Navigating regulatory headwinds

The Financial Conduct Authority (FCA) has a tough job ahead when it comes to regulating the P2P sector effectively, says Jay Tikam, former regulator and managing director of alternative finance advisory Vedanvi

Recently we have seen the FCA reach out to Cambridge University to get better objective research on the P2P market, while the Peer-to-Peer Finance Association released a study indicating that the UK’s P2P sector can withstand a downturn without further regulation. But every P2P professional knows that regulation is coming and it is up to each individual and company to be properly prepared.

The FCA is carrying out a planned review, assessing the need for tighter regulation as this innovative sector matures to join mainstream lending markets. The regulator needs to finely balance the fostering of an innovative environment with adequate consumer protection – a tough job indeed.

Clearly, the P2P finance sector is joining the rapidly expanding alternative finance sector and filling a colossal void left behind by banks in retail, SME and real estate lending.  The birth of this innovative sector is undoubtedly contributing to the health of the economy and changing the lives of end borrowers. 

But this market hasn’t experienced a downturn yet, so no one knows how it will emerge through one.  All markets are subject to timely correction and the P2P market is no exception.

With greater institutional involvement, regulators are keeping an eye out for the potential of the P2P sector to pose a threat to financial stability.  Across the pond, P2P lenders raise money in the capital markets and lend it out to the retail market, behaving somewhat like a bank.

Like a newly plastered house, cracks are inevitable until the foundation settles. Take China for example, where unscrupulous players took advantage of an unregulated market to scam thousands of vulnerable investors. 

This reminds me of my past experience as a regulatory supervisor in South Africa.  While leading Basel II in the banking sector through the central bank, I was asked to caretaker the supervision of 21 banks over a period of six months whilst they awaited a replacement. During this time, one of the banks failed and caused contagion risk, taking out another bank ranked just above this one.

The underlying cause of this failure was a lack of corporate governance, which then led to a crisis of confidence, which in turn led to a mass exodus of deposits (initially corporate then retail), causing a liquidity crisis, forcing the banks to fail.

Now admittedly, the P2P sector doesn’t face liquidity risk in the same way a bank does, however, it is exposed to the same corporate governance risks banks are – and who knows, this sector could also experience contagion risk if investors seek the safety of the larger banks, even if it’s just to seek shelter amidst a heavy thunderstorm in the P2P sector.

Corporate governance is one of these nebulous concepts that is hard to define and is better experienced by its lack rather than when it is functioning perfectly.

It’s not uncommon for wildly successful and rapidly growing firms to meander towards self-sabotage.  This behaviour often manifests itself in a breakdown in corporate governance.

So whether it’s the industry itself or the regulator, sound advice to this industry is to police signs of weakening culture that lead to a breakdown in corporate governance.  Rather than more regulation, the trade body or the regulator should check in at the corporate governance level through proactive dialogue, thematic reviews and a proactive watching brief.  This is especially true when it comes to the rapid growth of the P2P sector.