The timing was so bad it could have been scripted. Right in the middle of the FCA’s recent consultation on new rules for peer-to-peer (P2P) lending, news broke of problems at an operator called Lendy. This company arranges high-yield, short-term property bridging and development loans, offering annualised returns of up to 12% to retail investors willing to provide the funding.
Trouble was brewing, the
Financial Times (FT) reported, because a large borrower had threatened legal action after Lendy gave notice of recovery proceedings against it. More than £8m of investors’ money, tied up in a development in London’s Marylebone district, is at stake. And that’s not all. The
FT reported that £112m of Lendy’s £180m of outstanding loans were over their term, with some borrowers already bust. Lendy’s investors could end up nursing big losses.
Although most in the P2P sector would disagree, this episode lends weight to the assertion in the FCA’s consultation paper that P2P loans “are generally high risk”. The air must have turned blue in the offices of the leading players on the morning the news broke.
Aside from the blast of negative publicity, the main reason for their consternation is that problems like this might increase support for the FCA’s big idea to protect retail P2P investors: requiring them either to take regulated advice or to give an undertaking that they won’t put more than 10% of their investible assets into P2P loans. The FCA’s proposal attempts to answer one of the biggest questions the regulator faces right across the financial services market: how should it protect retail investors against the dangers of chasing high returns from financial products they don’t understand? Or to put it less delicately, how should it save greedy people from themselves?
Virtually everyone at the big P2P platforms is bitterly opposed to the idea of a 10% limit on retail investors. They fear it will signal to the public that P2P is too risky for them and so scare them away, stifling the sector’s growth.
Virtually everyone at the big P2P platforms is bitterly opposed to the idea of a 10% limit on retail investors
I have some sympathy with their concerns. The P2P players could simply turn their back on retail investors and fund their lending with institutional money, of which there is plenty. This would get the FCA off their backs, but it would run counter to the founding ideas of the sector – to give private individuals access to opportunities previously reserved for professionals and the very rich. It would also leave the P2P providers with a less diverse funding base.
But there are other reasons to question the regulator’s approach. First, the risks in P2P lending vary enormously. At one end there are loans to prime consumer borrowers of the sort that banks court, where default risks are very well understood and there is wide diversification across a big pool of loans. At the other end are outfits like Lendy, which operate in highly specialised, private lending markets where you need to know the rules of the game to survive.
Most people would be shocked to learn that the 1% interest per month that they receive on these high-yield property loans frequently comes out of their original advance – they’re being paid with their own money. But not those in the know. Where else can it come from when the underlying asset is a building site that’s not generating any cash flows? For lenders, getting their money back depends entirely on the borrower’s ability to finish the project on time and refinance their loan with a new one. There are often hiccups and delays in that process, hence loans frequently go over term. It’s all part of the game, if you know how to play.
Bracketing this kind of lending with much more plain vanilla activities and imposing a blanket 10% limit for retail investors seems wrong-headed. But just as importantly, I cannot see how the FCA’s 10% limit would be enforceable in practice. Who’s going to check how much of my wealth I’ve put into P2P loans and how?
This points to a much wider problem for regulators in the age of online finance – self-certification. As a private investor, I can get access to lots of racy opportunities simply by clicking a box to confirm that I’m a sophisticated investor. Again, no one checks whether that’s true. But under the
Financial Services and Markets Act, by doing that I sign away my statutory protections as a retail investor. Bingo – the investment providers are covered and all the risks fall on me.
There’s another way. Instead of allowing investors to give hollow promises about their knowledge or intentions that absolve providers of major liabilities, the FCA should insist on suitability tests to verify that people understand the risks. It will always be possible to find out from the internet how to answer the suitability questions and gain access, but at least that means investors will have to read a little about the risks they are taking, rather than just ticking the box.
This article first appears in the Q1 2019 print edition of The Review. All members, excluding student members, are eligible to receive the quarterly print edition of the magazine. Members can opt in to receive the print edition by logging in to MyCISI, clicking on My account, then clicking the Communications tab and selecting ‘Yes’.
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