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FCA Threatens to Derail P2P-Lending Market by Shutting Out Retail Investors

written by Bella Palmer

A little over two years since P2P lending was given its own ISA wrapper, the FCA has published a consultation paper that threatens to destroy the nascent market by restricting retail investor access. The April 2016 introduction of the Innovative Finance ISA looked to rubber stamp P2P lending as a mainstream investment product that could offer retail investors an alternative to the stock market in their pursuit of inflation beating returns. Now, however, the FCA is arguing that P2P lending should come with the same restrictions marketing to retail investors as other investments categorised as high risk, such as crowdfunding for equity brokerage platforms.

P2P lending platforms broker loans or mortgages for businesses or individuals and stepped in to fill the gap in the lending market that appeared in the wake of the ‘Credit Crunch’. Tightened rules that restricted bank lending left many SMEs and small property developers cut off from traditional bank finance. At the same time, with interest rates at historical lows and, more importantly, significantly behind inflation, holding cash was no longer an option for savers and investors unwilling to see its purchasing power eroded over time.

Well-structured P2P lending that offered businesses a new finance option and retail investors an alternative to the stock and bond markets appeared an elegant solution to a market need and the sector boomed. Last year P2P lending provided £1.23bn of loans to small businesses, equivalent in value to 15% of all new SME loans by UK banks. Similar sums went to onsumer and property loans, according to the Cambridge Centre for Alternative Finance. 

Over the past decade P2P lending has also worked out well for all three sides of the process. SMEs and small or private property developers benefited from the new financing options as did those investing online in P2P lending with solid returns earned. P2P loans are often backed by assets such as property and brokers advise investments are spread across multiple loans, often offering this as a portfolio. This lowered risk to an acceptable level, a view apparently shared by the government. The P2P lending-specific Innovative Finance ISA was considered a stamp of approval that the sector was suitable for retail investors.

The third party in P2P lending, the brokerage platforms conducting due diligence on borrowers and facilitating the investment, have also been rewarded and several have grown into significantly-sized companies. Funding Circle, one of the biggest P2P lending platforms, has been preparing an IPO and would be the first P2P broker to become a publically traded company. However, a significant change in regulation around P2P lending could throw the proposed IPO into doubt.

The FCA are concerned that too many of those investing online towards their pension could be overexposed to P2P lending. The new asset class has, to date, provided solid returns and an acceptably low default ratio has kept risk levels moderate, especially if investors spread their capital thinly between a number of loans. But the regulator is concerned that the risk to return ratio so far demonstrated by P2P lending is embellished by the fact that its history to date has taken place during the economic growth cycle that followed the international financial crisis.

Its recent analysis of the sector found that 40% of 4500 P2P investors surveyed had invested more than their annual income. 20% had invested more than double their annual income. The survey also found that almost 10% of funds invested in P2P lending are “redirected retirements savings of individuals who are at or approaching retirement age” and that 40% of correspondents are investing in P2P lending with a view to financing their retirement. This has raised concerns of overexposure when the economic tide next turns. The FCA paper read:

“So far, losses and defaults across the P2P sector have been low. However, it is important to recognise that the sector is still relatively new and has not been through a full economic cycle. When economic conditions tighten, losses on loans and investments may increase.”

In its response to the consultation, the Peer-to-Peer Finance Association, an industry body, agreed that stricter measures to protect investor funds in the case a P2P platform or broker finds itself in financial difficulty should be welcome. However, the Association also warned against overly protective new regulation hobbling a sector that in recent years has been making a positive contribution to the UK economy.


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