For savers and investors, the financial services compensation scheme (FSCS) represents a safety net. Established in 2001 and expanded after the global financial crisis of 2007/2008; it has recovered billions of pounds of consumer money over the past two decades.
Prior to the financial crisis, the FSCS protected just £2,000 of consumer savings, but that has risen to £85,000 today. It is funded by levies taken from all regulated financial services firms which accept customer deposits. The idea is that if one of these financial services firms fails – as Northern Rock did in 2007 – FSCS funds can be tapped to help return any lost money directly to the customer.
However, there are some caveats. The scheme is only available to individuals and small businesses, and any FSCS payments are subject to an investigation, which means that there could be a delay of up to six months on claims payments. Compensation will typically only be paid out if your financial services firm goes into liquidation or if you are advised to take on a financial services product that is unsuitable for you, and causes you to lose money. FSCS cannot be used to supplement investment losses, or to back out of a financial service that you no longer want to use.
Are P2P investments covered under FSCS?
FSCS protection for peer-to-peer lending platforms is quite limited. Money that is actively invested in P2P loans is not covered by FSCS, meaning that loan defaults may lead to the loss of investor capital.
But any uninvested money which is being held on a P2P platform may be protected by FSCS.
Read more: FCA to review compensation limits
P2P firms are not authorised to act as banks by holding cash deposits for their investors, so any uninvested lender money must be held in a third party bank account or an e-money account. If your unlent cash is held in a UK-based bank, your money will be protected in the same way that a regular bank deposit would be protected. Ergo, if the bank collapses, any unlent cash that is being held in an external bank account will be refunded up to the value of £85,000 by the FSCS.
What happens if the P2P platform goes bust?
If the P2P lending platform goes into liquidation, your invested money will not be protected by the FSCS. However, there are other guard rails in place to protect against consumer losses. In 2019, the Financial Conduct Authority (FCA) made it a requirement for all P2P platforms to publish their wind-down plans in an effort to avoid widespread losses if one or more platforms collapse.
“P2P platforms must take reasonable steps to ensure they have arrangements in place to ensure P2P agreements will continue to be managed and administered if, for any reason, the platform ceases to operate,” said the FCA’s then-chief executive Andrew Bailey. “There also needs to be sufficient funding to cover the cost of managing and administering the wind-down; and any third party that is engaged to conduct the wind-down needs to have the appropriate regulatory permissions.”
While P2P platforms are not covered by FSCS, these wind-down rules ensure that investors won’t be financially disadvantaged if the platform goes bust. As ever, the key risk in P2P lending is that the borrower defaults on a loan payment.
What happens if a loan defaults?
Investments in defaulted loans are not covered by FSCS, in the same way that FSCS protection doesn’t cover investment losses. The risk of loss should therefore always be factored into an investment decision.
Some P2P lending platforms have maintained an impressive ‘zero loss’ track record by maintaining strict credit policies and monitoring loan performance closely. While past performance is no indication of future results, it is wise to check a platform’s track record on default management in order to get a sense of the actual risk to your money. You can read more about how different platforms manage their risk by reading Peer2Peer Finance News.