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.