Peer-to-peer lenders previously came under the remit of the Office of Fair Trading - and it’s fair to say that the regulatory touch was light. But in April 2014 the Financial Conduct Authority (FCA) took control.
The FCA also regulates banks, building societies and insurance companies. Its firmer approach means peer-to-peer lending platforms must now adhere to strict rules, or face harsh penalties.
The peer-to-peer lending industry is growing rapidly. It lent more than £500 million to consumers and small businesses in the second quarter of 2015, bringing the total so far to more than £3.15 billion, according to the latest figures from the P2P Finance Association. So it’s perhaps no surprise that it has caught the eye of the regulators.
The tougher regulatory regime was broadly welcomed by the P2P lending platforms. Many were already members of the P2P Finance Association and so voluntarily agreed to abide by a code of conduct. The more formal regulatory framework could only enhance their reputation and help the P2P industry move from niche to mainstream.
But the aim of the rules is not just to boost a burgeoning industry. The FCA is also keen to offer greater protection to the consumers. It wants to make sure that investors understand how the process works, who they are lending to and the risks to their cash.
Information about peer-to-peer platforms must therefore be easy to find and presented clearly. The FCA also expects P2P lenders to outline the risks to potential investors, both on the website and in all other forms of communication. You should, for example, be told that interest rates are not guaranteed and that your capital is at risk.
The FCA is equally strict about promotional material, whether it be an online advert or a radio promotion. The rules state that all promotions must be fair, clear and not misleading. If they flout the rules, they will be banned.
Particular care should be taken over any comparisons with savings accounts. The FCA wants to draw a distinct line between savings accounts and peer-to-peer lending. So any comparison, particularly of interest rates, must be well judged.
Investors can change their minds and cancel without penalty or reason within 14 calendar days, unless there is access to a secondary market where the loan can be traded with another lender.
Consumers even have access to the independent Financial Ombudsman Service if they wish to complain.
The regulations are intended to help consumers make an informed decision about peer-to-peer lending. However, the rules are not so prescriptive as to eliminate variation. Some websites are certainly better than others at explaining the ins and outs of peer-to-peer lending. Some are also better at highlighting the inherent risks. But there are at least minimum standards in place that carry regulatory force.
The regulations also provide some protection for consumers in case something goes wrong. The FCA, for example, insists that contingency plans be made. So, if the platform goes under, a third party must be in place to manage the loan book and collect the repayments. Client money must also be ring fenced from the lending platform’s own cash and held in a third party account.
In addition, the P2P site must set aside capital reserves to cushion investors in the event of a financial shock. The size of the reserves is decided according to size of the loan book but must be at least £20,000 rising to a minimum of £50,000 in April 2017.
The reserve requirement offers some reassurance to investors, but it is unlikely to cover the total amount of outstanding debt. It should also not be confused with a provision fund. Many platforms run a provision or safeguarding fund, though there is no regulatory obligation.
Some also lend only against an asset that can be sold if the borrower defaults.
Don’t forget that P2P lenders are not covered by the Financial Services Compensation Scheme (FSCS) in the same way as banks and building societies in the UK. The FSCS is a valuable safety net for savers in deposit accounts because it guarantees savings up to £75,000. It does not, however, extend to P2P lenders.
Consumers can undoubtedly have greater confidence in an industry that is properly regulated, but it’s important to remember that the rules do not entirely eliminate the risks.
You can still lose money if you invest through a P2P platform, whether regulated or not. It’s therefore important to be vigilant, do your own research and only deal with a site that offers a level of protection that suits your attitude to risk.
It’s also worth checking the regulatory status of your P2P lender. Only seven firms have so far been granted full authorisation. A further 77 applications are currently in the system.
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