FCA Guidance on Consumer Credit Lending Authorisation

A key supporting document for applications to the Financial Conduct Authority for authorisation and permission to carry on a regulated activity is the 'regulatory business plan'. 

The requirements for what the plan must cover are usually summarised in various guidance, depending on the type of authorisation or permission being sought, but there's a lot of variation as most advisers have developed their own templates. 

Helpfully, however, the FCA has published a sample regulatory business plan for use by firms seeking authorisation/permission that is also useful for consumer credit lending, with a web page that also contains link to other relevant guidance for prospective lenders.

What is consumer credit lending?

This is a huge topic, but very broadly...

Permissions required for consumer credit lending activity will include entering into regulated credit agreements as the initial lender (under article 60B(1) of The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO) and/or buying or exercising the rights under pre-existing regulated credit agreements (under 60B(2)), subject to exemption under article 55 of The Financial Services and Markets Act 2000 (Exemption) Order 2001, for example). That deserves a post of its own.

A similar regime applies to regulated consumer hire agreements (under article 60N of the RAO), while hire purchase and conditional sale agreements are treated as regulated credit agreements.

There are also various related permissions that will likely be required to deal with credit agreements and consumer hire agreements, including credit broking (article 36A, RAO), operating a peer-to-peer lending platform (article 36H), as well as debt adusting (39D), debt counselling (39E), debt collecting (39F) and debt administration (39G). These activities and various exemptions also deserve their own post.

Regulated credit agreements do not generally include "exempt agreements" (based on many exemptions in articles 60C-60K of the RAO that would require yet another post), but carrying out credit broking in relation to exempt agreements is still a regulated activity, and facilitating entry into exempt agreements can also still constitute peer-to-peer lending.

There are also specific exemptions for consumer hire agreements (articles 60O-60R, RAO).

Regulated credit agreements and consumer hire agreements and so on are also subject to the Consumer Credit Act 1974 and related regulations, though some provisions (including those relating to the 'form and content' of agreements) will not apply to "non-commercial agreements" or exempt agreements (though some exemptions require certain declarations in the paperwork). The CCA also deals with pawn receipts, revolving credit (e.g. credit cards), small loans and so on - yet another whole post in itself.

Finally, the FCA's 'Handbook' of rules generally apply to authorised firms who conduct consumer credit/hire activity, as well as specific rules on consumer credit (CONC) which distinguish between different types of consumer credit (e.g. pawnbroking, high cost short term (payday lending) and P2P agreements) for certain purposes.

Please get in touch if any you need advice on any of this.

New Rules For P2P Lending And Crowd-Investment

A year after consulting on its proposals, the FCA has issued new rules for P2P lending and crowd-investment platform operators from 9 December 2019 (and certain mortgage rules immediately). I'm trawling through the detail, but have summarised the changes below. Let me know if I can help.

Originally, the FCA proposed to:

• set out the minimum information that P2P platforms need to provide to investors; 
• clarify what systems and controls platforms need to have in place to support the outcomes platforms advertise - particularly on credit risk assessment, risk management and fair valuation practices; 
• ensure arrangements are in place that take account of the practical challenges that platforms could face in a wind-down scenario; 
• extend marketing restrictions that already apply to investment-based crowdfunding to P2P platforms; 
• apply Mortgage and Home Finance: Conduct of Business sourcebook (MCOB) and other Handbook requirements to P2P platforms that offer home finance products, where at least one of the investors is not an authorised home finance provider - to address a potential gap in protections for home finance customers who undertake transactions through a P2P platform.

Sure enough, the new rules:

• Clarify what governance arrangements, systems and controls must be in place to support advertised performance (especially credit risk assessment, risk management and fair valuation practices);
• Strengthen plans for the wind-down of P2P platforms;
• Apply marketing restrictions to protect less experienced investors in loans;
• Introducing an appropriateness test for an investor’s knowledge and experience of P2P investments where no advice has been given to the investor, and what the assessment should include; and
• Specify minimum information that P2P platforms need to provide to investors. 

In addition, P2P platforms that offer home finance products (where none of the investors is an FCA authorised home finance provider) must comply the FCA's Mortgage and Home Finance Conduct of Business sourcebook (MCOB) and other Handbook rules from now. 

New FCA Consultation on P2P Lending and CrowdInvesting

The FCA is consulting on proposed changes to the regulation of P2P lending and crowd-investment platforms. Firms have until 27 October 2018 to respond. While the Treasury recently insisted at EU level (for what that's worth, post-Brexit) that it sees a significant distinction between P2P lending and crowd-investment platforms, the FCA's proposals severely erode any such distinction.

The FCA is concerned that investors 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 may happen if the platform administering their loan fails;
• understand the costs they are paying for the services the platform provides; or 
• may pay excessive costs for a platform’s services

As a result, the FCA proposes to:

• set out the minimum information that P2P platforms need to provide to investors; 
• clarify what systems and controls platforms need to have in place to support the outcomes platforms advertise - particularly on credit risk assessment, risk management and fair valuation practices; 
• ensure arrangements are in place that take account of the practical challenges that platforms could face in a wind-down scenario; 
• extend marketing restrictions that already apply to investment-based crowdfunding to P2P platforms; 
• to apply Mortgage and Home Finance: Conduct of Business sourcebook (MCOB) and other Handbook requirements to P2P platforms that offer home finance products, where at least one of the investors is not an authorised home finance provider - to address a potential gap in protections for home finance customers who undertake transactions through a P2P platform.

Can You Use P2P Loans to Provide Finance To Others?

The FCA and others have become concerned that some people or firms may be borrowing money on peer-to-peer lending platforms and using that money to provide finance to others without being authorised to do so, rather than borrowing solely to finance their own activities. 

So the Treasury proposes to clarify when a person or business can borrow on a P2P lending platform without needing to be authorised to 'accept deposits' by amending the 'business test' for deposit-taking as explained here.

For the sake of argument, let's just accept that a 'loan' can be a "deposit"; that borrowing on a P2P lending platform can involving "accepting" a deposit; and no potential exemptions apply. The question is whether this is being done "by way of business".

The current test merely says that a borrower will not be 'accepting deposits by way of business' if the borrower doesn't hold himself out as accepting deposits on a day-to-day basis; and any deposits are accepted only on "particular occasions".

This is considered too vague to be helpful in the P2P lending context, so the government proposes to add a specific carve-out for the situation where:

• the acceptance of deposits is facilitated by an authorised P2P lending platform;
• the borrower is not a bank or 'credit institution' (as they are already in the business of accepting deposits) or other type of regulated person (who would need to add the permission to accept deposits);
• the borrower is not carrying on the business of accepting deposits (which is obviously kind of circular, but another provision will say that if the borrower uses the capital or interest on the funds solely to finance other business activity carried on by the borrower (not a third party), this will be evidence that the borrower is not carrying on the business of accepting deposits);
• the borrower does not hold himself out as accepting deposits on a day to day basis, other than as facilitated by the P2P lending platform.

The key element in the context of borrowing on a P2P lending platform is that the borrower's use of the loan proceeds is to finance that person or firm's own activities, as opposed to being used to provide finance to others.

Of course, this post is for information purposes only and does not constitute legal advice.

P2P Lending Goes Global: FinTech Credit v OldTech Credit

Twelve years after the launch of Zopa and the peer-to-peer finance sector finally gets its first report from the Bank of International Settlements (BIS), the central bank of central banks. The report is surprisingly positive, given financial regulators' preference for the status quo. Basically, they believe that change increases risk and increased risk is bad, so innovation is both risky and bad. Similarly, they're fond of shoe-horning innovative services into existing regulatory frameworks without seeing that the innovation may itself be exposing and/or solving flaws in that system. At any rate, the banking situation must be pretty dire for the industry's global beacon to produce a positive report on alternatives...  But in the the interests of time I want to ignore the positives and answer a few criticisms:

Is P2P lending "procyclical"?

No.

In fairness, the BIS report only suggests that P2P finance represents the "potential for ...more procyclical credit provision in the economy", but I still disagree that this is a feature of the model.

Bank lending itself is procyclical, which is to say that banks lend lots of money when the economy is booming, yet try to protect their balance sheets when times are tough and we need credit the most. In fact, this was such an alarming feature of the recent/current financial crisis that BIS itself introduced capital rules that it thought would force banks to become less procyclical. Recently, moreover, the BIS's own Basel Committee reported that these rules are proving ineffective. They think there is too much bank credit available and/or the quality of creditworthiness is in decline.

If that's the case, then we really are in trouble, since UK banks have been lending progressively less to real businesses, and we aren't exactly in the grip of an economic boom...

Compare this to the rise of P2P lending. We started Zopa in 2005 when the 'spread' between high bank savings rates and cheap credit was actually very narrow (heavily subsidised by PPI revenues) - yet proved that lending directly between humans without a bank in the middle produced a better deal for both lenders and borrowers. This is why P2P lending has become ever more popular since 2008, while banks have sat on the sidelines waiting for the good times to roll. Lenders get higher interest on their money, diversify risk by lending to lots of people and businesses who are starved of bank loans - apparently leaving the banks with leaner opportunities...

But I believe the banks have simply chosen to chase higher yielding loans and other assets because their cost base does not allow them to make money serving the better risk customers.

Indeed, the BIS report acknowledges that banks have "left room" for platforms that enable people to lend directly to each other "by withdrawing from some market segments" after the financial crisis (which, I'd like to emphasis, still hasn't ended).  The report notes that P2P lending equated to 14% of gross bank lending flows to UK small businesses by 2015... only 5 years after the launch of the first P2P business lending platform.

So, P2P finance is actually counter-cyclical by its very nature.

The real issue, perhaps, is what happens when banks start being able to offer better interest rates and cheaper loans. Yet Zopa's early experience shows the new platforms will still be able to compete successfully (especially because those PPI cross-subsidies are no longer available: refunds and compensation have now reached £26.9bn, according to the FCA!).

Is it likely there will be a 'run' on P2P lending?

No. Far from seeing a potential 'run' on P2P lending platforms by lenders trying to get their money out, many platforms are seeing excess lender demand due to continuing low yields on bank deposits (not to mention high fees on investment products). Zopa, for example, has been closed to new lenders for some months, even while seeing record borrower demand, yet still plans to offer P2P lending within Innovative Finance ISAs. Everyone is chasing yield, not just the banks. But, again, the early experience shows that the rates will still be more attractive if and when banks are able to offer higher rates to savers, because they need fatter margins than P2P platform operators.

Meanwhile, the P2P model has expanded from consumer and small business loans into car finance and commercial property loans. But so far the regulators have protected banks against head-to-head competition for other forms of finance, such as retail sales finance or mortgages, through lack of reform to arcane procedures dictated by consumer credit and mortgage regulation and refusing to allow longer term finance to be supported with short term loans - which banks are allowed to do all the time.

So, rather than a run on P2P lending, we're more likely to see successful P2P lending operators adding a bank to their group, at the same time as expanding their existing P2P offerings. In other words, a twin-track attack on Old Tech banks and banking models.

Will P2P lending help solve problems with banks' legacy systems?

No.

There's no doubt that this BIS report and the regulatory obsession with 'FinTech' generally, springs partly from regulators' fervent wish that OldTech banks will simply take advantage of the latest trend to rejuvenate their systems for the longer term.

But there are many reasons why established retail banks won't do that - and will continue to passively resist regulatory edicts to do so. That's why the UK government had to impose the open banking initiative (not to mention sharing business credit information and declined loan applications); why the Bank of England has opened up the Real Time Gross Settlement system; and why PSD2 regulates a new class of  third party 'account information' and 'payment initiation' service providers.

Why won't the banks renew their legacy systems to save themselves? For starters, they don't actually have legacy "systems" so much as separate bits of very old kit connected manually by employees holding hands with electrical chord between their teeth using their own spreadsheets. So the shiny new government-mandated open banking interfaces will likely be connected to computers that aren't really party of any type of integrated "system" that, say, a Google engineer might recognise.

Aside from that insurmountable IT challenge, bank management teams are simply not incentivised or empowered to think about the long term, and all their key decisions are made (after a very long time) in committee to avoid personal blame.

So it's more likely that the aspects of 'banking' which are within the scope of P2P lending will gradually drift away from banks altogether, while activities outside that competitive scope will need to be reinvented by others, including new banks, from the ground up.

Will traditional banks launch their own P2P lending platforms?

Probably not.

Some have bought shares in such platforms and others have actually lent their own funds on P2P lending platforms. But that's a long way from allowing their depositors to lend directly to their borrowers.

That's because bankers make their money by keeping savers and borrowers separate of each other and treating deposits as their own funds. 

It's high time regulators admitted this to themselves and got on with the job of supporting more transparent, fairer mechanisms for allocating people's spare cash to other people who need it.

Is P2P lending an "originate-to-distribute" model?

No.

Here, again, P2P lending is a reaction away from this type of model and is transparent enough to reveal attempts to introduce it. BIS says that "originate-to-distribute" refers to the fact that neither the primary lender nor the operator of the platform retains any ownership or interest in the loan that is agreed. But this does not fully describe the model or its potential hazards.

The "originate-to-distribute" model may have that basic feature but the point is that it's driven by a market for secondary instruments (bonds and other derivatives) that are based on underlying loan contracts, where demand in that secondary market has outpaced the supply of loans. In that case, loans may start to be originated solely to support the secondary market. This transpired in the context of the sub-prime mortgage crisis, where investment banks arranged bond issues in a way that effectively concealed the poor quality of underlying loans. From their own problems with undertaking due diligence, they knew that the underlying loan data was hard to find and in many cases unreliable (hence the related 'fraudclosure' issue of investors foreclosing on mortgages they could not prove they owned). That's why the banks involved have since been paid billions in fines and compensation towards the repayment of bailouts (at least in the US).

But, as the name suggests, P2P lending - at least in the UK - involves a direct loan between each lender and borrower on the same platform, where the data concerning the loans is available to the participants, including lenders who may receive assignments of loans already made on the same platform. The visibility of the loan performance data and reputational impact for the platform operator if all goes wrong limits the temptation to conceal the original credit quality or performance of the loan.

So, BIS's assertion that P2P lending represents the same model or suffers from the same potential for moral hazard is not right.

It is possible for a lender to ask a P2P platform to provide it with access to some less creditworthy borrowers to achieve a higher overall yield, perhaps even with a view to selling the resulting loans to other lenders or even securitising them; but even if you deem that to be 'originate-to-distribute', the 'moral hazard' is not there because the data is readily available for all to understand the lesser quality or performance of the loan.

The BIS report cites the Lending Club 'scandal' in 2016. But, ironically, Lending Club is not based on a genuine P2P lending model at all, because the SEC refused to allow direct 'peer-to-peer' loans without full security registration requirements (just ask Prosper!). So the regulators forced the US platforms to operate the same securitisation model that the banks pioneered in the sub-prime crisis... We abandoned attempts to launch the direct P2P model in the US because this model is nothing new - as well as being cumbersome, convoluted and expensive. But even there the relevant 'scandal' was 'only' that when selecting a portfolio of loans to issue bonds to the relevant investor, Prosper selected some loans that did not meet the investor's specified criteria. Not great where the data is available, but the point was that the problem was spotted quite quickly because the relevant data was readily available, so the loans could be re-purchased by the issuer.  

The report also cites the problems at Trustbuddy, in Sweden, but the problems there were again detected early by new management looking at the collections data, who promptly alerted the authorities; and Ezubao, in China, which was a ponzi scheme operated between July 2014 and December 2015 that was detected quite quickly - certainly faster than Madoff's activities in the supposedly heavily regulated US investment markets.

It is worth acknowledging, however, that there is always scope for something to go wrong. This is why the UK P2P lending industry pushed for specific regulation of P2P lending from 2011; and highlights why regulators should stop their hand-wringing about innovation and get on with the job of adapting to change.

Consultation on Transposing PSD2 In the UK and Loads Of Other Stuff

Just when you thought it was safe to go on holiday, the Treasury let's slip that it will begin a 6 week consultation on transposing PSD2 in August, which is a bizarrely short time frame and awkward time of year, given the issues and scale of uncertainty involved.  

Kind of makes it tough to engage with clients, and for clients to engage the right management and staff internally.

Maybe that's the point?

Meanwhile:

• the FCA has just called for input on crowdfunding proposals; 

• the FCA also chose August to publish its final policy statement on the Payment Accounts Regulations; and

• the CMA is about to publish its final report into competition in retail banking.

At this rate, we'll have between Christmas and New Year to consider the regulatory implications of Brexit.

FCA Calls For Input On #P2Plending and #CrowdInvestment Rules

It's been two years since the FCA created specific rules governing peer-to-peer lending and crowd-investment in securities, and the FCA promised a review of those rules in 2016. That review has just begun with a call for input closing on 8 September. 

This comes at an important time for the industry, as the FCA's report reveals that it has only processed 9 of 97 applications for authorisation by P2P lending platforms (44 of which operate under a two year old interim permission) and only 9 firms have been authorised to join the 25 firms that were operating in the crowd-investment market during the FCA's interim review in 2015. This shows that the FCA authorisation process, and regulation itself, are significant 'choke points' in the development of innovative financial services, notwithstanding firm support for the sector from the Treasury and strong growth in supply and demand from consumers and small businesses on existing platforms. 

It remains to be seen whether the FCA will further complicate life for crowdfunding entrepreneurs and their customers or clear the regulatory path to facilitate the growth of alternatives to the declining supply of bank finance, likely to worsen post-Brexit...

Humans At The Heart of FinTech

My article on this theme has been published by the Society of Computers and Law in connection with the IFCLA conference, where I participated on a panel discussing disruptive technology in financial services. 

It is interesting to see how people's belief in the 'efficient market' and appeals to the authorities for help when things get out of hand is playing out in the context of the Ethereum project and the DAO!

RegTech Bottleneck?

The UK's Financial Conduct Authority is rightly proud of its Innovation Hub, Regulatory Sandbox and new "RegTech" approach, which includes "managing regulatory requirements more efficiently, and... how we can best support developments and potentially adopt some RegTech solutions ourselves."

But the figures suggest that either more resources are required or there has to be a quicker route to market for new firms.

Of 413 requests received as at February, about 215 firms (52%) obtained support from the FCA's Innovation Hub. But only 39 firms (18%) have either been authorised (18) or are going through the approval process (21).  And in a recent statement defending its record on processing applications for authorisation by P2P lending platforms, the FCA said that it has only processed 8 of 94 applications received (about 9%).

Something is gumming up the works!

In its statement on the P2P lending process, the FCA bravely claims that it is "taking a proportionate approach to regulation, recognising the need for consumers to be adequately protected and have the information they need". It has a deadline of 12 months to decide on applications (actually 6 months for complete applications). But it's not like these firms are trying to flout the law - they have willingly approached the FCA for approval. Indeed, the P2P lending industry spent years lobbying for regulation of the sector, which was introduced by the Treasury in early 2013 and took effect on 1 April 2014. Yet since then the FCA's figures suggest that over 40 new firms have applied to enter the market and 42 of them are unable to trade because their application to do so is yet to be approved. Another 44 firms are still relying on their interim permission by virtue of being licensed under the previous regulatory regime, and therefore (ironically) cannot offer the new Innovative Finance ISA because they are not yet fully authorised.

How many firms are able to persist against these regulatory headwinds remains to be seen, but the approach seems neither proportionate nor worthy of the FCA's ambition to foster innovation and competition for the benefit of consumers. So far, the traditional players remain pretty safely sheltered behind the FCA's regulatory wall.

Something must be done.

Either the FCA needs more resources or it must adopt a more expeditious approach to granting regulatory approval - a mechanism that allows firms to begin trading more quickly under certain thresholds, for example, as is the case with small payment institutions and small e-money institutions. Indeed, payment services firms enjoy their own regulatory regime (with a 3 month turnaround time for complete applications); and the P2P industry lobbied for that regime to be used as the basis for regulating their platforms - an approach which the French and Spanish have since adopted and the European Banking Authority supports.

Recent Changes to FCA Rules for P2P Lending Platforms

The FCA has announced some changes to rules on P2P lending (explained amongst other non-P2P changes here). Feedback on the prior consultation papers and final rules are here.

You should consult the listed FCA Handbook sections for the detailed changes, but in summary they are designed to: 

• simplify client money requirements for P2P platform operators that hold money in relation to both regulated and unregulated peer-to-peer business which come into force immediately on 21 March, as they are helpful. The rule changes and related guidance are in: 

Glossary; SYSC 4; CASS 7; TP 1, Schs 1 and 2; SUP TP 1 

• support the introduction of the Innovative Finance ISA (IFISA) and new regulated activity of advising on P2P agreements, by clarifying the FCA’s expectations about standards for IFISA disclosures and establishing a regulatory regime for the provision of regulated advice on P2P agreements that reflects the recent changes to the Regulated Activities Order. The rule change come into force on 6 April 2016. The rule changes and related guidance are in: 

Glossary; SYSC 1 and 4; TC 2, App 1.1 and 4.1, TP 8; FEES 4; COBS 2, 4, 6, 9 and 14; CASS 7; SUP 10A, 12, 16, App 3; DISP 2; COLL 6; and PERG 1, 2, 5, 7, 8, 10 and 13

P2P #ISAs: FCA's Approach

Although we are yet to see the legislative changes required to include peer-to-peer loans in the new Innovative Finance ISA from April 2016 and regulate advice on P2P loans, the Financial Conduct Authority has helpfully set out its proposed approach for when the law does change. We have until 31 December to respond. Broadly, the FCA proposes to:

• give guidance on how disclosure rules will apply to including P2P loans in an IFISA - particularly where the P2P platform only has interim permission (pre-April 2016) and risks arising if the firm does not get full authorisation;

• consult on applying suitability rules to advice on P2P loans, including changing the application of the rules and banning the payment or receipt of commission in relation to making P2P loans (note that the regulation of advice generally is being reviewed, so those rules could also change in due course anyway); however, because direct holdings of shares and other investment instruments are not included in the list of products that independent financial advisers must consider when making recommendations, P2P loans will also be excluded from that list; and

• ensure any risks related to IFISA inclusion are disclosed, like whether they can be transferred or sold (the FCA considers P2P loans to be "a much higher-risk alternative to buying an annuity" but doesn't mention the risk compared to buying a Lamborghini other types of investment that also compete with annuities).

The Innovative Finance #ISA

The Treasury has announced the details of its commitment to extend tax-free Individual Savings Accounts (ISAs) to include peer-to-peer loans from 6 April 2016, effectively adding a third basket for your nest eggs. The enabling regulations will be published later this year. In the meantime, the government is also consulting on adding certain 'crowd-investment' instruments to ISAs in due course.

From April 2016, there will be a new "Innovative Finance ISA" in which individual investors will be able to hold P2P loans (formally known as 'article 36H agreements' in article 36H of the FSMA (Regulated Activities) Order 2001, and "P2P agreements" in the FCA's Handbook).

Advisers will be able to advise on P2P loans within the scope of their existing FCA advisory authorisation.

For ease of administration, each P2P lending platform is likely to become the ISA Manager for the Innovative Finance ISA that covers P2P loans agreed on its platform. 

P2P platforms (and other relevant ISA managers) will not be required to enable customers to sell their loans or to move their loans to another platform. But platforms may, if they wish, facilitate the sale of loans on their own secondary markets (as some do already) and enable the transfer of the cash proceeds to another ISA manager - indeed customers must be able to withdraw un-lent cash withdrawn within 30 days. However, it won't be possible for you to transfer only part of the money you subscribed in that tax year.

The different rules for P2P loans mean that they won't qualify for Junior ISAs or Child Trust Funds, which are less flexible than adult ISAs.

EBA Sees #Payments Regulation As Best Model For #P2Plending - Updated

When the UK peer-to-peer lending industry began calling for proportionate regulation in 2011, we pointed to payments regulation as the ideal model. By the end of 2012, about 30 firms from across Europe signed an open letter calling for that approach to the regulation of crowdfunding generally. And that was the thrust of my response to the EC consultation on the topic. After all, these marketplaces are all basically payment platforms that enable the wallet-holders to agree to lend or invest money rather than just pay it. They have far more in common than there are differences.

Unfortunately, the UK authorities were determined to apply the existing investment rules to the P2P model, with consumer credit rules adapted to cover loans to individual borrowers and some small businesses. So instead of a dedicated set of regulations dealing with common operational risks among all platforms, with some extra rules to cover different types of instruments, we ended up with rules sprinkled all over the giant FCA Handbook.

Since then, however, the French have opted to apply payments regulation to P2P lending, and last week the European Banking Authority suggested a similar approach.

Of course, the additional attraction to payments regulation is that it is the subject of a 'maximum harmonisation' directive that allows for passporting throughout the EEA far more easily than under investment regulation.

If I were a betting man, I would put good money on the EBA's approach eventually winning out, with the real battle being fought over whether there should be any restriction on the amount that individuals should be able to lend [see update below]. The UK, France and Spain have each taken different approaches to this question. I'm glad to say that the UK has been the most pragmatic in recognising that platforms will struggle to generate enough liquidity without the possibility for some individual investors to lend significantly more than others to any one borrower, particularly in the SME lending markets. As I mentioned in the context of the recent European crowdfunding conference, my sense is that French and Spanish platform operators will realise this problem as they try to scale...

[updated as follows on 18 March 2015]

The battle over the restrictions around who should lend on P2P lending platforms, and how much, seems to flow from the mistaken belief by some authorities (the EBA included) that 'loans' are somehow 'debt securities'. Ironically, in its discussion of why investor type restrictions might be extended to simple loans, the EBA opinion underscores why that should not be the case - and indeed isn't the case in the UK.

For instance, in summarising the risks to lenders involved in P2P lending, the EBA, states (at para 28) that "the assessment of an investment opportunity requires a profound analysis as well as a thorough understanding of the project or business of a potential borrower." Yet making a loan does not equate to an 'investment' opportunity (and you would have thought that a banking regulator could fully elucidate the difference).

A loan is just a debt - which is a simple enough concept for anyone to grasp. It chiefly involves 'credit risk', not 'investment risk'; unlike bonds, for example, which are typically held for investment purposes rather than simply to earn interest (hence the focus on bond 'yields' rather than the interest rate or 'coupon').

The EBA later refers to the need for "explanations about a project, financing mechanisms and other investor education material", which also seems to misunderstand the straightforward nature of credit. Later still, the EBA states that P2P lending "usually means that lenders enter into loan agreements with a borrower which is, in many cases, a start-up enterprise." But that is certainly not the case in the UK, where such companies typically turn to equity investors who are looking for a share in the growth of a business, rather than simply the repayment of their capital plus interest. A subsequent discussion of "investment advice" and "investment recommendations" also highlights the EBA's mistaken assumptions about the essence of P2P lending. It's almost as if someone simply substituted "loan" for "equity" in a section about equity-based crowdfunding platforms.

This mistaken classification of lending as an investment is doubly ironic, given that the EBA is responsible for policy related to payments, banking, savings and loans and not securities (which is ESMA's territory). In fact, were it not for the EBA's view that payments regulation is the best fit for regulating the common operational risks of P2P lending, I would suspect the it of trying to limit competition with the banking sector by pushing P2P lending into the investment world. Yet, somewhat weirdly, when it comes to the section on credit risk the EBA suggests that platforms might be "required to cooperate with a bank, either in the way that the bank processes the assessments [of creditworthiness] on a professional basis or takes over any credit risk by contracting with each borrower directly." Which also ignores the fact, of course, that banks are busy walking away from the markets now served by the P2P lending platforms!

The EBA is also being somewhat disingenuous in suggesting that P2P lending platforms should carry out criminal records checks on borrowers - an extremely time-consuming, personally intrusive and costly process that not even banks are required to undergo when making loans. Compliance with anti-money laundering regulations, PEP/sanctions screening and membership of industry anti-fraud databases are adequate and proportionate controls for screening borrowers. Likewise, P2P lending platforms do not represent any greater source of risk to a lender's personal data than many other types of business, and data protection law should govern this type of risk, as it already requires appropriate IT and information security controls.

Overall, one is left with a nagging concern that, while it has made the best choice of regulatory frameworks for controlling the common risks associated with P2P lending, the EBA has not really engaged properly with the concept or the sector. Let's hope that changes soon.

#Crowdfunding the EU

Suddenly it's all go on the EU crowdfunding front.

I'm still digesting last week's ESMA opinion on crowd-investing and the advice on how to regulate it, which is to be followed by the European Banking Authority's view on the regulation of P2P lending.

It's too early to expect anything conclusive - both ESMA and the EBA say they are merely supporting the Commission in its broader efforts to embed crowdfunding in a range of policy areas - but it's good to see official recognition of the benefits of crowdfunding, as well as the risks, and some sunlight on the highly technical challenges to accommodating the new business models. Let's hope they consider how any changes will impact customer experience, marketability and the need to scale these platforms quite quickly.

In addition to regulatory reform, it would be great if the EU agenda could evolve to include realigning traditional tax incentives to boost personal investment in new asset classes.

More on the detail soon!

Thoughts On The Growth Of EU #Crowdfunding

I've just spent a fascinating few days at the ECN Crowdfunding convention in Paris this week discussing the development of crowdfunding across the EU. The main focus was on regulation, since that is perceived as being the key difference from country to country. But of course there are other factors involved and these were also covered in the presentations. In particular, crowdfunding is a huge marketing challenge, given the vast advertising budgets of mainstream financial services providers and customer inertia. There are also many perverse incentives and implicit subsidies favouring the traditional financial models. I helped explain such problems in a recent submission The Finance Innovation Lab to the Competition and Markets Authority on retail/SME banking, for example.

A European twist on the scale and nature of the competitive problems was emphasised by an early presentation from our hosts, BpiFrance, a state financial institution targeting traditional funding at SMEs. It has 2000 staff in 37 offices and arranged funding of €10bn for 3500 French SMEs in 2012 alone. So not only do French crowdfunding platforms face a banking monopoly, but they must also compete against direct public programmes. With that kind of competition, it's little wonder the French crowdfunding market is only a twentieth the size of the UK! Thankfully, Bpi appears to have switched to supporting the development of many new private platforms, rather than trying fund plug the French SME funding gap all by itself - rather like the strategy adopted by the British Business Bank.

Of course, the SME funding gap is not exclusive to France. Christian Katz, CEO of SIX, the Swiss stock exchange, explained that the EU's 23 million companies face a funding gap of 2 trillion over the next 5 years. Yet only 11500 have access to the public markets. Currently, SMEs are creating 1 job for every 5 that big companies are eliminating. In other words, the companies that create the jobs are starved of access to working capital.

This kind of problem is not simply financial, and Joachim Schwerin, Policy Officer, DG Industry & Enterprise gave an excellent presentation on Friday explained how Crowdfunding features in five of the EC's key policies for stimulating economic growth:

• Improving access to finance, especially for SMEs;
• Financing projects that have found it hard to obtain traditional finance
• Boosting the digital economy
• Increasing the level of entrepreneurship, which is completely lacking in many EU countries; and
• Enhancing democracy, by enabling people to mobilise their savings to produce financial returns, rather than always having to trust their funds to banks and other traditional intermediaries that may not actually have their interests at heart.

Joachim outlined plans for extensive guidance to SMEs on types of crowdfunding via the EC's "Access to finance for SMEs" portal, highlighting the opportunities for SMEs rather than just focusing on the risks to investors. So watch that space during early 2015.

Many delegates were pressing Joachim to outline an EU regulatory timetable, but he was right to point out that this is premature. He confirmed that the EC is still in listening mode, which is as refreshing to hear now as it was in October. Regulation does not create markets, as the EC has discovered in its regulation of consumer credit and contract law. Indeed, it is plain from the recent French law and German proposals that regulating without an understanding of the market could kill them altogether.

For instance, the French authorities have limited participation in P2P lending to individuals who may only lend up to €1,000 per project/borrower. The authorities say this is necessary to ensure that lenders diversify the total amount they lend. This seems harmless enough until you realise the marketing challenge faced by someone starting a brand new P2P platform who cannot rely on a few large lenders to fund the bulk of early loans, or to step in where liquidity is scarce from time to time. Yet in more developed markets there is no evidence that lenders fail to diversify. In the latest UK market study Nesta has found that 88% of lenders say they engage in P2P business lending because they think diversification is important, which is supported by the figures:

"The average P2P business lending loan size is £73,222 and it takes approximately 796 transactions from individual lenders to the business borrower to fund a listed loan, with the average loan being just £91.95. P2P business lenders have, on average, a sizeable lending portfolio of £8,137 spread over a median of 52 business loans."

As a result, project-by-project caps are not a feature of the regulation of P2P lending in the UK, nor the rules allowing wider retail participation in crowd-investment. These regulations only took effect in April 2014, well after these markets were firmly established, well understood, and were able to benefit from the credibility that proportionate regulation can bring without being strangled by red tape.

Finally, it was interesting to hear Christian Katz's recommendations to help ensure the success of crowdfunding in the EU, based on how stock exchanges have developed:

• Clear, common terminology;
• Code of conduct - especially promoting transparency - e.g. disclose the details underpinning credit ratings;
• Platform stability/availability;
• Fund recovery - safeguarding customer funds and how to get money out;
• Cross-border - don't ignore potential that the Internet brings;
• Positioning crowdfunding - e.g. as a source of pre-IPO funding (under €5m).

Each of these points merits a post in its own right, but an EU code of conduct would seem to be a good way to focus market participants on achieving them. The team at ECN presented some early thoughts. Clearly the code will need to be consistent with applicable national laws and accommodate all the different types of crowdfunding. It should also be negotiated by the CEOs of platforms, as they understand the development plans for their own businesses better than the lawyers and the policy staff. Such codes have already been agreed by the leading participants in more developed markets. For example, the Peer-2-Peer Finance Association (P2PFA) has developed Operating Principles specific to P2P lending, and the UK CrowdFunding Association (UKCFA) has produced its own code of practice to accommodate donation-based and investment-based crowdfunding.

While it is possible that specific enabling regulation may be necessary in some countries to initiate the ability to establish dedicated crowdfunding platforms (e.g. allowing normal loans to be concluded on such platforms, rather than only participation loans, or lifting the €100,000 limit on equity crowd-investment in Germany, for example), the EC's approach of allowing platforms to develop in line with self-regulation seems the wiser than rushing to regulate in detail.

Adding Peer-to-Peer Loans To #ISAs

The Treasury is consulting on how to implement the government's decision to allow us all to hold peer-to-peer loans within our Individual Savings Accounts (ISAs). This is revolutionary because it increases the range of assets that can be held in ISAs - increasing diversification and therefore the value of the ISA portfolio - and significantly improves the visibility of where your investment money ends up (as I've argued for some time). Adding P2P loans will also change the way ISAs and ISA managers operate, which raises the various questions that the Treasury is consulting on (set out below). This post explains the difference between P2P lending and investing in funds typically held in stocks and shares ISAs, and addresses the main issues outlined by the Treasury.

What are peer-to-peer loans?

Peer-to-peer (or 'P2P') loans are just simple loans agreed directly between lender and borrower. There is no bank or fund manager in the middle, and the operator of the platform on which the loans are agreed is not a party to the loans.

How is P2P lending different to investing in funds?

Perhaps the best way to understand the difference is by starting with the role of the fund manager as opposed to the P2P platform operator. In simple terms, a fund manager collects money paid by investors in return for 'units' in the fund, and then controls the investment of that money in its own name (or that of the fund entity) - so the manager controls the management of the money or other assets in the fund, not the investors,.

However, the operator of a P2P lending platform enables many lenders to lend small amounts of money directly to many different borrowers, and then simply administers the individual loan contracts in accordance with their terms.  So the lenders on a P2P platform, rather than the platform operator, keep control over the management of their money and loan contracts. This is a key reason why P2P loans are a fundamentally different asset class to units in investment funds.

What does this mean for ISA managers?

These differences present a challenge for today's ISA managers - whose job it is to enable you to invest using your annual ISA limits, and keep track of those for HMRC.

Currently, when you buy units in an investment fund through an ISA manager, the manager adds your order to many other orders that it receives and then buys the total number of units in the investment fund in its own name. Each unit is standardised with the same price/value and issued by the same entity. The manager then records how many units it bought on your behalf in its own systems. You have no direct contract or any other link with the investment fund at all.

But on a P2P platform, you agree many small loans directly with lots of other people for the purposes specified, and different platforms tend to specialise in different types of loans (personal loans, working capital for small businesses, commercial property etc). Everyone's holding is different, even though some lenders end up lending to the same borrower. You also directly agree the platform's fee, if any, which may be waived in some cases (sometimes the borrower pays the fees, for tax reasons, leaving the lender with just the net income).

So existing ISA managers will probably need to make systems changes to enable it to track your own unique holdings of P2P loans in your ISA, and it seems likely they'll want to see a lot of demand before they do so. Accordingly, to meet demand for P2P loans in ISAs it's likely that the operators of P2P lending platforms will become ISA managers in their own right.

What does this mean for ISA rules?

You will probably be able to withdraw P2P loans from ISAs without having to sell them and take the cash.

ISA assets can typically be transferred between ISA managers, but that isn't practicable between different P2P platforms, so it's likely that any transfer would only work by selling the loans and transferring the cash directly to the other ISA manager. However, the Treasury is not sure whether to require this, as it could discriminate against platforms that do not have ready secondary markets for the loans agreed on their platforms. Another reason not to insist on transferability is that even if there were a secondary market, there could be a delay in finding a buyer for the loans, as opposed to just waiting for them to be repaid; and a 'forced' sale could mean a low market price, even from a market-maker or underwriter.

The Treasury is also interested in arrangements for continuing to manage P2P loans in ISAs in the event that the P2P platform operator ceases to qualify as an ISA manager, similar to the FCA requirements for administration of loans in the event that the operator ceases to trade.

The Treasury is still not sure whether to allow P2P loans to be kept in their own ISA or in a stocks and shares ISA. However, assuming P2P platforms are likely to need to become ISA managers in their own right, it would seem unduly onerous to make them apply for the extra FCA permissions required to offer other investments available through stocks/shares ISAs. So I'd suggest that there will need to be a third 'P2P loans ISA', or at least the ability for platform operators to offer a stocks/shares ISA that is limited only to holding P2P loans.

The Treasury expresses some concern that P2P lending on behalf of children through Child Trusts Funds (CTFs) or Junior ISAs could mean that the parent or guardian and not the child will be the one who understands the business activity or loan purpose of the business/personal borrower. But this is no worse than investing in a managed fund where you don't know the precise mix of the constituent stocks/shares or even the actual issuers and therefore their businesses or use of proceeds.

Finally, the Treasury believes that title to P2P loans made via CTFs and Junior ISAs would need to be held by the ISA manager or some third party, as loans made by minors are not enforceable (as a matter of contract law).

Those Treasury questions in full:

1. In relation to the proposals generally, what necessary set-up costs (one-off costs) would be necessary for your business to arrange peer-to-peer loans meeting the proposed eligibility requirements for ISAs? What would be the estimated ongoing annual costs of doing so?
2. Do respondents agree that the government’s proposed approach provides sufficient clarity as to which peer-to-peer loans will be eligible for ISA inclusion?
3. Do respondents agree that the proposed regulatory requirements strike the correct balance between investor protection and a proportionate regulatory regime?
4. Are existing ISA managers considering offering peer-to-peer loans alongside other ISA eligible investments? What factors may affect this decision?
5. Are firms operating peer-to-peer platforms considering seeking authorisation to act as ISA managers if the government permits this? What factors may affect this decision?
6. Do respondents have any concerns regarding FCA-authorised firms operating peer-to-peer platforms being allowed to act as ISA managers? If so, what are they?
7. Do respondents see any risks arising from firms operating peer-to-peer platforms approved as ISA managers not being required to have legal ownership of peer-to-peer loans held within ISAs?
8. Are there any drawbacks to the proposed withdrawal procedure for peer-to-peer loans? If so, what are they?
9. If the transfer requirement is applied to peer-to-peer loans – do respondents foresee any risks or detriment for consumers resulting from the proposed modification of the current ISA requirements? If so, what are these?
10. Following the sale of the peer-to-peer loan and transfer instructions from the investor, what would be the most appropriate time period within which the cash realised should be transferred?
11. Is the proposed modification to transfer requirements t likely to present any difficulties or administrative obstacles for ISA managers (including those receiving transfers)? If so, what are these?
12. What are respondents’ views on requiring the existence of a secondary market in order for a peer-to-peer loan to qualify for ISA eligibility? Would such a requirement provide a useful degree of reassurance to investors?
13. Would a requirement to offer a secondary market pose any problems or difficulties for peer-to-peer platforms and if so, what are these? Could secondary market arrangements of this type be easily defined?
14. Do respondents think that a guarantee of a sale at market value within a given period would be desirable in addition to the proposed requirement of a secondary market?
15. Is there merit for investors in requiring that there must be a mechanism by which loans can be sold at market value within a given period? What period should this be, taking account of the times taken at present to achieve sales on existing secondary markets?
16. Are there other ways in which to facilitate transferability, besides those described above? If so, how might these work?
17. Overall, do respondents feel that the benefits to investors from applying transfer requirements to peer-to-peer loans held in ISAs outweigh the possible risks of doing so?
18. Do respondents have suggestions as to how loans held within ISAs could continue to be managed by an ISA manager in cases where either a firm operating a peer-to-peer platform collapses and they were acting as ISA manager, or where such a firm becomes ineligible to act as an ISA manager following removal of its FCA permissions?
19. How important is it that investors should be able to mix peer-to-peer loans with other eligible investments within their ISA in a single tax year? Do respondents believe most investors wishing to place peer-to-peer loans into an ISA account will additionally want to invest in other types of non-cash ISA investments within the same tax year?
20. Would a third ISA type be helpful in alerting investors to the different rules which will apply to peer-to-peer loans within ISAs? Overall, would a third ISA type aimed specifically at alternative finance products such as peer-to-peer loans be a good thing – and if so, why?
21. What potential difficulties or challenges might the creation of a third ISA type present for savers, investors, ISA managers or others?
22. If the government decides not to introduce a third ISA type, how can we best ensure that customers are clear about the special characteristics associated with peer-to-peer loans, for example that they are not covered by the FSCS, and that they may be difficult to liquidate?
23. Do respondents have any concerns about offering a tax advantage where loans made by or on behalf of children might be made without knowledge of the intended recipient(s) or usage of the loaned funds? If so, what are they?
24. Do respondents agree that if peer-to-peer loans are made eligible for CTFs and Junior ISAs, these loans should be in the legal ownership of the ISA manager? If not – what alternative approach might be considered?

Developing EU Policy On #Crowdfunding

I've finally had a chance to catch up with the minutes of the initial meeting of the EC's "European Crowdfunding Stakeholders Forum" (ECSF) in late September. Clearly these are still early days and the Commission is rightly (and rather atypically!) waiting to see how the various types of crowdfunding develop at national level, rather than rushing to regulate.

Unfortunately, it seems there was no time to take account of the UK regulations on P2P lending and crowd-investment, which took effect on 1 April 2014. These are cited in either the European Banking Authority's submission to last December's EU crowdfunding consultation, or the AK Wien high level review of various platforms.

That's a pity, since the UK regulation addresses all the various issues raised in those reports relation to peer-to-peer lending and crowd-investment.

It's interesting that the AK Wien report calls for rewards/donation-based crowdfunding to be regulated like in similar fashion, the UK declined to include that activity - and even the US has excluded donation-based funding from the otherwise all-embracing US securities framework. Perhaps AK's concern is that Europeans won't even start rewards/donation platforms without explicit permission to do so. That would be consistent with the civil law expectation that governments should specify which activities are lawful, rather than the common law view that the law should follow commerce where necessary to resolve issues that arise. But, unfortunately, that's no way to foster the growth of a nascent industry, as the Commission has recognised in its subtle approach to this area so far.

It's encouraging, however, that both the Commission and the ECSF seem to be taking a holistic approach to crowdfunding generally. That also reflects the Commission's approach to regulating payment services, on which the UK industries' self regulatory approach to crowdfunding has been based. At least that may produce a more unified set of rules, rather than the FCA's multiple rule books governing the same operational risks at the platform level. Perhaps a more unified approach will emerge from the FCA's review of the effectiveness of its rules in 2016.

In the meantime, the ECSF should also consider whether there are any tax incentives for personal investors that may be impacting the growth of alternative financial services. Again, the UK policy work in this area should be instructive, as discussed in the Treasury's consultation on proposals for including P2P loans in Individual Savings Account 'wrappers'.

Timetable And Forms For Full Authorisation - #ConsumerCredit #P2PLending

The FCA has published the application 'windows' during which various types of consumer credit and P2P lending firms can apply for full authorisation. 

The dates are in Table on page 9. They vary by type of firm and may also vary by region for some types.

The FCA will write to all firms with interim permission by 1 May 2014 to confirm their application period. You should contact the FCA if you have not heard by 15 May 2014. In the meantime, you should register for an online account with the FCA.

In my experience it takes at least 3 months to prepare an application for authorisation, as there is a lot of information to gather and/or summarise at the same time as running a business. The FCA has published an authorisation application checklist, some sample forms and guidance on the supporting documentation required. Note that if you a P2P lending platform or your are offering high cost short term credit (payday loans) or a credit reference service, you will also need to complete a detailed description of your IT controls, which you can download here. There are a few FAQs here. 

Top tip: make your application for authorisation a proper project and start the process of completing all forms and supporting documents on Day One - especially the application form, regulatory business plan and IT controls forms. Complete the forms in parallel, not one after another, as you may be waiting 3 months before each form is complete. I recommend nominating one person to oversee completion of the application documents and a separate person to gather and provide data.

Please note that the FCA has also published the relevant information sheets that must be sent to a consumer with any notice that they are in arrears or default (under section 86A of the Consumer Credit Act 1974).