Peer-to-peer lending has expanded significantly as an alternative form of investment and borrowing. Adam Burgess explores the industry
This article was originally published in the October 2017 issue of Adviser magazine and was correct at the date of publishing.
Peer-to-peer (P2P) lending falls under the broad definition of ‘crowdfunding’, which enables borrowers to raise money for their activities from a large number of individuals and lenders to find potentially high-yielding investments. Some of the more popular crowdfunding sites are based on donations, whereby people support charities, projects or enterprises, sometimes in exchange for a reward.
Broadly, with P2P lending investors get the chance of a good return on investment, and borrowers benefit from being able to access a loan without using traditional lenders. Everything is done online and the model effectively removes the banking middleman from the process for savers and borrowers, with both receiving a better interest rate. This appeals to people who would rather not borrow from a bank, as does the repayment flexibility and lack of early repayment charges.
In practice, money is lent and borrowed via a central pot, which is facilitated by the P2P lending companies, such as Zopa, RateSetter and Funding Circle. Investors who are willing to take on more risk can receive a better return by lending to individuals with a lower credit score. This means that a borrower’s credit score, just as in traditional borrowing, will affect whether the application is successful and what interest rate they are offered. The P2P firms make their money by charging a fee.
For the debtor, taking a peer-to-peer loan is usually the same as taking out any other form of unsecured personal loan online. The key difference being that they are borrowing the money from an individual, or more likely a group of individuals, rather than from a traditional financial institution, although this is not really apparent from the application process.
The online-only model means P2P lenders can keep running costs to a minimum, allowing them to pass these savings onto their consumers. Some P2P websites have no minimum loan amount, which means that there is a wider appeal, and they help fill the gap in the short-term credit market. There are often fees to pay for both arranging the loan and for early termination, which are often payable regardless of how long an individual has had the loan and usually make up part of the borrowing. These fees help to cover company running costs and contribute to a fund protecting lenders against unpaid loans. Overall, though, P2P provides consumers with an alternative method of obtaining credit, often with a favourable interest rate.
For an investor, although investing in P2P can often resemble regular saving, it does come with considerably more risk, as the returns, including the capital investment, are not guaranteed. The lender’s money does not fall under the Financial Services Compensation Scheme, which protects the first £75,000 of funds should the provider go bust. If the P2P lender went under, the debt to the lender would still have to be repaid. However, all members of the Peer-to-Peer Finance Association are required to have insurance to pay for a third-party collection agency.
In fact, in what is among the first indications that P2P lending may not be immune to the issues that affect traditional banking, in July 2017 RateSetter committed to use its own funds to prevent losses being taken by its 50,000 users. After announcing that companies they had invested in had gone into administration, RateSetter told its investors that they could withdraw their deposits free of charge.
Technically, the loans are between the individual investors and the borrower. However, in practice, collections are usually dealt with by the P2P company. If you default on a P2P loan, you will face charges in the same way you would with a bank loan, and any late or missed payments will be noted on an individual’s credit file — potentially affecting their ability to get credit in the future. As with any new product questions arise about what risks are involved and what protection consumers have, whether they are investing or borrowing.
How is the market regulated?
Since April 2014 the Financial Conduct Authority (FCA) has regulated P2P lending and investment-based crowdfunding, which enables people to invest in businesses by buying shares or debentures (long-term, fixed-rate securities secured against assets) that are not readily realisable. This means that all the FCA high-level principles apply.
FCA rules state that P2P firms must provide clear information, be honest about the risks involved and have contingency plans in case things go wrong. By April 2017, firms were required to have a minimum of £50,000 of capital in reserve to protect against financial shocks or difficulty.
The FCA has also been proactive regarding the regulation of crowdfunding as a whole. It published a discussion paper to consider regulation of the market in November 2015 and followed up in July 2016 with a call for input on the post-implementation review of its crowdfunding rules; its interim findings were published in December 2016. Although it primarily addresses the investor experience of crowdfunding and P2P lending, the paper does raise some interesting points and problems regarding the position of borrowers.
It also confirms that the FCA intends to consult on proposed new rules. This was due to happen in early 2017 to address some of the more immediate concerns, but was delayed due to the snap general election. As yet no further time scale for the consultation has been made public.
Where a borrower on a loan-based crowdfunding platform is an ‘individual’, as defined in the Consumer Credit Act (a consumer, sole trader, a partnership of no more than three people or other unincorporated body) and is borrowing less than £25,000 for business purposes, the agreement will be Consumer Credit Act (CCA) regulated unless a specific exemption applies. If the investor is lending in the course of a business, which is likely to be the case for an institutional investor, the agreement will be subject to the full requirements of the CCA and the investor will need to comply with the Consumer Credit Sourcebook (CONC) and have FCA authorisation.
If the lending is not for business purposes, the agreement may still be CCA regulated, but is classed as a ‘non-commercial’ agreement and the lender does not need to be FCA authorised; for example, non-commercial lenders do not need to comply with CCA requirements on pre-contract information or the form, content and execution of the credit agreement. Unfortunately, it is not always easy to determine whether such loans for non-business purposes are regulated or not.
To address this gap in regulation and consumer protection, the FCA introduced rules in CONC specifically for P2P lending providers. These mean that even in the case of ‘non-commercial’ lending the platform needs to provide pre-contract explanations of agreements, including the risks, and complete an adequate assessment of the borrower’s creditworthiness. It also needs to give a 14-day cooling off period similar to CCA and to comply with CONC rules on arrears, default and recovery.
More than three quarters of P2P lending market companies are members of the Peer2Peer Finance Association (P2PFA), which was founded by the three biggest names in the sector (Zopa, RateSetter and Funding Circle) in 2011 as a self-regulatory body charged with ensuring high standards in this fast growing industry. The P2PFA has a set of rules and operating procedures, but, while there are specific references to borrowers, they focus on the investor side of the market.
The rules are more a set of overarching principles that members should adhere to, whereas the operating procedures provide more specific processes that firms must comply with. The rules state that members are bound by both sets of regulations, and that failure to comply can result in the P2PFA making recommendations for action by the lender. Recommendations can include, but are not limited to, issuing apologies, changing procedures, or altering publicity or other customer-facing materials. Action can also include expelling members from the association.
Operating principles eight and 16 are of most interest to the consumer. Principle 8 states that: “Information for borrowers should be equivalent to that required by FCA regulation and in particular include:
a) details of any specific fees and charges and interest rate payable;
b) information on whether the loan can be repaid early and if so on what terms;
If any of these do not apply to the circumstances of the platform it will explain and provide such information as appears relevant and material to a borrower’s informed decision about whether to borrow.”
Principle 16 states: “Bad debt recovery should be undertaken in accordance with acceptable industry wide standards of responsible business practice.”
One assumes that, given that part of the P2PFA’s role is to ensure that members demonstrate high standards of business conduct and their ability to recommend actions to its members, consumers should be able to notify them of complaints against individual firms. However, there are no details of how to do this on the P2PFA website.
It is also worth noting that the Financial Ombudsman Service has actively started to take notice of crowdfunding. Issue 137 of Ombudsman News contains six examples of cases they have dealt with.
How can these loans be enforced?
If they are consumer-credit regulated agreements, enforcement of the debt would take the usual civil procedure route. Unregulated agreements would still be a civil matter, but may be pursued using the High Court — it appears that P2P platforms (or at least the larger ones) will act as the creditor in these cases and chase the consumers for payment, rather than leaving it to the individual investors themselves. Some P2P lenders provide their investors with a provision fund to make up any payments that a borrower misses. Others offer insurance (such as Zopa’s ‘safeguard’), which ensures payments are made to the investor even if the borrower stops paying.
P2P lending clearly offers an attractive alternative to traditional banks for both investors and borrowers. This is evidenced by how quickly the market has grown in such a short space of time. For all intents and purposes the P2P companies play the part of the creditor even up to the point of collecting arrears, and the larger firms are taking steps to safeguard their investors against bad debtors. Although the market is still growing, and will undoubtedly evolve as a result, the FCA does appear to be committed to ensuring that consumers receive as much protection as possible. The ongoing review of associated regulations is certainly welcome from both a consumer and debt advice perspective.
Adam Burgess is Senior Creditor Liaison Policy Officer in the Partnership Intelligence team at Citizens Advice