Getting regulation right

Speaker: Christopher [1]Woolard[1], Director of Strategy and Competition
Event: LendIt Conference, InterContinental, The 02, London
Delivered: 10 October 2016
Note: this is the speech as drafted and may differ from delivered version.

Highlights

• The crowdfunding markets are continuing to develop rapidly.
• The authorisation process acts as a gateway to protect consumers. We expect us to complete the major authorisations work in this sector soon.
• We are currently considering responses to our call-for-input on the post implementation review of crowdfunding rules. We expect to publish a feedback statement by the end of the year.

It feels like a very busy year has gone by for the industry.

The market is evolving, with more players, products, and customers. 

Internationally, events in China, and around Lending Club in the US, have brought greater scrutiny in every market. 

There have been some legislative changes, and we have our own review underway of whether the framework for regulating the crowdfunding industry remains appropriate and fit for purpose.

But I thought it worth starting with a reminder of the things that haven’t changed.

Consistency of regulation

Since the Financial Conduct Authority (FCA) introduced its regime for peer-to-peer in 2014, we still have the same objectives, and our role as regulator is still to balance promoting competition, protecting consumers, and enhancing the integrity of UK markets.

They still underpin the logic for the creation of a crowdfunding regime in the UK and what we want to see emerge in this market as a regulator. We want a sector that has capacity to be innovative, for viable firms to challenge established players and business models, without putting consumers at unacceptable risk.

The framework we apply to achieve that – that is, our Principles, rules and guidance – hasn’t changed substantially since we introduced it in 2014.

Of course, our post-implementation review is considering whether we may want to consult on changes in the future, but I will say more on that in a moment.

Last year I described the market as being like a building development. That hasn't changed. We expect firms to be the architects for each of the buildings: to choose the bricks; to find a layout that works for you; to make something that stands out for consumers.

Our job is to be the structural engineer – that is, the person who takes a view of the safety and underpinning of the market. Someone has to say it’s unacceptable to make a house of straw. Or that some structures are plainly unsuitable.

Authorisations

Although it may not feel like it at the time, the gateway is also good for a firm. Where we challenge your business model, pose questions about risks or ask for further information, we are helping to get you on a stronger footing, and hopefully make you better prepared for regulation in the future.

To develop that point, I also said that authorisations could be a demanding process that could take time to complete. That hasn't changed either. It’s in that context I would like to say a few words about the authorisations regime.

Having a gateway that effectively manages risk helps ensure consumers have confidence in the sector and that all firms are on a level playing field.

Although it may not feel like it at the time, the gateway is also good for a firm. Where we challenge your business model, pose questions about risks or ask for further information, we are helping to get you on a stronger footing, and hopefully make you better prepared for regulation in the future.

It’s also a very serious process. We will work with firms to make the authorisations process as smooth as possible. It is important that firms respond to our requests fully and promptly. Ultimately though, we do have to make decisions, and if a firm is not able to prove it meets our threshold conditions in a timely way, the outcome may be that we refuse to authorise that firm.

The positive news is that many firms have been working with us. If we look at just loan-based crowdfunding for a moment, by the end of September 2016, we had authorised 12 platforms, 39 were still operating with interim permission. We have a significant number of new firms under consideration, including an additional 6 applications since the update we gave in March.

Of course, we are also very conscious that authorisation acts as a deliberate barrier to entry. The question we always have to ask ourselves from a competition perspective is whether the regulations we have in place are proportionate and working appropriately, which is another reason for the post-implementation review

The changing market and the FCA review

So, if those are the constants, let me turn to the future and our review.

One of the things that we are considering in our post-implementation review of the regime is how the market has changed.

First, over the last few years the market has been growing. When we first introduced our rules, in 2013, the value of loan-based crowdfunding was £480m. By 2015, it had rocketed to £2.4bn, as detailed in our call-for-input on the crowdfunding rules[2]. All forms of crowdfunding reached £3.2bn last year. However, the industry may now be entering a different, more mature stage in which growth doesn’t look quite as dramatic.

There are a number of factors driving this.

The growth has come in part from the increase in institutional investment. The UK Alternative Finance Industry Report noted that by 2015 32% of peer-to-peer loans to consumers were funded by institutional investors. We’re also seeing some firms explore the potential of securitisation.

From a regulatory perspective, this creates some interesting issues.

In the post-financial crisis world, loan securitisation wherever it comes from is always going to be something that we need to think about, even if it is of a modest scale.

And – as we said in our call for input – we have an interest in seeing that all crowd funding platforms manage conflicts of interest with great care. If institutional investors are being granted more favourable treatment in investing compared to less knowledgeable, or less experienced, retail investors – we need to consider whether that amounts to fair treatment of customers.

Other factors may also be changing that base of retail investors.

As crowdfunding becomes better known, and particularly as firms begin to offer new tax wrappers like the Innovative Finance ISA, a larger pool of retail customers are likely to be investing their hard-earned cash.

I know this is something the industry is thinking carefully about.

Particularly at this stage of its development, consumer confidence is paramount: you need to make sure that consumers have a clear understanding and expectation of the nature and performance of their investments and that they can make appropriate comparisons across platforms, or against other asset classes. That is key to the future good health of the industry.

It’s also an issue of concern to us, particularly as we look at it through the lens of different groups of consumers having different needs, and different drives to invest.

Firms are also expanding the variety of credit they offer. Hire-purchase, guarantor lending and pawn broking are already available, with some firms looking to offer mortgages in the near future.

Expanding into new product types creates potential risks for platforms and also raises an important question for the regulator: are we confident that firms sufficiently understand the risks in new markets, and that investors are not being exposed to risks that they are not well placed to assess in advance?

Firms that lend to consumers and some micro-businesses also have to meet our requirements on consumer credit lending, including undertaking a creditworthiness check. We want to be sure firms don’t respond to greater investment supply by lowering their underwriting standards, which could create affordability issues for borrowers and increased credit risk for lenders.

That segues to the rather thorny issue of due diligence in general.

Our rules are high-level to give firms flexibility in how they perform their due diligence on loans. This is our preferred approach – we set minimum core standards, but allow firms to innovate and find different ways that work.

But it is absolutely essential that whatever system a firm puts in place, does work, and that you are able to demonstrate this to us.

Both sides need to understand what due diligence the firm is going to do and what investors need to do for themselves. Marketing must reflect the nature of the instrument – that is, it mustn't imply that there are no circumstances in which investors won't lose money. Firms must be transparent about performance and the use of reserve funds or financial support. We do not want to see an expectations gap emerge in this respect as the industry becomes more diverse and reaches more investors.

And, with an illiquid asset it is important that investors can act on the information available to them in a timely and meaningful way – that they can use it to avoid unsuitable investments, or diversify correctly with and across platforms; not just to cut their losses.

Much of the peer-to-peer lending industry has embraced transparency and we commend you for that; but it is also firms themselves that tell us that there is more that can be done.

Whether there is a role for us in that process is one thing our review is looking into – whether the commercial incentives are strong enough for all firms to keep up with and add to good practice.

Like any other firm we regulate, we expect crowdfunders to have in place systems and controls to mitigate these risks. And this is a set of issues that we are looking at very carefully as we consider firms’ applications for authorisation.

One final point on business models.

I want to be to be absolutely clear.

In ‘regulator speak’: you must have the correct permissions for your regulated activities. In layman’s terms: if you hold deposits like a bank then you should not be surprised if we expect you to be regulated like a bank. We want innovation, but we will not compromise on market integrity or consumer protection.

But we can also help. For example, we have a new bank unit set up specifically to help foster competition in banking.

Evidence-based regulation

It's also been a noisy year in the industry.

Events in China and the US have led to some hard questions. Others have made criticisms of the crowdfunding industry as a whole.

On the other hand, crowdfunding in the UK now accounts for around 2% of the small business lending market. But in some sub-segments it accounts for significant double digits share. That's funding for the real economy that matters. But also profitable business potentially being lost by more traditional firms.

It shouldn't leave us surprised that, in such circumstances, commercial competitors should raise concerns that they face a level playing field or speak about what they see as issues in the industry.

It will be the FCA’s task to listen carefully to legitimate concerns. But also to gather and weigh the evidence in the round.

Conclusions

So what next?

You should expect us to complete our major authorisations work in this sector soon.

In terms of our review of the landscape, we expect to publish a feedback statement before the end of the year.

Our objectives in doing so will be to get regulation right for the sector. We want to see competition, consumers appropriately protected, and successful and sustainable firms. If we can achieve that together – firms, consumers and regulator – we can look forward to an industry that has continued success.

Thank you.