REGULATING PEER-TO-PEER AND

ALTERNATIVE FINANCE

ACCA 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

Types of P2P Finance

Crowdfunding charities/social

Crowdfunding Donations/rewards

P2P lending Consumers/SMEs

Crowd-investing

Other (e.g. invoices)

Microfinance

Crowd-investing Debentures Crowd-

investing Equities

P2P Payments (e.g. Foreign

exchange)

How P2P Finance Works

Transaction Flow

Lender/Investor’s Bank

Platform Operator’s Bank (Seg. Account)

Borrower/Entrepreneur’s Bank

Lender

Investor Entrepreneur

Borrower

Platform Operator

Offer/acceptance => Loan agreement

Offer/acceptance => Investment agreement

platform agreement platform agreement

Share/debenture

How P2P Finance Works

Funds Flow

Lender/Investor’s Bank

Platform Operator’s Bank (Seg. Account)

Borrower/Entrepreneur’s Bank

Lender

Investor Entrepreneur

Borrower

Platform Operator

Loan agreement

Investment agreement

Tran

sfer

requ

est

Funds Transfer Disburse Loan/Investment

Repayment/dividend Funds Transfer

Transfer request

platform agreement platform agreement

Share/debenture

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 impact

Exclusive, 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

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