Regulating peer to-peer and alternative finance - sdj
REGULATING PEER-TO-PEER AND ALTERNATIVE FINANCEACCA Alternative Finance Conference 2013 Simon Deane-Johns Keystone Law
Agenda• Peer-to-peer finance – Types – How they work – Common features – Operational risks and controls• Other forms of alternative finance – Supply chain finance – Marketplace finance• Regulatory barriers and options for removal
How P2P Finance Works Transaction Flow Offer/acceptance => Loan agreementLender Borrower Share/debenture Offer/acceptance => Investment agreement Investor Entrepreneur Platform Operator platform agreement platform agreement Lender/Investor’s Platform Operator’s Borrower/Entrepreneur’s Bank Bank (Seg. Account) Bank
How P2P Finance Works Funds Flow Loan agreement Lender Borrower Share/debenture Investment agreement Transfer request Investor EntrepreneurTransfer request Platform Operator platform agreement platform agreement Funds Transfer Disburse Loan/Investment Funds Transfer Repayment/dividend Lender/Investor’s Platform Operator’s Borrower/Entrepreneur’s Bank Bank (Seg. Account) Bank
Common P2P Features• Platform operator not a party to instrument agreed between participants – Segregates participants’ funds rather than treating them as own assets; – Margin stays with the participants;• Online only –> low cost –> lower fees• Low minimum commitment – Accessible to retail customers (may be subject to questionnaire and/or cap); – Aids diversification of small investment amounts; – Finance from many in small amounts at outset –> no need to securitise;• Centralised data aids risk assessment, performance analysis, enforcement
Standard Operational Risks• Lack of adequate internal controls, governance – Financial mismanagement, operator insolvency; – Internal fraud; – Lack of system integrity/availability; – Lack of business continuity; – Failure to manage/respond appropriately to customer complaints; – Unclear, unfair or misleading promotions/communications.• Basic credit or investment risk• Money laundering, external Fraud
Common P2P Operational Controls• Senior management systems and controls;• Minimum working capital;• Segregation of participants’ funds;• Clear, fair and not misleading service terms/communications/promotions;• Secure and reliable IT systems;• Fair complaints handling;• Orderly administration if platform ceases to operate;• Appropriate risk assessment, AML and anti-fraud measures• Extra measures appropriate to specific instruments
Other Forms of Alternative Finance• Supply chain finance – Funding the early payment of single invoices or batches of invoices – Shifting the credit risk from supplier to buyer – Crowd-funding individual invoices?• Marketplace finance – As part of end-to-end e-commerce marketplace service – Independently of marketplace service – Crowdfunded?
Regulatory Barriers - Overview• Exclusive framework limits types of products, suppliers, intermediaries and activities• Reinforced by guarantee of bank liabilities, Financial Services Compensation Scheme, personal tax rules and savings incentives• Related silos of officials/regulators with powers focused inwardly, and no overriding supervisory powers, responsibility or accountability for how the ‘system’ works as a whole, either internally or in terms of external impactExclusive, rigid, self-reinforcing, officially-endorsed marketing environment creates super-normal profits for incumbents and limits innovation and competition
Barriers for Platforms• Confusion over what is lawful – Slight change in facts has big consequences, EU Directives overlap – Different rules for ‘promoting’ vs ‘offering’ a security; – Unregulated operators may still face rules on public offers and promotions; – Expensive in terms of advice + regulatory creep – Slows time to market• High net worth investor limits – Limits accessible market, liquidity• Incumbent competitors heavily subsidised – State guarantee of bank liabilities, – Financial Services Compensation Scheme – personal tax rules and savings incentives
Barriers for Entrepreneurs• Confusion over what is lawful – Which platform to list on?• High net worth investor limits – Limits accessible market, liquidity• Disincentives for ‘ordinary’ lenders/investors to engage with alternative finance and diversify – Inhibits trend towards customers directly supporting projects – Limits accessible market, liquidity
Barriers for Lenders/Investors• Confusion over what is lawful – Lending or investing in the course of a business? – Easier to give or gamble money away than to receive repayment with interest or a share in the business!• Disincentives to engage with alternative finance – Not available via ISAs – Can’t deduct bad debt before tax, distorting effective tax rate (unlike a bank) – Inhibits diversification beyond cash deposits and some regulated bonds/shares – Deprives consumers of return on savings
Regulatory Options• New regulated activity of “operating a Platform” – Rules similar to Operating Principles of the P2PFA; – ‘hybrid’ businesses and small firms (e.g. Payment Services)• Specific exemptions - clarify meaning of “business” - remove EU overlap - ease rules on promotions, offers to public via Platforms;• Issue permissive guidance where changes can’t easily be made;• ISA-status on instruments available via regulated Platforms;• Remove bad debt tax distortion for instruments available via regulated Platforms.• Ensure framework is joined-up and permeable/responsive
Thank you Twitter: @sdjohns Blog: Pragmatist http://sdj-pragmatist.blogspot.comBlawg: The Fine Printhttp:// sdj-thefineprint.blogspot.com
A particular slide catching your eye?
Clipping is a handy way to collect important slides you want to go back to later.