On 4th June 2019, the FCA published its feedback to CP18/20 and its final rules on loan-based and investment-based crowdfunding platforms in Policy Statement PS19/14.
The changes largely match the proposals within the original consultation with some subtle differences/clarifications. The requirements, which must be complied with by 9 December 2019 (except for the application of MCOBS which applies with immediate effect) are summarised below.
FCA had consulted on a range of measures it proposed to put in place to improve standards in the crowdfunding sector, which would apply to both P2P loan based and investment based platforms. The changes related to both prudential and conduct rules applicable to the sector, and were the culmination of a lengthy review, which had identified the need for several changes to existing rules and guidance to reflect how the sector had developed over recent years.
The wide-ranging changes cover:
- Governance: setting out the systems and controls platforms should have, including controls on credit risk assessment, risk management and fair valuation, and the SMFs that will apply
- Wind-down planning: existing rules already required firms to have in place wind-down plans, but FCA is now strengthening them
- Marketing: improving consumer protection by limiting the types of financial promotion that platforms may make to consumers before they have categorised and on-boarded them as customers
- Consumer protection: requiring firms to carry out an appropriateness assessment where the investor has not received advice
- Information: specifying minimum information requirements
- Prudential rules: introducing application of MCOBS and other requirements to home finance platforms, where at least one investor is not an authorised home finance provider.
Risk Management Framework
The rules in COBS 18.12 set out detailed provisions in relation to pricing and risk awareness.
Where a platform sets the price of the P2P agreement, the rules set out a minimum common standard to ensure that the platform properly assesses the credit risk of the borrower:
- gathers sufficient information about the borrower to be able to competently assess the borrower’s credit risk
- categorises borrowers by their credit risk in a systemic and structured way
- sets the price of the agreement so it reflects the risk profile of the borrower
(Where the platform does not set the price, the platform need not undertake a credit risk assessment – but FCA considers that if it does decide to determine the price of loans on behalf of investors it should have in place arrangements to do so effectively).
Additional requirements and safeguards apply where platforms also choose the investor's portfolio to generate a given target return rate. FCA made some changes to its proposals following feedback from consultation. It had considered banning the transfer of defaulted loans, but will not now do so. Where defaulted loans are transferred, the loan must be re-priced to ensure the transfer is done at a fair price.
A new COBS rule 18.12.16 confirms that all P2P agreements must be valued in each of the following circumstances:
- when it is originated
- where the platform believes the borrower is unlikely to pay its obligations under the P2P agreement without recourse by the platform
- following a default
- where the lender is exiting before maturity of the P2P agreement
It also adds that this list is non-exhaustive, and the frequency of re-pricing will depend on the platform’s business model.
Publishing a target rate of return can only be done if a platform can demonstrate that it has the data and modelling to support the figure advertised. Platforms will also be required to publish outcomes statements (showing their actual performance against target rates) for each financial year starting after 9 December 2019 (as part of the outcomes statement).
Risk management policies and procedures must be documented, monitored, reviewed and reported on.
Mortgages and Home Finance
FCA noted there is currently no P2P market in the UK for regulated home finance, but is aware some platforms are thinking of expanding into regulated secured lending. If they do this, FCA considers they would be likely to be carrying out some regulated home finance activities, but it may be that some or all of the investors are not required to be authorised for what they do - and it will therefore be essential that someone has responsibility for the relevant activity. As a result, with immediate effect, MCOBS and other relevant areas of the handbook (including reporting and data retention) will be applied to P2P Platforms which facilitate regulated mortgage contracts, home purchase plans, home reversion plans or regulated sale and rent back agreements where at least one of the parties is not an authorised home finance provider.
FCA planned to bring the governance structures of P2P platforms more into line with those of mainstream investment firms. In principles all P2P platforms should have:
- an independent risk management function and an independent internal audit function
- maintain a permanent and effective compliance function which operates independently
Following feedback on consultation, FCA has acknowledged it may be disproportionate to expect all firms to be large and complex enough to have an independent compliance function – but says firms that consider they fall within this category should be able to explain why. FCA also decided it is not appropriate to set a fixed threshold to help firms decide when they need an independent risk and internal audit function. As a rule of thumb, where the platform sets the price and chooses the investor’s portfolio, FCA thinks it would be proportionate for it to have that independent fucntion. It has not currently taken forward its idea of requiring plaforms that operate discretionary models to have independent trustess, but will keep this under review. For the time being, FCA merely highlights the importance of identifying and preventing or managing conflicts between either the platform and a client or between different clients.
FCA has also clarified that the person with overall responsibility for establishing and maintaining the platform's risk management framework will need to be an SMF holder, but does not mandate which individual it must be. The risk management function development and oversight can be performed by any of:
- SMF1: Chief Executive
- SMF3: Executive Director
- SMF27: Partner
- SMF9: Chair
- SMF16: Compliance Oversight (although FCA would not normally expect this, given the importance of an independent compliance function)
- SMF17: Money Laundering Reporting Officer
All P2P firms must also ensure that their senior personnel receive certain reports at least annually in relation to a number of areas of SYSC.
FCA was concerned that only consumers capable of understanding the risks of investment using P2P agreements should invest in them. These proposals drew significant criticism, but FCA has pressed on. While it appreciates some P2P platforms do have a lower risk profile than investment platforms, others do not, and it would be impractical to apply the marketing rules in a targeted way.
Essentially, it has now decided to promotions of loans in the same way as promotions of investments are regulated, and will restrict the permitted recipients of direct offer financial promotions. It will do this by applying the current restrictions in COBS 4.7.7 that apply to non-readily realisable investments also to P2P platforms. This means that direct offer financial promotions (DOFPs) can be made only to retail clients who are either certified or where permitted self-certified as HNWI, sophisticated or restricted investors, or who confirm they will receive advice from an authorised person.
So long as a promotion is not classed as a DOFP, however, a platform can freely provide details of:
- the identity of borrower(s)
- the price or target rate
- the term
- the risk categorisation
- a description of any security interest, insurance, guarantee or other risk mitigation measures adopted by the platform.
Investment-based platforms commenting on the proposals noted the difficulties of the inconsistency between the COBS rules on non-mainstream pooled investments and non-readiliy realisable securities. FCA acknowledged the comments, but is taking no further action now as the issues have a wider market impact.
Platforms will also require to carry out an appropriateness assessment in line with the FCA guidance (COBS 10.2.9G) that considers a client’s knowledge and experience of the P2P investment before they can accept an instruction to invest. FCA suggests questions that firms might probe in making their assessment.This should include understanding of a number of warnings (e.g. that all capital is at risk, that the investment is not covered by the FSCS etc).
Wind-down Arrangements and the Resolution Manual
FCA wanted to strengthen its requirements on wind-down arrangements to ensure a "reasonable likelihood" that P2P agreements facilitated by firms that ceased business would continue to be administered. A platform must continue to disclose its wind-down arrangements to investors pre-sale. These arrangements must not be biased towards a particular type of investor. Wind-down arrangement requirements are set out in SYSC 4.1.8 C, and include guidance for firms on the type of arrangements they might put in place.
All platforms must maintain a resolution manual which contains information about the platform in the event of the firm’s insolvency and would assist in resolving the firm’s business of management and administration of the P2P agreements it has facilitated. A non-exhaustive list of requirements is included in the rules (including details of critical staff and roles, IT systems, outsourcing arrangements, bank account details etc).
Disclosure Requirements and Contingency Funds
In addition to any other risk warnings that must be given by a firm (including about the role of the plaform, the impact of providing a direct loan to a borrower, the nature of the investment and outcomes expected, and what will constitute default) a firm which offers a contingency fund must include the risk warning (set out in 18.12.33R) and a copy of the contingency policy in a prominent place on every page of each website and mobile application of the firm containing any reference to a contingency fund, or in a durable medium in good time before the firm carries on business for a lender where a website/app has not been used.
There are additional reporting requirements that must be complied with in relation to contingency funds.
FCA is not currently progressing its discussion on whether there could be additional prudential requirements for P2P platforms, not with its proposal to put in place a standardised disclosure format.