An introduction to crowdfunding: Part 2

Part 2 – P2P lending in the UK

This is the second article in our four-part series covering UK and EU crowdfunding regulation. Part 1 considered how crowdfunding is regulated in the UK, Part 2 looks more closely at peer-to-peer (P2P) lending, Part 3 will explore how crowdfunding is regulated across the EU, and Part 4 will consider the effects of the new EU regulation on European crowdfunding service providers.

What is P2P lending?

P2P lending, also known as loan-based crowdfunding, is where the crowd lend money to a borrower in return for repayment (with interest) over a period of time.

The FCA note that whilst investment-based crowdfunding business models "tend to be relatively simple", in contrast "P2P platforms have developed a wider, more complex, range of business models, with many now taking a much more active role, by taking decisions on behalf of the investor". As a result, the regulation of these platforms in the UK has developed over recent years.

How is P2P lending regulated?

P2P lending was previously regulated under the consumer credit regime by the Office of Fair Trading, which required P2P platforms to apply for a consumer credit licence. Responsibility for the regulation of consumer credit firms transferred to the FCA on 1 April 2014, bringing with it changes to legislation, which clarified how operating a P2P platform fits with other regulated activities.

As set out in Part 1 of this series, Article 36H of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (the RAO) establishes that P2P platforms are carrying on a regulated activity, which requires FCA authorisation, if it constitutes an electronic system which facilitates an "Article 36H agreement". This covers P2P platforms which:

operate a system, which is capable of determining which agreements should be made available to each lender and borrower
undertake to receive payments from the lender and make payments due to the borrower
procure the repayment of debt from the borrower.

Further, an "Article 36H agreement" is an agreement under which the investor provides the borrower with credit, in relation to which:

the operator of the P2P platform does not provide the credit itself, or assume the rights of the investor or borrower
either the lender is an individual, or the borrower is an individual and either: the credit is less than or equal to £25,000, or the agreement is not entered into by the borrower wholly or predominantly for the purposes of a business carried on, or intended to be carried on, by the borrower.

Breaking this down, P2P platforms facilitating individuals lending to individuals, individuals lending to companies, and companies lending to individuals can be caught by the regulations, but the facilitation of companies lending to other companies will fall outside of the Article 36H RAO definition.

P2P platform models

As highlighted above, there is a wide range of P2P platform models. The FCA has grouped platforms into three main categories:

conduit platforms – this is where the investor chooses the investments it wishes to partake in, and the platform administers the loan or investment arrangements
pricing platforms – this is where the platform sets the price of the loan or security it advertises, but the investor chooses the underlying loan or investment
discretionary platforms – this is where the platform not only sets the price of the loans, but also chooses the investor's portfolio to generate the target rate of return.

These models are not exhaustive, and a platform can adopt a different model for different types of investors.

FCA's approach to regulation

In July 2016, the FCA launched a call for input to the post-implementation review of its regulation of the crowdfunding sector, and in July 2018 it published a consultation paper, which set out its feedback. In particular, the FCA's review of the sector identified a number of potential harms that could affect investors using these types of P2P platforms, including:

unreliable performance
unsuitable products
poor customer treatment
unsatisfactory prices for the platform's services.

In June 2019, the FCA published a policy statement, setting out its final position in respect of new rules for P2P platforms. In particular, the FCA confirmed that it was:

introducing more explicit requirements to clarify what governance arrangements, systems and controls P2P platforms need to have in place to support the outcomes they advertise
strengthening rules on plans for the wind-down of P2P platforms
applying marketing restrictions to P2P platforms, designed to protect new or less experienced investors
introducing a requirement that an appropriateness assessment be undertaken, where no advice has been given to the investor
setting out the minimum information that P2P platforms need to provide to investors.

P2P platforms were required to implement these changes by 9 December 2019.

One change which has particularly impacted the industry is the marketing restrictions, which limit P2P platforms to only being able to market to sophisticated and high-net-worth investors, investors receiving regulated investment advice, or investors who certify that they will not put more than 10% of their investment portfolio into P2P loans. The FCA explained that this rule provides protection for unsophisticated investors, who are likely to be unaware of the risks involved in P2P lending.

Deposit taking

As touched upon in Part 1 of this series, the FCA expects crowdfunding platforms applying for authorisation to ensure that their activities fall within the scope of the permission which they have applied for. In particular, the FCA is concerned with the regulated activity of deposit taking, and in 2017 it published a "Dear CEO" letter, which highlighted that if a lending business borrows through a platform and then lends that money on to others, it may be deemed to be accepting deposits, within the meaning of Article 5 of the RAO. If the borrower does so without the correct permission, this would involve a breach of FSMA.

In the "Dear CEO" letter, the FCA explained that it expects P2P platforms to establish whether they have facilitated loans to businesses who have lent that money to others (without the required permission), and if so, to stop facilitating the acceptance of deposits by these borrowers.

Further regulation of high-risk investments in the pipeline

The FCA is currently looking to strengthen its financial promotion rules for high risk-investments (which includes P2P loans) and is expected to consult later in 2021 on further measures aimed at reducing the harm to consumers caused by investing in "inappropriate high-risk investments".