Portfolio letter: FCA expectations for Loan-based Peer-to-Peer Lending platforms

On 15.01.2024, the Financial Conduct Authority (FCA) published a letter outlining the harms and risks associated with loan-based peer-to-peer lending platforms and the FCA’s strategy to address them.

The document is a letter from the FCA (Financial Conduct Authority) outlining their expectations and strategies for Loan-based Peer-to-Peer Lending platforms. ​ It focuses on key areas such as strengthening financial rules, wind-down plans, and implementing the Consumer Duty. The FCA expects firms to review their findings, make necessary changes, and improve consumer understanding. ​ They will proactively engage with firms to ensure compliance and intervene if there are poor consumer outcomes. ​ Firms are also expected to identify minimum levels of liquid and capital resources for a wind-down and regularly review their wind-down plans. ​ The FCA will continue to ask for wind-down plans and may require an injection of capital if necessary. ​ The Consumer Duty requires firms to prioritize consumer needs and deliver good customer outcomes. ​ The FCA will use the Consumer Duty to intervene and seek redress for investors if harm arises. ​ Data is an important aspect of the FCA’s supervisory approach, and they plan to issue data requests to monitor firms’ behaviors and identify potential risks. ​ The letter concludes by emphasizing the responsibility of the board and senior managers in meeting regulatory requirements and expectations.

1. The FCA has outlined its expectations for Loan-based Peer-to-Peer Lending platforms, highlighting the potential harms to consumers and markets that may arise from these business models. ​
2. The FCA has implemented rules to strengthen financial regulations for high-risk investments and financial promotions, including risk warnings, inducement bans, cooling-off periods, and client categorization. ​
3. A review conducted by the FCA found that compliance with risk warnings in the Peer-to-Peer and Investment-based Crowdfunding portfolios was below the expected standard. ​
4. The FCA expects all firms to review the findings of the review and make necessary changes to improve consumer understanding and outcomes. ​
5. The FCA is focused on wind-down plans, triggers, and liquidity monitoring to prevent disorderly wind-downs and financial losses to investors.
6. Firms are required to identify minimum levels of liquid and capital resources that would trigger a wind-down and regularly review their wind-down plans for suitability. ​
7. The FCA will continue to ask firms for their wind-down plans and may require an injection of capital if a firm has not adequately prepared for an orderly wind-down. ​
8. The Consumer Duty, which prioritizes consumer needs and good customer outcomes, is a key focus for the FCA’s supervision of P2P firms. ​
9. Firms are expected to fully implement the Consumer Duty, ensuring consumer understanding, conducting due diligence on borrowers, providing complete and correct information to investors, and offering appropriate products and services. ​
10. The FCA will use the Consumer Duty to intervene assertively and seek redress for investors when necessary. ​
11. The FCA plans to issue data requests to firms to supplement regulatory returns and better monitor behaviors and business models, identifying outliers and assessing risks of harm. ​
12. Firms should ensure that senior managers are accountable for meeting regulatory requirements and expectations. ​
13. The FCA requests firms to nominate a senior individual responsible for the attestation relating to wind-down plans. ​
14. Contact details for further queries and interactions with the FCA are provided.

Risks for borrowers seeking loans for multiple inter-connected entities

Borrowers seeking loans for multiple inter-connected entities pose the following risks: ​

1. Concentration risk: When borrowers seek loans for multiple inter-connected entities, there is a risk of concentration of exposure. ​ This means that if one of the entities defaults on the loan, it can have a cascading effect on the other entities, leading to a higher risk of greater losses. ​ This is because the loans are interconnected, and a default in one entity can lead to a contagion effect on the entire portfolio of loans. ​
2. Higher risk of defaults: Borrowers seeking loans for multiple inter-connected entities increase the risk of defaults. ​ If one entity defaults on the loan, it can put additional financial strain on the other entities, making it more likely for them to default as well. This interconnectedness increases the overall risk of default for the borrower.
3. Lack of transparency: When borrowers seek loans for multiple inter-connected entities, there is a potential lack of transparency. ​ Platforms need to ensure that the decision to promote the loan is appropriate and that the appropriate controls are in place. ​ This includes managing conflicts of interest and ensuring that investors are aware of the risks associated with investing in a portfolio of loans for multiple entities. ​ Lack of transparency can lead to unforeseen harm to investors who may not be fully aware of the concentration risk and potential losses.
4. Foreseeable harm to investors: The interconnectedness of loans for multiple entities can lead to foreseeable harm to investors. ​ If investors are not adequately informed about the risks and concentration of exposure, they may unknowingly invest in a portfolio that carries a higher risk of losses. Platforms need to manage conflicts of interest and ensure that investors are provided with complete and correct information to make informed investment decisions. ​

It is important for platforms to be very clear about the risks associated with loans for multiple inter-connected entities and to have appropriate risk management frameworks in place. ​ This includes conducting due diligence on the borrower, assessing the suitability of the investment for retail investors, and providing transparent information about performance, fees, charges, and order of recoveries. ​ By addressing these risks, platforms can mitigate potential harm to investors and ensure good customer outcomes. ​

Actions will the FCA take in response to weaknesses or failings that result in poor consumer outcomes

The FCA will proactively engage with firms in the portfolio to ensure that the new rules have been fully embedded. ​ If weaknesses or failings are identified that result in poor consumer outcomes, and if there has been the potential for harm or actual harm to investors, the FCA will intervene quickly and seek redress for investors. ​ They may also require an injection of capital and consider whether it is still appropriate for the firm to continue offering new loans to retail investors. ​ The FCA will use attestations as a supervisory tool to ensure that regulated firms and senior individuals within them are accountable for taking the required actions. ​ They will ask firms to complete a Self-Certification Attestation, which is a formal statement that the firm will take or has taken the necessary actions. ​ The FCA will also use formal tools, if necessary, to restrict business activity and seek redress for investors. ​

Key areas of focus for P2P firms according to PS22/10

The key areas of focus for P2P firms according to PS22/10 are: ​

1. Strengthening risk warnings: P2P firms need to improve the risk warnings provided to consumers, ensuring that they are clear and comprehensive. ​
2. Banning inducements to invest: Firms are prohibited from offering inducements or incentives to encourage consumers to invest in P2P agreements. ​
3. Introducing positive frictions including a cooling-off period: P2P firms are required to introduce measures that create positive frictions, such as a cooling-off period, to allow consumers to reconsider their investment decisions. ​
4. Improving client categorisation and appropriateness testing: Firms need to enhance their client categorisation and appropriateness testing processes to ensure that consumers are matched with suitable investment opportunities based on their risk appetite and financial situation. ​

These rules aim to ensure that P2P firms communicate and approve financial promotions to a high standard, enabling consumers to make well-informed investment decisions. ​ The focus is on protecting consumers and improving their understanding of the risks associated with P2P lending. ​

Harms to consumers and markets outlined in this letter

1. Inadequate risk warnings: The letter mentions that a review of the risk warnings of firms within the Peer-to-Peer and Investment-based Crowdfunding portfolios found that the level of compliance was far below the expected standard. ​ This implies that consumers may not be adequately informed about the risks associated with P2P lending, which could lead to poor investment decisions and potential harm.
2. Inducements to invest: The letter states that one of the key features of the financial rules for high-risk investments is the banning of inducements to invest. ​ This suggests that some firms may have been offering incentives or rewards to encourage consumers to invest, which can distort their decision-making process and potentially lead to harmful outcomes.
3. Lack of positive frictions: The letter mentions that positive frictions, such as a cooling-off period, are being introduced to improve the customer journey into restricted mass market investments, including P2P agreements. ​ The absence of such frictions in some firms’ practices may increase the risk of consumers making impulsive or uninformed investment decisions, which can result in harm.
4. Inadequate client categorization and appropriateness testing: The letter highlights the importance of firms communicating and approving financial promotions to a high standard, ensuring that consumers receive high-quality financial promotions that enable them to make effective, well-informed investment decisions. ​ The mention of improving client categorization and appropriateness testing suggests that some firms may not have been properly assessing the suitability of their products for different types of investors, potentially leading to harm. ​
5. Risk of disorderly wind-down: The letter expresses concern about the risk of disorderly wind-down and increased financial losses to investors on platforms. ​ This indicates that if a P2P lending platform were to experience financial difficulties or fail, it could result in significant losses for investors and disrupt the market, potentially causing harm to both consumers and the overall market.
6. Lack of adequate liquid and capital resources: The letter emphasizes the importance of firms identifying absolute minimum levels of liquid and capital resources that would trigger a wind-down. ​ The mention of firms needing to monitor their financial health and maintain adequate financial resources at all times suggests that some firms may not have been sufficiently prepared to handle potential financial challenges, which can lead to harm to investors and the market. ​
7. Non-compliance with the Consumer Duty: The letter states that the Consumer Duty, which requires firms to put the needs of consumers first and deliver good customer outcomes, came into effect in July 2023. ​ The letter outlines several expectations related to consumer understanding, due diligence, transparency, and support. The mention of examples where borrowers seek loans for inter-connected entities and the need for appropriate risk management and communication systems indicates that some firms may not be fully complying with the Consumer Duty, potentially resulting in harm to consumers. ​

It is important to note that the information provided in this answer is based on the content of the document. Additional harms to consumers and markets may exist outside the scope of this letter and would require further research and analysis. ​