News analysis: There is no 'B' in 'P2P'

The news that US financial services firms are beginning to use peer-to-peer or person-to-person (P2P) platforms as a method of reaching borrowers is a bit concerning. More worrying is that P2P loans are being sold on and securitised.

Q: What is P2P lending?

A: P2P platforms typically bring together individual lenders to invest in loans to individual borrowers, often small businesses. The lenders check across approved loan requests and can buy notes from the borrowers that they like the look of. Some platforms, such as Kiva, are non-profit and support the growth of small businesses by supporting microfinance initiatives. Some, such as Funding Circle, are fierce in their determination to cut banks out of the lending loop.

Q: But financial services firms are getting involved?

A: The nature of P2P lending makes it hard to prevent someone lending funds if they have them; how a platform can block a participant is unclear. What the last ten years have shown us is that when under pressure to compete, banks cut corners or misrepresent facts in order to avoid losses more often than might be thought decent. The P2P market is untested when it comes to such activity; it does not share the same level of oversight as other financial markets and so the potential for nefarious activity to go uncovered is higher within it. This may subject other borrowers and lenders to higher risks.

Q: Who regulates the market?

A: In the US there is no single point of oversight. Lenders are protected by the Securities and Exchanges Commission (SEC) while Consumer Financial Protection Bureau (CFPB) has the responsibility to “research, monitor, and report on developments in markets for consumer financial products and services to, among other things, identify risks to consumers.” That is a far cry from having oversight of, or mandated reporting from, P2P lenders. The CFPB does not have a single mention of P2P lending on its website.

Securitised products based on these loans would fall under the SEC however, as noted in a report by the US Government Accountability Office in 2011 on P2P lending, “[The SEC] does not comprehensively regulate and examine companies that issue securities. Rather, federal securities regulation is intended to protect investors in specific securities through disclosure requirements and antifraud provisions that can be used to hold companies liable for providing false or misleading information to investors. State securities regulators—represented by [voluntary body] the North American Securities Administrators Association (NASAA)—generally are responsible for registering certain securities products and, along with SEC, investigating securities fraud.” This fragmentation of oversight is liable to have gaps in it.

The Financial Stability Oversight Council (FSOC), comprising the heads of US regulators, has to identify potential threats to the financial stability and spot gaps in regulation.

Q: Would a single regulator be better?

A: The UK will test that out. From April 2014, the P2P market will be regulated by the Financial Conduct Authority (FCA). It issued a consultation to the market on 24 October 2013 which was welcomed by trade body the Peer-to-Peer Financial Association (P2PFA).

Christine Farnish, chair of the P2PFA said, “It is good to see that the FCA recognises the important differences between peer-to-peer lending, which provides term loans to consumers and small businesses, and equity type investing via crowd funding platforms. These activities are like apples and pears and present very different risks to consumers whose money is being handed over. They need different regimes.”

Under the FCA regime P2P platforms must give borrowers full explanations of the important features of a loan including risks, before an agreement is made, and assess the creditworthiness of borrowers before granting them credit. What is not clear is the extent to which banks may be able to access the market or securitise assets. As with the global financial crisis, an issue in the US may be enough to trigger problems elsewhere.