A new regulatory regime for peer-to-peer lending

In June, the FCA published its policy statement on crowdfunding platforms (PS19/14). PS19/14 contains two new sets of rules which apply to: (i) loan-based (P2P); and (ii) investment-based crowdfunding platforms.

Prior to this, P2P and investment-based crowdfunding platforms were already subject to the FCA's High Level Standards, such as the Principles for Business. However, as the evolution of the two types of investment has differed, so has the regulation around them. Investment-based crowdfunding platforms were already subject to detailed regulatory obligations. The changes introduced by the new rules extend the application of the marketing restrictions which applied to investment-based crowdfunding platforms to the P2P sector, bringing standards around disclosure and provision of information in line. This addresses some of the complexities of the P2P sector, and brings the regulatory regime more in line with that of investment-based crowdfunding. With the creation of two distinct regimes, the FCA has taken a different approach to the one contemplated by the European Commission's proposal on crowdfunding, which proposes a single regulatory framework. This blog post focuses on the most significant of the new rules for P2P platforms.

The majority of these rules will come into force around the same time that the Senior Managers and Certification Regime (SM&CR) will apply to solo-regulated firms. Therefore, firms will need to grapple with addressing internal practices in order to comply with both.

Marketing restrictions and appropriateness assessments

The FCA has decided to limit P2P platforms' ability to market to certain investors. Significantly, P2P platforms that communicate direct offer financial promotions will be restricted to communicating only with retail investors who have certified that they will not invest more than 10% of their investible portfolio in P2P agreements (unless they are certified as a sophisticated investor or as high net worth). The 10% cap is aligned with the current restriction in respect of non-readily realisable securities (NRRS). The introduction of this 10% cap could have significant impact on businesses whose platform focuses on retail investors. Therefore, P2P firms will need to consider how to implement these changes and monitor ongoing compliance with the 10% cap while not appearing off-putting to investors.

Risk management

The new rules require appropriate arrangements to be in place for the effective setting of the price of the P2P agreement. The rules are focused around structuring the relationship with the borrower in accordance with an assessment of their credit risk. The move away from relying on investors to make this assessment themselves will increase the responsibility and potential liability of the platforms.

Governance

In addition to the governance arrangements already required, firms will need to put in place adequate risk management policies. Firms will also be required to have independent functions in the following areas: (i) risk management; (ii) internal audit; and (iii) compliance, where it is proportionate to do so based on the nature of the business, its scale and complexity. Where independent risk management and internal audit functions are appropriate, individual responsibility for these must be assigned at a senior level, which presents an opportunity for firms to consider the new rules alongside their preparations for implementing the SM&CR.

Firms will be expected to apply their judgement as to whether these requirements apply to them. It will be worth firms documenting their assessments of above in case of a challenge from the regulator regarding compliance, as well as reviewing their approaches to assessment and compliance as the platform grows.

Wind-down arrangements

The FCA has clarified the rules in relation to wind-down of P2P platforms following Lendy's high-profile collapse, introducing changes on the basis that a disorderly wind-down could cause considerable harm to investors. This includes an obligation to notify lenders. The aim of this is to ensure that, in the event that a platform ceases to perform its operations, agreements they facilitate would have a reasonable likelihood of being managed on an ongoing basis and in accordance with the contract terms. The need to have sufficient funding to cover the cost of administering the wind-down imposes further requirements on these platforms.

A 'Dear CEO' letter from the FCA in March of this year identified certain areas requiring urgent attention to mitigate some below par standards the FCA recently observed. This requires platforms to review whether a firm's wind-down plans are adequate and effective; that they are suitably developed and reviewed; and to ensure that a platform would know when to invoke their wind-down plan. It also includes other considerations on wind-down such as tax status, arrangements for client money and IT system continuity.

The FCA's particular focus on this area will exacerbate the pressure on firms to ensure they are implementing the guidelines effectively.

Disclosure requirements

The FCA is also imposing detailed disclosure requirements to ensure investors have the necessary information to enable them to make informed decisions. Firms will need to change current practices to ensure that they provide investors with the correct information at the pre-investment stage, at the outset of the arrangement and on an ongoing basis. The disclosure requirements focus on providing information on:

• The role of the platform, for example by providing a description of how loan risk is assessed;
• Details of the platform's wind-down arrangements, making it clear that in the event of a platform's failure, the P2P agreements may cease to be managed and administered; and
• Investment information, including more transparent information on the platform's fees for services provided.

The ongoing disclosure requirements in particular are likely to prove burdensome for firms.

Conclusion

P2P platforms have until 9 December 2019 to comply with the changes that the FCA has introduced. In issuing the policy statement, the FCA is aiming to address areas of poor practice by establishing additional measures to protect consumers, whilst allowing the P2P sector to grow without stifling competition. Of the changes to come into force, it seems the most difficulty may arise from the enforcement of the 10% cap on retail investors' investible portfolio. For example, firms will need to think about their assessment of how investors declare assets.

The FCA has aligned the deadline for compliance with the introduction of the new SM&CR rules, and firms will be expected to use their judgement regarding whether new requirements apply to them. The introduction of these changes in conjunction with the new SM&CR rules could place substantial pressure on firms. However, firms could use this as an opportunity to address many of their relevant practices, and where applicable, ensure compliance with both sets of new requirements at once.