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Regulation catch up: Crowdfunding and peer-to-peer

by Eamonn McMahon

Moaning, groaning and howling; could be the grounds of any English football team but instead it’s a conference of small business bankers. The level of discontent is rattling the rows of polished glasses. A rather plump, red-faced executive picks away at his smoked fish while plucking the feathers of the unwanted seabirds who have recently taken residence. Dismissing the now two year old UK regulation of p2p lenders he grunts at recent efforts by the FCA: “Too soft on the techies!” He seems to find a quorum with a younger colleague arriving and exclaiming  “they should stop kicking the wheel out of shape and start cleaning the road of s***! ”

Hardly surprising but still painfully disingenuous. Could as well be a French trade union spilling perfectly fine milk into the river.

The fact is the FCA here in the UK and the French duo of Autorité des Marchés Financiers (AMF) &  ACPR have both made significant strides in optimising (and clarifying along the way!) the regulatory framework for P2P and loan-based Crowdfunding. BaFin, the German regulator, remains staunchly inflexible towards P2P with platforms receiving the full supervisory approach and are consequently coerced into cooperation with established banks.

The iron trilogy of European financial regulation is broadly doing well across fintech but yes, more work to do. Increased competition for traditional asset finance players is a necessary change, particularly in the SME arena where small businesses have had a raw deal for far too long.

As we know the FCA announced a probe into P2P/crowdfunding back in July on the back of increasing criticism of maturity mis-match and associated potential liquidity issues. The concerns were broadly correct in principle but were presented with unnecessary alarm. Key public figures such as the clearly opportunistic Lord Turner and Andrew Tyrie (chairman of the parliamentary treasury committee) sent ripples through the media with excessive scaremongering.

On the back of this review it looks like P2P and crowdfunding will face a testy new-year fitness regime. Last week saw the FCA released their interim report reviewing feedback on regulation for crowdfunding and P2P.

Broadly speaking, the tone was one of mild anxiety and the underlying message, while not unsettling, was that there would be increased scrutiny of developing structural risks. Specifically the FCA were concerned with:

1.     P2P and crowdfunding platforms have grown in complexity and their business models appear to now look “similar in substance to other, existing regulated activities but without being subject to the same regulatory requirements or offering the same consumer protections”. Or in other words: a slippage towards potential regulatory arbitrage. When the FCA lifted the castle drawbridge in 2014 and regulated the sector, platforms offered simplicity (and in turn, low systematic risk) with substantial cost savings for the real economy. This was in a world where excessive complex structuring within banking had created a liquidity black-hole that ultimately required public sector intervention. Hence we can hardly be surprised with a slightly dishevelled gatekeeper as platforms creep away from facilitating simple bilateral financing into a world of auto-reinvestment to 2nd line development and bridging loans.

2.     Secondly, in keeping with good Victorian egalitarian principles, the FCA are correctly in my view, nervous of institutional funding taking precedence over retail money. Regarding the pooling of retail money alongside institutional money, the organisation stated “it is unlikely to be possible to employ such arrangements and treat customers fairly.” And that they “will consider further intervention if we find that current business practice is creating a significant risk of consumer detriment”. While any ethical participant in the industry would of course agree that retail lenders should not be unknowingly disadvantaged or exploited unfairly, most would generally agree that institutions, by offering economy of scale and ‘platform-critical’ funding, hold fair claim to somewhat a enhanced deal. The answer is surely moderation in enhancement of terms with full disclosure to all investors of the different ‘tiers’.

3.     Thirdly the FCA are uncomfortable to a degree with the naivety of the ‘Regular Joe’ investor particularly given the unveiling of the Innovative ISA wrapper. It’s as clear as bad British weather that knowledge and ability to fully appreciate the risk profiles of the various asset classes (SME secured vs unsecured.. commercial property vs BTL property..etc etc) are lacking. Furthermore the fact little regard is given to liquidity is an issue.

4.     Furthermore, the FCA aren’t pleased with survivorship planning that some platforms are lacking, increased commercial pressures to originate at the expense of credit strength, poor debt recovery systems and youthful ignorance of risk management.

5.      Some of the FCA’s most pointed criticism was aimed at the presentation of risk and return profiles to investors where they specifically alluded to loan-based crowdfunding being marketed as a ‘savings’ product.

The FCA are clearly determined to push as hard as possible for best practice and thankfully in keeping with their historic approach they are doing this with full transparency and with demonstrated objectivity. Of course for the some of the largest platforms such as Rate Setter, Zopa and Funding Circle delays to gaining their full approval are frustrating ( Not that Funding Circle are having any issues raising equity capital from ‘A’ listed investors such as Singaporean sovereign wealth fund and Ballie Gifford, a well-respected “real -money” asset manager with more 100 years of history )

Across the water in France both the ACPR (who look after credit institutions) and the AFM continue to take an approach centred on proportionality. Where a payments platform is niche and based on nominal amounts the regulatory burden will be less. Franck Guiader of the AMF has in recent months pushed harder for crowdfunding regulations as their presence in France becomes more substantial. A fintech forum involving all parties that started earlier this year has been well received so far and the ACPR will continue to push this forward

So in the end what do we have… ? a good portion of traditional finance providers who ought to get a grip and swap the brandy for breakfast juice. Regulators who are increasingly moving fast and in fairness, aiming for a sensible balance of protection with flexibility for innovation. And finally platforms that who while justifiably exhausted with regulation should take breath and remember everything achieved so far in such short time. Just like the early days of football there will be horribly poor ball skills and all sorts of chancers twisting the rules. Lets just focus on the ball as Jack Charlton would say.

The original football rulebook.  No room for slippery players exploiting the grey area !