How regulations influence marketplace lending

Marketplace lending (MPL) emerged from the rubble of the global financial crisis. Online communities discovered that lending and borrowing could occur outside the traditional banking sector regulations. Now, over a decade into an era of democratized finance, it’s clear P2P is here to stay.

However, many have questioned how regulations will develop. While some initiatives have been proposed lenders and borrowers alike are unclear on what governing body will prevail and what rules will be enacted.

Here, we look at how regulations have unfolded to date and what new developments we’re likely to see in the future. To better answer these two questions we’ll examine the industry within three regions, Europe, the UK and the U.S.

Europe

A 2016 comprehensive review of marketplace lending across 27 European countries reached some insightful conclusions. Researchers discovered that countries adopting a progressive stance on MPL saw increased volumes in the industry. One clear example of this phenomenon is the UK where registration obligations and tax reliefs are designed to be more welcoming of P2P firms.

However, this finding is based on limited data due to another finding; data on volume totals in countries is scarce. This has prompted many to call for increased transparency. This open information approach will be particularly important for countries with a cross border presence. This kind of geographic reach has made several firms successful but investors are looking for more data of recoveries and defaults.

How are regulations answering these calls? An advocacy group called the Marketplace Lending Association has formed to encourage uniform practices within MPLs. The main areas of reform they’re seeking are:

  • Transparency: Accuracy in loan performance data and historical returns.
  • Responsible Lending: Avoiding Payday Loan practices & protect borrower rights.
  • Safety: Proving liquidity cash reserves and business contingency plans.
  • Governance & Controls: Keep investor and operating funds separate.
  • Risk Management: Customer authentication and anti-money laundering.

For now these are recommended guidelines. Legislation has not yet made all of these parameters the rule of law. Those participating in MPL today can expect future regulations to resemble this list. Some in Europe are looking to the more developed regulatory landscape in the U.S. for guidance.

U.S.

In the U.S. all peer-to-peer firms are required to register with the Securities and Exchange Commission (SEC) which is the regulatory body overseeing all aspects of investments. Early in 2016 The Consumer Financial Protection Bureau (CFPB) started accepting complaints from consumers using MPL sites. The CFPB has stated that all MPL firms are required to comply with state and federal financial protection laws. However, as of now the CFPB does not conduct direct oversight of the MPL industry.

In the future, the Department of the Treasury will likely create more robust standards for MPLs. They began this initiative in 2015 when they sent out a Request For Information (RFI) seeking input from consumers, small businesses and the economy. Using data from this RFI the Treasury will build a framework for regulations. Some areas that the Treasury will likely make their focus include:

  • Securing digital information of lenders and borrowers.
  • Expanding credit offerings to currently underserved markets.
  • Accuracy and thoroughness in credit risk measurements.
  • Maintaining fraud detection.
  • Improving safeguards against cyber threats.
  • Monitoring success of collection efforts.
  • Openness in sharing default data and general transparency.

As regulations emerge the Treasury is likely to also turn to the United States Government Accountability Office (GAO) which has conducted research on marketplace lending risks. In one of their earlier reports the GAO found that additional protections might be needed for borrowers. Some loan applications require so much information that the borrower’s identity may be discoverable by others.

At the same time, agencies agree that a certain level of information on borrowers must be provided to lenders so they can make sound risk assessments on their investments. Future regulatory changes will address these concerns.

UK

Marketplace lending has its origins in the UK. The first P2P firm came from Great Britain. With a longer history the country has had more time to build a framework for regulation. In 2014 the Financial Conduct Authority (FCA) began regulating this industry. “Our focus is ensuring that investor protections are appropriate for the risks in the crowdfunding sector while continuing to promote effective competition in the interests of consumers,” remarked the FCA CEO.

This organization has the most stringent and direct oversight of any group in the U.S. or Europe. In some cases the FCA has issued communication to UK P2P firms with explicit warnings regarding their conduct. For example, in the first quarter of 2017 the FCA told marketplace lenders that firms borrowing funds must first have a license to take deposits. Though the act is illegal on the side of the borrowers the P2P firm is also responsible since they’re permitting the act.

After concluding a 2016 inquiry the FCA proposed the following rules:

  • Side by side P2P comparisons must be made simpler.
  • Risks must be clearer and more finely measured.
  • Promotions must be more transparent regarding risks.
  • Risks arising from new complex structures must be explained.
  • Provision funds must be acknowledged as they can mislead on risk.
  • Contingency plans must be drafted for P2P firms that go bust.

The general conclusion of the FCA CEO was “we believe it is necessary to strengthen investor protection in a number of areas.”

The limited regulations across the U.S., UK and Europe illustrate how young the industry is. For the moment this fact puts a lot of burden on the consumer to investigate the risks and rewards of different MPLs. However, this is also difficult given that some MPLs don’t offer enough data for the investor to make an informed decision. For this reason we’ve always worked to keep our users in mind when creating transparency and clarity regarding interest payments, risks, originations, portfolio performance, defaults and recoveries.