Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
How investors will be affected by peer-to-peer lending clampdown
The Financial Conduct Authority (FCA), a regulator, will make it harder for novice investors to put their money into peer-to-peer (P2P) products at the end of this year.
In its latest statement on the peer-to-peer market, the FCA has brought in new rules and checks on investors to stop people putting too much money in the investments, and to make sure they understand them before they buy.
Peer-to-peer enables people with spare cash to lend their money to individuals or small businesses who want to borrow. Peer-to-peer websites match investors with borrowers and provide a platform that allows the two groups to agree lending arrangements, or they package up a number of loans into portfolios that investors can buy into.
WHY HAS THE REGULATOR CLAMPED DOWN?
The peer-to-peer market sprung up after the financial crisis when banks had reduced lending to businesses and interest rates had plummeted, meaning investors were getting minimal returns on their cash.
The regulator is concerned that people have been buying into peer-to-peer without fully understanding how it works and the risks involved. For example, the investments are not covered by the Financial Services Compensation Scheme (FSCS), meaning that if a platform or investment folds, investors will have to bear the losses.
There is also a concern that novice investors don’t realise that in order to get higher returns than offered by cash accounts they have to put their money at significant risk. The returns on offer from P2P are variable and investors can lose all their money.
WHAT IS GOING TO CHANGE?
The regulator will now impose new rules on the industry, including a ban on mass marketing of peer-to-peer investments. The latest ISA season highlighted the flood of marketing from peer-to-peer lenders, some of which made comparisons with cash ISA rates or didn’t fully highlight the risks involved in the sector – the new rules will prevent this from happening.
In perhaps its most controversial move, the regulator will also limit newcomer investors to the peer-to-peer space, who haven’t sought financial advice, to having a maximum of 10% of their ‘investible assets’ in the sector.
Exactly how this will be implemented remains to be seen, but it looks like it will be put in place by each platform, with investors having to self-certify that they aren’t investing more than 10% of their wealth in peer-to-peer.
The industry argues this limit is arbitrary and hard to enforce, but the regulator is pressing ahead regardless. The FCA says it’s to ensure that investors ‘do not over-expose themselves to risk’.
ARE THERE EXCEPTIONS TO THE RULE?
Investors can have more than this limit if they designate themselves as a ‘sophisticated investor’, with FCA rules allowing this if they have made two or more P2P investments in the past two years.
This is a relatively low hurdle to overcome. So it seems like the FCA is trying to prevent people seeing these as an alternative to cash, and putting money into P2P like they would put it into a cash account.
Rhydian Lewis, chief executive at RateSetter, says: ‘The limit on savers’ first investment is unnecessary and just patronises normal people. But the other aspects of the regulation mean savers can invest with confidence that P2P lending is particularly well regulated and here to stay.’
IS ANYTHING ELSE CHANGING?
Another rule to be introduced is that all investors will have to pass a knowledge test before they are allowed to invest.
Each platform will come up with their own test, but the regulator has recommended multiple-choice questions, saying that just having a tick-box confirming that you understand is not enough.
Areas they want investors to prove they understand include:
– That peer-to-peer investing is not covered by the FSCS
– That they could lose all of their money
– That returns aren’t guaranteed and can vary
– How the platform manages the risk of loans and if any contingency fund is offered by the platform
– What happens if a P2P portfolio becomes insolvent
Christopher Woolard, executive director at the FCA, says: ‘These changes are about enhancing protection for investors while allowing them to take up innovative investment opportunities. For peer-to-peer to continue to evolve sustainably, it is vital that investors receive the right level of protection.’
WHEN WILL THE CHANGES HAPPEN?
All of these changes will be introduced from December this year, meaning that the peer-to-peer market has until then to make the changes for new investors.
The problems with the peer-to-peer sector were recently highlighted by the collapse of prominent platform Lendy. The firm fell into administration last month and investors now face a nervous wait to see how much of their money they will get back – around £165m was thought to be in the firm when it shuttered.