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.

FCA Spotlight On How Consumers Deal With Money

Source: Audio Visual Excellence

Consumer Spotlight is the FCA’s view on how UK consumers deal with money and financial services, including the capabilities and potential vulnerabilities. It describes ten consumer segments, and reveals the data the model is built on.

The tool is intended to help the FCA identify the risks consumers face, and the protection required.

Charts show how each segment responded to questions in a survey of over 4000 consumers. Filters reveal characteristics, attitudes and behaviours associated with different group of consumers (e.g. inertia, risk appetite and impulsiveness). This can help firms design products and communications that "work well for different, specific consumers."

The FCA's model is said to differ from firm's models because it incorporates "some data not commonly collected in commercial models, such as vulnerability characteristics and financial capability." However, I wonder if another difference is that some firms treat evidence of vulnerability and financial capability as a reason to target a segment, rather than avoid it...

While firms would be wise to at least consider the data when designing products and communications, the FCA warns that:

"The data is based on consumer recall and self-reported behaviour and attitudes; it is not validated against other sources. Consumers may not know the answers to questions. Other industry data may be gathered in different ways or for different purposes, making direct comparisons difficult... Although it may inform a firm's thinking and planning, the model is not designed for commercial development. We do not intend to enable firms to profile their own customer base using the model for their own commercial benefit."

Changes to #MIF Regulation

Worth noting that the text of the Merchant Interchange Fees Regulation dated 16 January 2015 differs substantively from the version published on 31 October 2014 and considered by MEPs on 17 December. Troubling that no mark-up has been provided. However, I have done the work and updated my previous summary accordingly.

MEPs Agree To Cap Card Fees (#MIFs)

Based on the recent deal amongst MEPs, it looks like the Merchant Interchange Fees (MIF) Regulation will sail through the EU Parliamentary process in early 2015.

#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.

Lack of Transparency In Negotiation Of #PSD2

I don't think the Beurocrats are terribly concerned by rampant Euroscepticism pervading national electorates. The byzantine EU legislative process trundles on as secretively as ever. All the nonsense about immigration is a nice distraction from lack of transparency on more fundamental issues.

The latest attempt at a fait accompli is the revised proposal for a new Payment Services Directive (PSD2), which is designed to shape the EU's payment systems for the decade to come. Having published several drafts previously with some attempt to mark-up the changes from previous meetings of member state representatives, a rapid-fire draft (dated 21 November) was suddenly published on 24 November, the same day it was due to be debated.

Today, as a result of the 24 November negotiations, a further draft (dated 1 December) was published without any changes marked, along with a recommendation that it be used as the basis for negotiations with the EU Parliament. Never mind that alternative service providers and other stakeholders with minimal lobbying power are attempting to understand and warn of the impact of seismic changes to the payments regulatory framework.

This is no way to approach the regulation of the EU financial system - if you have any interest at all in bringing the market along with you. But it's a perfect way to leave control of the market to the major banks and card schemes who have lobbyists plugged into the process.

Rant ends. I'll be trying to update my article on the changes to the proposals in the coming week.

Though it's hard to see the point.