Dramatic clamp down on peer-to-peer investing in major blow to lenders

You’ve seen the adverts. In fact, with the surprisingly high interest rates seemingly on offer, you’d be forgiven for doing a double take.

At first glance, they look like compelling deals from high street banks or building societies. But these are peer-to-peer businesses – companies that provide loans by attracting small amounts from a large number of individual investors by offering a financial return.

In other words, they act as the middle-man between people who want to borrow money and those willing to lend it. What many people seeing those meaty interest rates flash up on-screen don’t realise is that these are not savings accounts, and the money is not protected by the Financial Services Compensation Scheme (FSCS).

And now the financial regulator, the Financial Conduct Authority (FCA), has imposed major restrictions on the amount of money everyday investors can put into these schemes if they don’t get financial advice first.

In a bid to make sure investors are aware of the risks surrounding peer-to-peer (P2P) lending, from December, the maximum new investors will be able to slot into this sector will be capped at just 10 per cent of their available assets. They will even have to pass a test to prove they understand how the loans work and the risks involved.

Risky

Providers will also be restricted in how they market products in the future by stopping mass advertising campaigns, the likes of which have allowed thousands of people to mistakenly believe they have been putting their money into a low-risk savings product with better than average returns.

Christopher Woolard, executive director of strategy and competition at the FCA, said: “These changes are about enhancing protection for investors while allowing them to take up innovative investment opportunities.”

The move, which comes after Lendy went to administration last week, had been widely anticipated after the FCA issued stark warnings back in April that investors often don’t know what they’re really putting their money into.

Whether the new rules would have helped protect more than 20,000 individuals now considering legal action against Lendy to recover in excess of ?165m from the ashes is up for debate. Fears also remain for investors in a further dozen P2P lenders rumoured to be on the brink of collapse, for whom the new restrictions may simply accelerate matters.

“These proposals will move the P2P industry much closer to the standards that the FCA expects of other financial products,” says Matt Hopkins, head of fintech in the financial services team at BDO.

“The primary outcome of these rules is to reduce harm both to the individual and to the sector. Parts of the P2P market have claimed to achieve high returns backed by investments identified as low risk but which are actually highly speculative. That will no longer be tolerated. Those platforms whose risk processes are ineffective or non-existent will need to change rapidly and the false suggestion of FSCS protection will have to stop.”

Tip of the iceberg

Hopkins also says: “The tightening of interest rates and the turning of the credit cycle is going to test even more P2P platforms and these reforms will undoubtedly accelerate the managed closure of those unable to comply effectively.

“Smaller players may find it difficult to shift from mass marketing to only marketing to HNW (high-net-worth) or sophisticated investors, but if smaller players were generating significant volume from retail customers you have to question if the products were appropriate in the first place.”

And amid the predictable statements from players in this industry about welcoming the decision, improved transparency and higher standards, it’s unclear how a rule like this will work in practice.

“The industry argued this limit is arbitrary and hard to enforce, but the regulator is pressing ahead regardless,” says Laura Suter, personal finance analyst at investment platform AJ Bell.

“It will be interesting to see how investors have to calculate and declare their investible assets to ensure they don’t exceed the cap. The flood of money to peer-to-peer in recent years has placed a spotlight on the sector, but it’s baffling that this limit is in place for peer-to-peer but not for other high-risk investment areas, such as cryptocurrencies, for example.

“Investors will now also have to answer questions about peer-to-peer before they’re allowed to invest, to ensure they understand they’re not covered by the Financial Services Compensation Scheme, how the loans work, and the risk warnings.

“The regulator’s moves to ensure peer-to-peer providers spell out the risks of the investments to customers should be encouraged, particularly looking at how providers manage the risk of a borrower defaulting and how they reach their example interest rate figures.

“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 Money Advice Service provides impartial information about P2P lending including a guide to the risks involved, here.