With the Innovative Finance ISA poised for greater uptake among UK investors the industry is at a crossroads.
The 2018 UK ISA season is almost upon us, and with the UK’s big peer-to-peer (P2P) industry players now in the Innovative Finance ISA (IFISA) market, we expect there will be significant inflows into IFISAs. This burgeoned by the government’s continued promotion of technological innovation in UK financial services, and its support for the P2P sector, which provides an alternative source of finance to bank lending for SMEs.
Despite the absence of an anticipated FCA review of the UK P2P sector, the bellwether for the IFISA looks good as it matures and makes its way into mainstream public consciousness. Increased inflows will not be without risks for P2P platforms, and as operations are scaled-up to meet demand, firms would be wise to review and enhance their risk governance models.
As with any business in growth mode, new customer acquisition is always a priority. However, this needs to be balanced with a prudent and forward-looking approach to risk management that accounts for expected and/or forthcoming regulatory change. Senior management in P2P firm should be ever mindful of this, particularly given the FCA’s drive towards greater personal accountability. In the FCA’s December 2016 Feedback Statement containing its interim feedback following a call for input on its postimplementation review of its crowdfunding rules (FS16/13), P2P firms received clear sign-posts on how the FCA is likely to develop its regulation of the sector. In particular, it may:
- Require firms to maintain an enhanced control environment, especially as regards retail protections, such as due diligence, disclosure, transparency, and creditworthiness;
- Mandate appropriate planning for wind-down/ insolvency scenarios, related controls on client asset and client money/safeguarding and potential enhanced capital requirements; and
- Impose additional restrictions around complex business models (e.g. cross-investment) or those where regulatory arbitrage is possible.
FS16/13 indicated that the FCA’s next step would be to publish a consultation on proposals for new rules and its final new rules during 2017. We understand from media commentary that the November 2017 update of the FCA’s policy development webpage removed reference to this consultation and that the FCA has since said that there is no timetable available for the document’s release. While this is potentially indicative that the FCA is now comfortable with the status quo, we still expect that a consultation or consultations will follow.
Regulation and collaboration
The potential upsurge in P2P platform usage driven by the IFISA will no doubt garner FCA attention, particularly if there is significant change in the demographic of the current crowd investor population. While it will certainly offer savers more choice as to how they invest their money, the FCA has previously expressed concern that unsophisticated investors lack sufficient understanding of the risks associated with investments into P2P.
Aside from the regulation, there are at least two other commercial trends in the P2P sector and the UK FinTech sector at large, which will continue into 2018. First, as firms scale up their propositions for the IFISA, we are increasingly seeing collaboration in service and product offerings between both new and old industry players. Second, firms are enhancing their service proposition, for example in the P2P sector we see a movement towards the challenger banking space. P2P platforms not shackled by the legacy systems and creaking infrastructure of their more established cousins are well placed to capitalise on these trends. Provided the core brand is protected and not diluted, clear commercial benefits can be recognised by P2P platforms via well managed collaboration and business model enhancement, leading to increased market profile and greater access to both investors and borrowers, the two sides of the P2P coin.
There also remains a need for P2P firms to ensure vigilance to macroeconomic risk. Critics of P2P lending are keen to point to the fact that the majority of UK P2P businesses have not been exposed to an economic downturn. A combination of unmanageable amounts of unsecured personal debt, increasing inflation, poor wage growth and a gradual increase in interest rates, could see a rise in UK borrower defaults. How P2P platforms loan books will fare remains to be seen. And of course, there is Brexit, which poses a threat to the UK economy at large but may also frustrate any plans that UK P2P platforms have to expand their businesses cross-EU border. With crowdfunding in the future sights of the EU Capital Markets Union, UK firms looking to achieve scale across Europe may in time have to establish group presences in other EU territories.
With the FCA positioned to consult on enhancements to its regulatory framework of the P2P sector in 2018, firms should be actively monitoring FCA announcements and be ready to respond. A strategic customer-focused approach to the roll out of the IFISA product will in the long-term lead to competitive commercial advantage, and see the leading P2P firms move from being perceived as FinTech ‘start-ups’ to trusted ‘household names’.