The Financial Conduct Authority (FCA) published its in Policy Statement (PS19/14) on 4 June 2019, outlining new rules for loan based ('peer-to-peer') platforms.
Why the new rules?
The final rules follow on from, and are broadly in line with, the FCA's proposals in the consultation it launched in July 2018 in CP18/20. The FCA's aim is to improve standards within the sector whilst supporting innovation, enhance investor protection and allow platforms to operate in a sustainable manner.
Key changes for peer-to-peer platforms
1. Risk management framework. Platforms need to be able to meet the expectations they create in respect of their offering to investors. To do this, peer-to-peer platforms must understand and be able to price the credit risk of the peer-to-peer loans they facilitate, at origination and over time. This requires having in place an appropriate risk management system. The FCA has introduced prescriptive rules for a risk management framework for peer-to-peer platforms.
2. Valuations. Platforms need to review the valuation of each peer-to-peer agreement on a frequent basis, and at least:
- when a peer-to-peer agreement is originated;
- where the platform considers that the borrower is unlikely to pay its obligations under the peer-to-peer agreement without recourse by the platform to actions such as realising security;
- following a default; and
- where the platform is facilitating an exit for a lender before the maturity date of a peer-to-peer agreement.
3. Advertised target rate of return. The advertised target rate of return must be based on a reasonable calculation/ assessment process. Platforms must be able to demonstrate that they use appropriate data and have robust modelling capability to calculate target rates effectively.
4. Governance. Platforms must, depending on the nature, scale and complexity of their business and the nature and range of the services they undertake, have an independent risk management function and an independent internal audit function. Platforms must also maintain a permanent and effective compliance function, which operates independently (if it is proportionate for it to do so).
5. Responsibility for the development and oversight of the risk management framework. The person with overall responsibility within the platform for the establishment and maintenance of the platform's risk management framework should be an individual performing a senior management function - e.g. Chief Executive (SMF1), Executive Director (SMF3), Partner (SMF27); Chair (SMF9) or Money Laundering Reporting Officer (SMF17). This must be someone sufficiently senior to influence strategic decisions. It might not be the same person that has day to day operational responsibility for the risk management framework.
6. Marketing restriction. To ensure retail investors who are new to the asset class do not over-expose themselves to risk, peer-to-peer platforms may only make direct offer financial promotions to retail clients who:
- are certified or self-certified as 'sophisticated investors' or are certified as 'high net worth investors';
- confirm before a promotion is made that, in relation to the investment promoted, they will receive regulated investment advice or investment management services from an authorised person; or
- will be certified as a 'restricted investor'. That means they will not invest more than 10% of their net investible assets in peer-to-peer agreements in the 12 months following certification.
Investors that initially fall within the 'restricted investor' category can be reclassified as certified sophisticated investors (removing the 10% investment limit) if they have made two or more peer-to-peer investments in the past two years.
7. Appropriateness assessment. Platforms must undertake an appropriateness assessment to assess an investor's knowledge and experience of peer-to-peer investments, where no advice is given to the investor. Guidance from the FCA says this should include an assessment of the investor's understanding of:
- the nature of the client's contractual relationship with the borrower, and with the platform;
- the client's exposure to the credit risk of the borrower;
- the fact that all capital is at risk;
- the fact that investments on the platform are not covered by the Financial Services Compensation Scheme;
- the fact that returns may vary over time;
- the fact that entering into peer-to-peer agreements or investing in a peer-to-peer portfolio is not comparable to depositing money in a savings account;
- the characteristics of any security interest, insurance or any guarantee taken in relation to the peer-to-peer agreements or peer-to-peer portfolio;
- the platform's risk mitigation measures, including in the event of its insolvency;
- the role of the platform and the scope of its services, including what the platform does and does not do on behalf of lenders; and
- the risks to the management and administration of a peer-to-peer agreement or peer-to-peer portfolio in the event of the platform's becoming insolvent or otherwise failing.
8. Wind down arrangements. There is already a requirement for peer-to-peer platforms to have wind-down plans and to notify investors of their wind-down arrangements (or when changes to the arrangements are made). The FCA has now clarified that platforms must have arrangements in place to ensure that peer-to-peer agreements facilitated by the platform will have a reasonable likelihood of being managed and administered in accordance with contractual terms between the platform and its borrowers and lender customers, in the event the platform ceases to manage and administer those peer-to-peer agreements.
9. Resolution manuals. Platforms must produce, and keep up to date, a 'peer-to-peer resolution manual' containing information about their operations that would assist in resolving the platform in the event of its insolvency.
10. Disclosure requirements. Platforms must, as a minimum, disclose to investors sufficient information about the risks they are exposed to, the nature of the investment opportunity, the fees and any platform charges, and the role of the platform itself (i.e. the service that is being provided by the platform). The FCA does not prescribe a format for these disclosures.
11. Tax disclosures. The FCA has confirmed that platforms must provide investors with sufficient information to help them understand their tax obligations, and the potential impact on their investment returns. This should enable investors to perform their own calculations and compare net returns with those of other investments. The FCA has clarified that it does not intend the disclosure to be the provision of personal advice.
12. Peer-to-peer platforms for mortgages and home finance. There is currently no UK peer-to-peer market for regulated home finance. However the FCA is aware that some platforms are considering moving into residential secured lending (e.g. by facilitating home finance products). By doing so, the platforms are likely to be carrying on the regulated home finance arranging activity. The platform would be subject to parts of the FCA's Mortgage and Home Finance: Conduct of Business sourcebook (MCOB) rules and other FCA Handbook rules when facilitating home finance products and where at least one of the investors is not required to be authorised as a home finance provider.
13. Regulatory capital. The FCA is considering whether it would be appropriate for peer-to-peer platforms to hold additional regulatory capital to protect investors in the event of platform failure.
When do the new rules apply?
The new rules and guidance will come into force on 9 December 2019 (with the exception of those applying MCOB to peer-to-peer platforms that offer home finance products, which came into force on 4 June 2019).
If your firm is affected by any of the above, we can help you to carry out a 'gap analysis' and consider what changes you will need to make to ensure you comply with the FCA's new rules.
For further information, please do not hesitate to contact us.