Financial Conduct Authority takes wind out of peer-to-peer lending’s sails

The City regulator has threatened a tougher approach to lending platforms if the industry does not clean up its act

The withering tone of a recent seven-page letter from the City regulator to bosses of 65 peer-to-peer lending platforms may have come as a shock to some of them.

Until relatively recently, the entrepreneurs behind the rapid emergence of the industry over the past decade had been used to being praised for bringing much needed competition and additional capital to areas such as small business lending, not to mention offering attractive returns to investors in an era of low interest rates.

Last month’s letter from the Financial Conduct Authority warned of a “strong and rapid” crackdown unless errant platforms cleaned up a litany of poor business practices. Those that are being run responsibly were advised to heed a “significant risk of contagion” if their less conscientious counterparts were not brought to book.

The letter, revealed by The Times, shows regulators are gearing up to take a much tougher approach to the industry, which runs web-based platforms to link retail and institutional investors with consumers, small businesses and property developers who want credit.

It was the latest blow in what has been a miserable year or so for peer-to-peer. The authority appears to have been stirred into action after fierce criticism of its handling of two failed platforms, Lendy and Collateral, which between them have left thousands of investors facing losses worth millions of pounds.

When the authority authorised Lendy in July last year it knew it had serious financial issues, while Collateral managed to give the false impression that it was regulated for two years after an unauthorised manipulation of the regulator’s own public register.

Anger over the Lendy and Collateral insolvencies has coincided with the disastrous flotation of one of the industry’s largest (and more reputable) players, Funding Circle. The small business lender has lost about 80 per cent of its value since it came to market a year ago.

“The flotation was an opportunity for peer-to-peer to show its maturity. It’s gone rather sour,” is how one senior industry figure describes the disappointment at Funding Circle’s rejection by the market.

It may get worse before it gets better. The Times understands that a further peer-to-peer platform is teetering on the brink of insolvency.

About 275,000 people have cash in UK peer-to-peer platforms. According to Brismo, which analyses the industry, more than £22 billion has been lent in the UK alone since peer-to-peer emerged more than a decade ago, and returns to investors have generally been impressive.

So why the downturn in confidence? There are some clues in the FCA’s recent letter, which talks about “rapid changes to business models” and problems in an alarming array of areas, including “disclosure of information to clients, charging structures . . . and record keeping”.

It’s quite the charge sheet for a sector whose raison d’être was simplicity and transparency. The idea was to link investors directly with borrowers on particular loans, in the process cutting out the financial services middlemen. These days that approach represents an increasingly small proportion of peer-to-peer, with investors more commonly obliged to invest into a general pool that is lent to a portfolio of borrowers.

The drift from active towards passive investment was designed to reduce risk for investors but hasn’t always been accompanied by increased transparency. Quite often, the reverse has been the case.

Meaningful comparison between platforms is practically impossible because there is no standard on key metrics such as what constitutes a loan default. Where lending platforms are reluctant to recognise defaults, as many are, published bad debt rates can be misleading.

Dr Roger Gewolb, founder of the loan comparison site, responded to the FCA’s letter by calling on the authority to “inspect these quasi-banks as if they are banks”.

As peer-to-peer becomes more like a marketplace for loans, investors, particularly institutions, will demand consistent standards.

Dr Gewolb told Altfi, a website that reports on the alternative finance industry, that he believes the problem is that “there is no standard, no best practice in this industry, no proper rules laid down by their trade association. This is an unsustainable way to operate and unfair to both borrowers and investors.”

Paul Smee, chairman of the Peer To Peer Finance Association, an industry trade body, says that standardisation will come, but it may take time.

“As the industry matures you will see key metrics becoming standard,” he said. “This is a new, dynamic industry. Market forces will drive it towards common standards, but at the moment the issue is whose metrics we go to. There isn’t consensus.”

Mark Turner, managing director at the regulatory consulting division of Duff & Phelps, says that the regulator finds peer-to-peer tricky to manage, not least because most operators are ambitious owner-managers rather than experienced financiers. “Entrepreneurs often haven’t had experience of dealing with the FCA. The regulator and the platform operators may not always understand each other’s perspectives, creating a communications barrier.”

He describes the cocktail of a fast-growing sector with thousands of retail investors, some of whom will be vulnerable, and the possibility of a downturn in the economy as a “perfect storm for the regulator”.

The failure of London Capital and Finance, which collapsed in January, having taken £237 million from 11,500 ordinary investors who backed its high-risk bonds, suggests that the problem with regulation of the “shadow savings” industry that has emerged in an era of low interest rates is wider than just peer-to-peer.

Indeed, Bruce Davis, of the UK Crowdfunding Association, says: “We have been at pains to point out [to the FCA] that these issues are not isolated to the peer-to-peer and crowdfunding sector, which we feel has been unfairly highlighted.” Tougher rules for peer-to-peer platforms come into force in December, but Mr Davis points out that speedier and more effective enforcement of existing regulations against the likes of Lendy would have reduced harm for investors, and perhaps broader reputational damage to the industry.

Rhydian Lewis says the positive contribution the sector has made to the economy should not be forgotten. Mr Lewis runs Ratesetter, a peer-to-peer platform that appears to be getting back on track after facing strong criticism for its admission in 2017 that it had used its own capital to prevent a default hitting investors. This move undermined the principle in peer-to-peer that investors should be exposed to the underlying risk.

Mr Lewis says that the failures of Lendy and Collateral were embarrassing exceptions rather than harbingers of broader issues. “They do not represent the mainstream industry. It is very frustrating that these outliers have tarnished the perception of our sector.”

He welcomes the prospect of a tougher approach from the FCA, saying that it “will quickly clean up our sector”.

If he is right, perhaps peer-to-peer’s promise of increased competition and transparency may yet be fulfilled, but that goal will have to be achieved in an environment of newfound scepticism.

Assetz Capital faces questions over redress scheme

The City regulator’s warning to peer-to-peer lenders came at an awkward time for Assetz Capital, which has provided about £900 million to businesses.

The company issued a mea culpa to some of its 35,000 or so retail investors around the time the Financial Conduct Authority promised a tougher approach to issues including a lack of clarity in disclosure to investors.

The Manchester-based business said it would “accelerate the return of funds” to investors on a “small group of wind turbine loans” after it “identified issues that we were not happy with”, understood to be a nod to due-diligence failures on a project Assetz lent millions of pounds against that went awry.

The statement said that “excess cash” from its provision fund, set aside to cover defaults for investors, would be used to provide redress to those exposed to the project and it had acted “after consultation with the FCA”.

Assetz said it had made the move in the spirit of transparency, but some investors felt its statement was so badly worded that it was anything but. “I barely understood a word of it,” one investor on an industry forum said. Some praised the company for getting to grips with the issue, but others debated what the statement meant and how it would affect the provision fund.

Assetz said “total provision fund balances” would stay at “the level . . . published on our website as at the end of March 2019, other than some of that balance being used for provision fund payments to lenders for any normal loan loss coverage”. They would “continue to monitor [provision fund] coverage ratios carefully”.

When The Times asked for a clearer explanation of how the redress scheme will work, the numbers affected and how much was being returned, Assetz said: “As we have legal actions being taken against multiple parties, we are not at liberty to go into more detail at this stage.” The FCA indicated it was not involved in the drafting of the statement.

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