PSD2...

You will recall (no doubt) that the PSD exempts payment transactions based on payment instruments accepted only within the issuer's premises or certain 'limited networks'. Such instruments are also exempt from the definition of 'electronic money' in EMD2 by reference to the PSD exemption. While this exemption survives under PSD2, operators will be obliged to notify the regulator if the average of their transactions in the preceding 12 months exceeds €1m per month. The regulator may then disagree that the exemption applies. This catches 'closed loop' stored value and other instruments such as retail store cards, gift cards, fuel cards and loyalty programmes. Yet, as discussed previously here and here when the UK Treasury considered self-regulation to ring-fence funds in this area, there is no evidence of any harm to consumers in such scenarios, compared to the collapse of retail pre-payment schemes such as those offered by Farepak or tour operators which appear not be caught.

Here are my additional thoughts:

1. Other than simply the volume/value, there seems to be implied an additional basis on which a regulator might decide that a service which otherwise fell within limited network exemption below the threshold average of €1m per month would no longer qualify when it reached that threshold. What basis would that be?


2. If the regulator were to disagree that the limited network exemption under PSD2 applies, is the service provider automatically guilty of an offence without any possibility of an orderly transition to full authorisation or finding an authorised payment institution or PSD agent to operate the service?


3. Similarly, if the regulator were to disagree that the limited network exemption under PSD2 applies to a ‘closed loop’ stored value service, does that amount to a decision that the exemption from the definition of “electronic money” under EMD2 would also cease to apply to that service? If so, a service provider who was lawfully operating within the exemption below the volume threshold would suddenly find itself in breach of both PSD2 and EMD2, again without any possibility of an orderly transition to full authorisation or finding an authorised e-money institution to operate the service.


4. Outcomes such as those in scenarios 2 and 3 above seem to conflict with the privilege against self-incrimination and may be otherwise unacceptable from a public policy standpoint (e.g. the avoidance of retrospective regulation). Practically speaking, this mechanism could also drive every service provider with a programme operating anywhere near the volume threshold to approach the regulator for an indication of whether it’s programme would, if it reached the threshold, be deemed in breach. However, even doing that would open up a similar risk that the regulator may disagree that the exemption applies, with the ugly consequences that may follow. Accordingly, we may find that the operators of all limited network payment schemes apply for authorisation, or use an authorised firm to operate their schemes merely as a precaution against the possible commission of an offence. Or they cancel their programmes altogether. 

Surely such 'regulatory creep' is not the intention...?

Cheaper, Faster EU Patents?

The cost of obtaining an EU-wide patent is likely to come down when the 'unitary patent package' is finalised, according to the European Commission in its recent consultation document on Crowdfunding in the EU. 

In turn, this should make it easier for inventors to protect their inventions and seek funding more openly on crowdfunding sites.

But as ever with the EU, progress on implementation... seems .... quite..... s..l...o...w...  

Austria broke ranks on 7 August to ratify the agreement on a unified patent court. No one else yet.

The Future of EU Payments Regulation?

I thought it would only ruin the Summer. But it's taken me until Autumn to get my head around the European Commission's plans for a new Payment Services Directive, or 'PSD2' (nope, that's not the train). I'm told that leaves falling from the local trees is purely coincidental and not some kind of arboreal reaction to the complexity.

At any rate, my review of the proposals is now up on the SCL website, along with my earlier article on how card acquiring really works.

If you receive payments by direct debit or you operate an online marketplace, gift card programme, loyalty scheme, mobile/digital wallet, bill payment service, telecoms network, payment initiation service, account information service or a small payment institution you should be particularly concerned. Existing institutions will need to work carefully through the detail.

All will need to take the time to explain to the Commission how their services actually work, and how the regulations might unduly constrain innovation and competition.

The Commission aims to get the changes adopted by Spring 2014, and Member states will have two years to implement. The Commission is giving itself a further five years to review its effectiveness, so it will be along time before we have another opportunity to rectify the mistakes...

Image from EuropeanBusinessReview.

Crowdfunding: Brussels Sprouts!

At last, the European Commission has realised that peer-to-peer finance might really be more efficient than banks at getting funding to those who need it. In Brussels, that translates roughly into "let's regulate". So, today the Commission launched a consultation aimed at understanding "crowdfunding: its potential benefits, risks, and the design of an optimal policy framework to untap the potential of this new form of financing."

The consultation paper is here, and responses are due by 31 December. The relevant Commission officials can be reached here. 

If my experience of the Commission's approach to regulating other aspects of e-commerce is anything to go by, it will be a huge challenge to educate officials - particularly for fast-moving entrepreneurs who have little time or resources to spare. 

Yet the risk of awkward, confusing and disproportionate regulation is high, so no one resident in the EEA can afford to be complacent.

So, at the very least, I'd recommend that any UK platforms and/or trade bodies capitalise on the evidence they've submitted to UK officials and Parliamentary committees over the past year or so, including whatever submissions are made in the current round of FCA consultations on peer-to-peer lending and crowd-investment. 

FCA's Consumer Credit Rules

The UK's Financial Conduct Authority (FCA) has published its detailed proposals for regulating consumer credit from 1 April 2014. Specific areas of focus include payday lending (Chapter 6), debt management (Chapters 7 and 9) and peer-to-peer lending (Chapter 8). The detailed rules are in the Appendices.

Peer-to-peer lending (P2P lending) is mentioned in the context of protection for borrowers and the transition arrangements for those who hold a Consumer Credit Licence or wish to take advantage of the interim permission regime. However, a separate consultation paper will cover the new regime for peer-to-peer finance or 'crowdfunding' platforms more generally, including protection for consumers who lend or invest through such platforms. I understand that is likely to be issued around 17 October. 

The consultation period ends on 3 December, and responses may be made online here. The final rules are expected in March 2014. 

The FCA's rules related to borrowing on P2P lending platforms are consistent with the way the consumer borrowing platforms already operate. Which is no surprise, since they have been calling for proportionate regulation for years now, and adopted their own self-regulatory code in July 2011. The key protective rules may be summarised as follows:

• It is proposed that platform operators cannot be an appointed representative of another firm 

• FCA proposes similar provisions in relation to pre-contractual explanations and creditworthiness for P2P lending. 

• introduces the concept of a 'P2P agreement' as a distinct form of regulated agreement

• the platform must provide adequate explanations of the key features of the credit agreement to borrowers (including identifying the key risks) before the agreement is made (see CONC 4.4)

• the platform must assess the creditworthiness of borrowers before granting credit (see CONC 5.5) 

•  rules relating to ‘financial promotions’ (see CONC 3 (where applicable)) 

• the platform must include in the agreement between borrower and lender a right for the borrower to withdraw from the agreement, without giving any reason, by giving verbal or written notice, within 14 days of the agreement being made (see CONC 11.2) 

• peer-to-peer lending platforms should be required to provide notices and information sheets to borrowers in arrears or default, directing them to sources of free and impartial debt advice (see CONC 7.18 to 7.20) 

• equivalent rules should be applied to the peer-to-peer lending platforms that help borrowers get high-cost short-term credit as to those applied to lenders providing such credit (see CONC 6.7.17 to 26 and 7.6.12 to 14) 

• peer-to-peer lending platforms should be required to provide a specific risk-warning to a borrower if the loan is secured against the borrower’s home – see CONC 4.4.5) 

• equivalent rules should be applied to peer-to-peer lending platforms carrying on debt collection (see CONC 7) and credit information services, including credit repair (see CONC 8.10) as to other consumer credit firms carrying on the same activities

• Borrowers with loans not regulated under the CCA (because of one of the exemptions) who borrow from firms currently authorised by the FCA will generally have access to FOS in relation to these loans.

Interestingly, the FCA does not anticipate that requirements with respect to P2P lending will affect mutual societies.

P2P Lending: Need FCA Interim Permission But Don't Offer Consumer Credit?

As mentioned earlier, this is a question on which I've have seen no official guidance on, but I have since followed up. 

In order to operate certain types of peer-to-peer lending platform after 1 April 2014, new regulations will requre you to be either fully authorised by the Financial Conduct Authority, or to have received 'interim permission' that is only available to operators who hold a consumer credit licence issued by the Office of Fair Trading.

But the scope of activity within the FCA regime is broader than the activities currently within scope of the OFT's consumer credit licensing regime. 

Whether your platform is 'in scope' for FCA purposes essentially depends on whether the platform enables loans to which individuals are a party as lenders and/or borrowers (either on their own or as a member of an unincorporated association or a partnerships of two or three). There is an exception in the case of borrowers, where either the lender provides the borrower with credit of more than £25,000 or the loan is entered into by the borrower wholly or predominantly for the purposes of a business carried on, or intended to be carried on, by the borrower.

So, for example, platforms that only enable individuals to lend money to companies would not need a consumer credit licence, but would fall within the FCA's peer-to-peer lending regime.

However, I am reliably informed by the FCA that although the OFT would not normally grant licences to firms that may not necessarily require them, it is aware of the interim permission issue and is prepared to grant consumer credit licences to P2P platform operators who need one for interim permission purposes, provided they otherwise satisfy the licence criteria. Such operators should contact the Head of Credit Licensing at the OFT in advance of submitting the application. The application should cover all the activities the platform will undertake from 1 April 2014, including ‘debt administration’. 

Regulating Convergence

This week I get the chance to chat about my three of my favourite topics from a legal standpoint: payments, peer-to-peer finance and data. 

All three are in a state of regulatory flux (which is also making for some late nights). But that tells you a lot about where commerce, and society itself are headed. The much vaunted 'convergence' of Web 1.0 has definitely arrived.

As ever, the challenge for independent regulation of these areas is to approach electronic commerce in a holistic way that promotes competition and innovation, rather than in a blinkered fashion that results that strangles innovative services at birth...

It should be a lively week.

More in a wrap-up post at the end.

Applying For Interim FCA Consumer Credit Permission?

The Financial Conduct Authority is now open to receiving applications for interim permission to engage in consumer credit activity beyond 1 April 2014. Registrations prior to 30 November 2013 qualify for a 30% discount on the registration fee.

Here's the FCA's step-by-step guide; a timeline, which includes consultation on the regulatory details later this month followed by workshops around the country from October to March. There is also some information on being supervised by the FCA; and a note of the differences in the scope of the OFT and FCA regimes.

Here's the OFT's page on the topic.

There are some specific issues not covered in the material released to date. Most importantly, how do you apply where you will need interim permission, but you don't have a current consumer credit licence and your activities do not fit the OFT's current application form? 

Holiday Fun With PSD2

No doubt you've seen the proposal to revise the Payment Services Directive (PSD2), and related FAQs. 

More on the detail of that later, but one question that recurs to me, as I wade slowly through the treacle, is why a document that was due in November last year has had to be packed into everyone's beach bag for the summer of 2013. 

Just sayin'...

Mobile Wallet Payments: EPC White Paper

The European Payments Council has issued a white paper on mobile wallet payments in an attempt to drive (bank-centric) 'standards, best practices and schemes' for mobile payments. 

While comments from "all interested stakeholders" are welcomed by 30 September 2013, one needs to bear in mind that the EPC represents the European banking industry. The claim (in footnote 3) that the banking industry includes payment institutions is disingenuous at best. The creation of payment institutions via the Payment Services Directive reflected the European Commission's avowed intent to carve out payment services from the banking monopoly. Some PIs are members of the EPC but most are not, and it's especially telling that neither e-money nor e-money institutions are mentioned in this white paper at all, yet are firmly engaged in providing mobile payment services. 

You will also gather from the overly enthusiastic use of banking and payment applications during the "day in the life of Mr Garcia" that the EPC is not overly fond of retail apps that embed the payment step to the point of convenient invisibility.

As a result, the paper may be interesting if you want to know how retail banks view the mobile payments market segment, but if you're interested in payments innovation more generally you'll need to spend most of the time reading between the lines...

Image from BankingTech

Draft Peer-to-Peer Lending Regulations

The draft regulations enabling the Financial Conduct Authority to regulated peer-to-peer lending have been published for parliamentary approval (see Articles 36H-I). There have been some changes to since the previous version in the March consultation to remove certain issues. The more detailed FCA rules should be out with a further consultation paper in September/October.

Basically, your platform is 'in scope' for FCA purposes if it enables loans to which individuals are a party as lenders and/or borrowers (either on their own or as a member of an unincorporated association or a partnerships of two or three). However, there is an exception in the case of borrowers, where either the lender provides the borrower with credit of more than £25,000 or the loan is entered into by the borrower wholly or predominantly for the purposes of a business carried on, or intended to be carried on, by the borrower. 

E-money and Payments Law Update

The UK's Financial Conduct Authority has updated its "Approach" to regulating:

• Payment Services (marked version here) under the Payment Services Regulations 2009; and

• E-money (marked version here) under the Electronic Money Regulations 2011.

Worth a look at the tracked versions, especially if you are interested in 'passporting'.

Banking Standards Commission Backs Alternative Finance Platforms

The Banking Standards Commission wants to change banking for good. And, as you might expect from the scale of its ambition, the Commission's long-awaited report is vast in its scale and scope.

For me the highlights are not only the recital of the banking problems and their causes, but also the remarks on alternative finance models (summary extracted below). 

In particular, it is great to see that the Commission has accepted industry pleas for the reform of both the regulatory framework and the perverse tax incentives that are protecting banks from competition. 

No doubt there will be devil in the detail, but this report at least provides a solid basis for addressing the challenges that lie ahead.

The report must be a daunting read for the staff in the newly created financial authorities, who have barely settled behind their new desks. But change will need to be part of their day jobs if we are to see genuine innovation and competition in the retail financial market.

"57. Peer-to-peer and crowdfunding platforms have the potential to improve the UK retail banking market as both a source of competition to mainstream banks as well as an alternative to them. Furthermore, it could bring important consumer benefits by increasing the range of asset classes to which consumers have access. This access should not be restricted to high net worth individuals but, subject to consumer protections, should be available to all. The emergence of such firms could increase competition and choice for lenders, borrowers, consumers and investors. (Paragraph 350)

58. Alternative providers such as peer-to-peer lenders are soon to come under FCA regulation, as could crowdfunding platforms. The industry has asked for such regulation and believes that it will increase confidence and trust in their products and services. The FCA has little expertise in this area and the FSA's track record towards unorthodox business models was a cause for concern. Regulation of alternative providers must be appropriate and proportionate and must not create regulatory barriers to entry or growth. The industry recognises that regulation can be of benefit to it, arguing for consumer protection based on transparency. This is a lower threshold than many other parts of the industry and should be accompanied by a clear statement of the risks to consumers and their responsibilities. (Paragraph 356)

59. The Commission recommends that the Treasury examine the tax arrangements and incentives in place for peer-to-peer lenders and crowdfunding firms compared with their competitors. A level playing field between mainstream banks and investment firms and alternative providers is required. (Paragraph 359)."

Crowdfunding Guest Post On Nesta...

My guest post on the impact of regulation on crowdfunding in the UK is now up on Nesta's "Economic Growth" blog. The overview appears as one of a series of posts that accompany Nesta's crowdfunding directory at Crowdingin.com, which lists information on platforms open to fundraising from individuals and businesses in the UK.

Why Doesn't The ECB Try P2P?

horizontal vs vertical credit intermediation

In April, European officials finally realised that Europe's banks will be unable to lend enough to small businesses to finance economic recovery. The failure of the UK's Funding for Lending scheme has not gone unnoticed. So rather than establish an EU version of that scheme, the European Central Bank has been considering whether to kick-start a small business securitisation market. Last week, however, the ECB played down that idea. After all, the banks don't have the capability to make enough loans in the first place, and the 'shadow banking' sector has demonstrated that it can't reliably price endless tiers of bonds, CDOs, CDOs of CDOs.

So now what?

Peer-to-peer lending has grown rapidly in the UK, despite an awkward (though permissive) regulatory framework and perverse tax incentives. That headwind is changing, as even the UK government has begun lending on some platforms, and officials are getting on with the job of bringing P2P lending firmly within the regulatory sphere.

Oddly, perhaps, those regulatory changes are being made in the context of moving the supervision of consumer credit from the Office of Fair Trading to the Financial Conduct Authority in April 2014. However, that merely reflects the fact that P2P lending originated in the personal loan market, whereas there are now platforms that facilitate business loans, asset finance and commercial real estate funding. In other words, P2P lending has expanded into institutional investor territory, which should be of real interest to the ECB as it looks beyond the banking sphere.

As I've pointed out many times since 2010, a key feature of P2P lending platforms is that each borrower's loan amount is provided via many tiny, direct loans from many different lenders at inception. This permits lenders to diversify at the outset, so that loan maturities and rates of return do not need to be 'transformed' via securitisation later on.  Enforcement and due diligence are made easy on P2P platforms because the one-to-one legal relationship between borrower and lender is maintained for the life of the loan, and the performance data also remains readily available via the lender's account. This enables P2P lenders to avoid the concentration of credit risk that securitisation tends to obscure through endless re-packaging and re-grading, and the ensuing disconnect between bonds and the underlying loans. 

It will also be of special interest to the ECB that the scope for moral hazard is contained in the P2P context - the platform operator itself has no balance sheet risk, yet is able to implement all the compliance and operational risk controls one would ordinarily expect of lenders. This brings regulatory efficiencies, too. The authorities need only supervise the P2P platform operator rather than the lenders and borrowers on either side, who are effectively just payers and payees, as in the case of a payment institution. Funnily enough, that's the reason the UK's Peer-to-Peer Finance Association borrowed the substance of its "Operating Principles" from the Payment Services Directive - a piece of legislation with which the ECB is also very familiar...

That paves the way for anyone to lend to consumers and small businesses via P2P platforms without any concern about the need for lender-licensing. Indeed, the UK's Financial Conduct Authority has said that it intends providing investor-type protection for P2P lenders. That would mean exemptions for marketing P2P lending to high net worth and sophisticated investors and professional investment firms. So it would be strange to also require such investors to be separately authorised to lend, especially when the platform operator is taking care of all the compliance obligations. It would be like requiring a firm to be authorised to deposit money in the bank or to make payments via a payment institution - just red tape.

Given access to loan capital on that industrial scale, the ECB could justifiably view P2P lending to small businesses as a significant potential driver of economic growth. 

Lawyers Who Code

My name is Simon and I can't code. 

There. I've said it. Despite working with and around computers since 1990, I can't really tell one what to do - at least not in any language it will respond to. 

But as internet and mobile technology becomes ever more accessible, it's becoming clear that computer programming is something I should learn. After all, it's really about writing rules and I write contracts all the time. Since writing the article on Linked Data for the SCL in March, it's also occured to me that more and more legal contracts should be capable of being acted upon by machines without any human intervention. Indeed, as a colleague on the SCL Media Board pointed out today, Creative Commons licences have a machine-readable layer, as well as legal code and human readable layers - which is also something we discussed in the WEF's tiger team on Rethinking Personal Data in June last year.

So I've decided to get a Raspberry Pi and give it a whirl. No doubt I'll struggle to find the time, and maybe the kids will learn faster than me, but so it goes with the guitar and piano. Hopefully it will be as much fun.

In the meantime, I'd love to hear from any lawyers (or others) who've learned to code, how they're getting on with it and any top tips on how to go about it.

Regulating Peer-to-Peer Lending

The Government recently outlined its proposals for regulating peer-to-peer lending, at the same time as its plans for moving the regulation of consumer credit from the Office of Fair Trading to the Financial Conduct Authority in April 2014.

Since the launch of Zopa in 2005, peer-to-peer lending platforms have provided nearly £500m in loans to consumers and small businesses. However, it has long been clear that regulation and perverse tax incentives are constraining the development of the sector. In 2011, the leading operators formed the Peer-to-Peer Finance Association to seek proportionate regulation that would encourage responsible growth. The government welcomed the creation of the P2PFA in several reports during 2012, and the Treasury foreshadowed its latest consultation at the P2P Finance Policy Summit in December, following some fairly intense debates on the Financial Services Bill in the House of Lords. At that time, the Department of Business Innovation and Skills also announced that the Business Finance Partnership would lend about £30m to small business borrowers through peer-to-peer platforms.

The latest Treasury consultation maintains this momentum, stating (at paragraph 4.12) that:

“The Government is keen to see this sector continue to grow and evolve, and therefore it will be important to develop a proportionate regime that recognises the needs of this innovative sector.”

Under the Treasury's proposals the activity of “operating an electronic system in relation to lending” will become a 'Tier 1' regulated consumer credit activity (along with consumer lending, for example), and certain 'ancillary' consumer credit activities will become more lightly regulated 'Tier 2' activities. There are various issues relating to the finer points of the definition which will hopefully be ironed out in the response to the consultation.

While corporations will not get the benefit of regulatory protection, the Financial Conduct Authority "envisages the lending aspect of a peer-to-peer platform’s activities being treated as an investment activity and that lenders providing the finance should be appropriately protected regardless of the status of the borrower." However, we won't know exactly what sort of protection this involves until the FCA consults on the detail of its proposed rules during the autumn of this year. It is to be hoped that the reasonably straightforward customer experience of today will be maintained...

What we do know is that firms wishing to undertake consumer credit activity (including peer-to-peer lending) after 1 April 2014 will need to obtain a Consumer Credit licence from the OFT (if they don't already hold one) and apply to the FCA for "interim permission" prior to 1 April 2014. OFT-licensed firms who are already FCA-authorised, or who are appointed representatives of FCA-authorised firms, must apply to the FCA for an “interim variation of permission”.

The FCA will then invite the various types of firms who hold interim permissions to apply for full authorisation in waves (since there are over 40,000 consumer credit licence holders in total). A firm's interim permission will last for as long as the FCA takes to consider the firm's application for authorisation or 1 April 2016, whichever comes first. 

However, it's worth noting that firms with interim permission “may not act as principal for appointed representatives in relation to the activity for which they hold an interim permission”. The effect of this could be that service providers who hope to avoid the cost of full authorisation may need to apply for interim permission in their own right until such time as the firm with interim permission obtains full authorisation and is entitled to appoint them as representatives. Perhaps this issue will be ironed out during the autumn, along with certain others. 

If you would like to know more, by all means get in touch via @sdjohns on Twitter.

Payday Loans: Can Borrowers Have Speed, Convenience And Affordability?

Source: OFT

Problems with payday lending are not new. As with payment protection insurance, campaigners in the US were attempting to address poor practices in this area long before they rose to prominence in the UK - and still are. Regulatory solutions don't seem to make much difference. However, recent research shows that 46% of the UK's online borrowers shop around, versus 28% of those on the high street. This suggests technology may also help ensure compliance with affordability requirements, if only creditors would provide transaction and fees data in machine-readable format.

In its consultation on Payday Lending in the UK, the OFT estimates that the volume of payday loans has grown from £900m to £2.2bn since 2008. It says the top 3 providers account for 57% of all payday loans, but concedes the number of lenders has grown from 96 in 2009 to 190 in 2012. This growth, and the efforts of UK campaigners, sparked the OFT's payday lending compliance review in February 2012. As a result of that review, the OFT is now considering a referral of the industry to the Competition Commission, though it believes the transfer of its own regulatory role to the Financial Conduct Authority in 2014 "is likely to increase regulatory costs and make entry to the payday lending market more difficult."

True, the FCA will have more powers, e.g. to limit the number of roll-overs, cap interest rates and control advertising (see the Treasury and FCA consultation papers on the transfer of consumer credit). But the past decade here and in the US has shown that regulation itself is no panacea. Technology appears to have had a bigger impact, both in terms of access and the ability to shop around, and this suggests that technology represents the best avenue for addressing affordability issues.

It's important to start with the borrower. You can't ignore the fact that 90% of online customers who responded to the OFT survey find it "quick and convenient" to get a short term loan and 81% say it makes it easier to manage when money is tight. Customers expressed their satisfaction in terms of decision speed (36%), convenience (35%) and customer service (27%). While affordability therefore appears to be a secondary consideration for all concerned, that's a bit misleading. Research shows that customers ignore the annualised interest rate and look at the absolute charges. These may make loan cost comparison harder, but makes more sense to someone who believes he's only borrowing for a month - which is the case for 72% of payday loans (see graphic). Assessing affordability is also hard - especially for the borrower, on whom the lender is largely relying to provide the relevant figures.

It is therefore no suprise that the industry advertising generally emphasises 'time to cash'.  But the OFT also found that some lenders seem to skimp on credit and affordability checks in order to deliver that speed. You would think that's a dangerous game for lenders to play when their own money is at risk. But the OFT found that about half lenders' revenue come from the 28% of loans that 'roll-over' at least once before being repaid (see graphic). Instinctively, that looks bad. But if those loans are so valuable to lenders, it seems odd that the OFT found little evidence of competition for them loans that are about to roll-over. Perhaps borrowers think they have no alternative at that point, or perhaps they don't care about the cost. But it's also consistent with the fact that these borrowers - and lenders - find it really hard to assess affordability.

While the OFT will decide in June whether to refer the payday lending 'market' to the Competition Commission, you can see from Annex A to its report that it's struggling to define that market. There's a long list of potentially competing finance products. But there are at least 4 unmentioned 'gorillas in the room'. The 'silverback' is the overall debt scenario facing any borrower considering a payday loan. Another gorilla in this troop is the charge for unapproved overdrafts, about which the OFT is understandably gun-shy after its long-running court battle with the banks. Yet another is the fact that when you use a credit card you have no ready means of knowing what the outstanding balance is, as some transactions may not yet be recorded, and interest and charges may only be added to the bill at the end of the month. That's a common reason that the so-called 'financial excluded' give for not trusting financial services, including cheque books and debit cards. The final gorilla in the troop is the borrower's overall financial situation, including the non-financial implications of failing to pay existing or potential creditors, like kids having no school shoes...

However, like a credit reference search itself, these gorillas are all really data problems that are capable of a technological solution, as I've explained previously. Rather than skimp on affordability checks, lenders should figure out how to enable them to be carried out quickly and conveniently. Small lenders might share the cost of a common underwriting platform, for example. But, more importantly, borrowers need to be armed with an application that very simply presents an option that is affordable, based on the analysis of their own transaction data (including fees) from their existing creditors, and the competing costs of different financing options (including charges for missing a payment). 

This may sound futuristic, but it only requires a commitment on the part of all the typical creditors and financial services providers to make this data available to their customers (or their nominated service provider) in machine-readable format. The analysis can be done by either the customer's or a supplier's computer, with the results accessible either online or physically, via a print-out. 

There are plenty of examples of individual customers' transaction data being made available to them or their nominees in this way already, and the immediate focus of the government's voluntary 'Midata' programme is to persuade the banks, telcos and energy companies to do this for all their customers (rather than only those with internet banking accounts, for example). 

Problems like the affordability issues in the £2.2bn payday lending sector represent a good argument for getting on with it.