This morning every P2P platform received a Dear CEO letter from the FCA, stating that platforms should not facilitate loans to a party who lends those monies onwards, unless that party is authorised for accepting deposits.
The issue here is really with the underlying lenders – i.e. unregulated or insufficiently regulated companies receiving borrowed money through the platform, only to lend it onwards. But by extension platforms have been caught up in the process and now need to be vigilant that they don’t lend to such borrowers.
Is it right to put the onus on the platforms?
If it’s not right it’s certainly not unusual for the FCA to pass down responsibility for checking third parties to the firms which they regulate. When the FCA reminded fund managers of their obligations in this regard a few years back there was much talk of devolved regulation or an unfortunate game of piggy in the middle. Yet it is generally seen as an effective and proportionate response. Who better to limit the activities of such firms than the people providing them with the means to do business?
Whatever sector you’re in, it all comes back to the general Principles the FCA holds regulated firms to – including managing your business with integrity, skill, care and due diligence as well as looking after the interests of your customers – and the need to impose take steps to see that those Principles are implemented throughout the supply chain. If P2P did not realise it before, it’s now clear that the FCA views the supply of finance to borrowers as a similar supply chain.
As long as the same standards are applied to banks and other forms of financier from whom the onward lenders borrowing from P2P platforms could approach, then the playing field should be level.
Is all two-tier lending caught?
The Dear CEO letter refers to a few exemptions to accepting deposits but it also flags that the FCA does not think these will be available to onward lenders borrowing from P2P platforms, other than for very infrequent relending.
Many firms might be wondering why there’s such a fuss over this. After all, is it really that different to selling on pre-originated loans? The FCA would likely answer ‘yes’ – and their rationale comes down to the slightly different structure and sequence of cash flow in the case of selling on pre-originated loans, compared to loans made on the basis of what is already borrowed money.
While the impact on the end borrower in each scenario might be the same, the risk faced by everyone else in the chain is markedly different. If a firm invests off its own balance sheet, it is taking the risk. When it sells onwards to a lender, the lender knows exactly what they’re getting. Neither of those two features are present in the scenario the FCA is concerned about. Particularly for platforms where there is an auto lender or auto diversification element, the lender thinks they are lending directly to a company and being exposed to the risks of that company, whereas the risk to their lent monies could be far greater than this. Quite frankly there isn’t enough transparency to know.
The FCA has been concerned about shadow banking activity for some time and previous comments about regulatory arbitrage in this area focus on maturity transformation and the fact that, as distribution chains become more complex, investors can easily become exposed to borrowers that have no direct relationship with the platform. The regulator is concerned that in this scenario, investors come to rely on platform due diligence in a way that basically mirrors their expectations of a bank with whom they lodge deposits. The catch, of course, is that investing through a platform involves very few of the same processes, guarantees or protections.
So, in short – not all two-tier lending will be subject to the limits announced by the FCA; the focus of their attention is firmly on situations where onward lenders are extending credit on the basis of what is already borrowed money.
The FCA’s four key steps – what are the practical steps P2P platforms can take?
Towards the end of the letter the FCA asks the P2P platforms to undertake four steps in the next two weeks – but with limited guidance and the volume of work involved, this timeframe may be a tall order. For those wondering how to respond, here are a few thoughts about what P2P platforms can do to strengthen their position alongside each of the FCA’s four key steps:
- Establish whether they have facilitated loans to lending businesses without the correct permission, who have lent that money.
Unless platforms were specifically asking the question of their borrowers previously, an audit of loans made is going to be necessary. Even where the platform identifies a potential onward lender, there are some practical challenges they will face. What happens if a lending business borrowed money for purposes other than lending? If they required, or stated that they required, new equipment or premises, but then lent the money, how will the platform know? After all if the money goes into one account, how will the platform be able to distinguish?
- Stop facilitating the acceptance of deposits by these borrowers;
- Consider what action they will take to ensure that you do not facilitate the acceptance of deposits by any such borrowers who do not hold the correct permission in the future; and
- Moving forward if platforms want to continue to deal with financial firms, P2P platforms will now need to undertake some form of ‘regulatory due diligence’ on borrowers to ensure the money lent is used only for business purposes or activities act within their permissions just as PE and VC firms do before investing in companies potentially undertaking regulated activity. As highlighted above, this may not be a guarantee that the loan monies aren’t re-routed.
Many platforms may think this is just a step too far and will look to limit the types of companies they lend to non-financial firms, simply to avoid any risk of onward lending.
- Consider what action you will take in cases where a borrower has already been accepting deposits via your platform and does not hold the correct permission.
The obvious step of ceasing to work with the onward lenders has been taken out of platforms’ hands at this point so what are the FCA looking for? Many firms will be left wondering what is expected, and thinking that it surely would have been more helpful if the FCA had flagged its expectations and suggested options.
We also wonder if the knock-on implications of platforms taking action without guidance have been considered. If platforms took steps to undo lending to such borrowers this could create damage to both lender and borrower plus damage to market confidence. And it also raises the question of what platforms can do. In most cases they have simply facilitated a loan agreement between two people and may be limited in the next steps they can take.
By asking CEOs to provide a response to these questions the regulator is making this an individual responsibility. Perhaps the most controversial aspect will be the need to confirm whether they have lent to lenders who should have been authorised to accept deposits, and therefore may have been acting criminally. The other, of course, is the fact that any action they state their firm will take will be read as a commitment by the regulator. The strength of the letter, and its response shouldn’t be underestimated by CEOs or the teams supporting them. In reality, however, there is really only one path forward: open up your records and cooperate.
The FCA letter is embedded below.
Gillian Roche-Saunders is Partner & Head of Compliance at Baites, Wells & Braithwaite, a professional services consultancy, combining a top legal practice with services in impact measurement, outcomes-based planning and strategy, and financial services regulatory compliance. Gillian advises financial services firms on the regulatory issues affecting them. Gillian’s compliance experience spans a wide range of financial sectors. Her area of particular specialism is regulation for the venture finance industry – companies involved in providing finance to SMEs. Her clients in this part of the market range from venture capital and private equity investment houses to corporate finance advisers and business angels. She is particularly well known in the EIS, crowdfunding, and P2P lending industries for being the go-to consultant for regulatory support. The advice Gillian provides covers all areas of regulation that affect UK financial services companies including the FCA rules and regulation from Europe such as AIFMD, MiFID and PSD. Her advice is both technical and practical, with Gillian taking particular pride in making sure her recommendations are closely tailored to the needs of each client.