Platform Lending

Overview

  • Marketplace lending is often described as one of the most significant developments in fintech, although its basic elements are not new. From a lending-product perspective, consumer peer-to-peer loans are typically unsecured, amortizing loans, very similar to personal installment loans provided by traditional lenders such as banks and finance companies.
  • From an investment perspective, the concept of investing in loans made by another lender also is not new, given the range of arrangements—such as loan securitization—that have allowed third-party investment long before marketplace lending developed. The key innovation represented by marketplace lending and facilitated by technology—specifically by online platforms—has been to give prospective borrowers, particularly consumer borrowers, access to potential lenders that they did not have before. As a result, it can offer alternative sources of funding for consumers to more traditional channels. Similarly, from a lender/investor perspective, and particularly from a consumer investor perspective, it has given consumers access to investment opportunities in loans that they formerly did not have.
  • Many terms have been used internationally to describe this form of lending – for example: marketplace lending, peer-to-peer lending, loan-based crowdfunding, crowdlending, social lending etc. –encompassing many business models.

Provision of credit facilitated by online platforms that match borrowers with lenders, encompassing a spectrum

Provision of credit facilitated by online platforms that match borrowers with lenders, encompassing a spectrum

Platform Lending

Risks for both lenders and borrowers

RisksPossible regulatory approaches

Conflicts of interest: Conflicts of interest between operators (or their related parties) and lenders/investors or borrowers may lead operators to engage in conduct not in the interests of consumers – for example:

  • Imprudent lending assessments.
  • Unfair or inappropriate loan pricing or allocation.
  • Intra-platform arrangements favoring related parties over consumers. See Country Examples

    As a credit licensee and a financial services licensee under Australian legislation, a peer-to-peer lending operator would be subject to obligations to: (i) have in place adequate arrangements to ensure that its borrower clients are not disadvantaged by any conflict of interest that may arise wholly or partly in relation to credit activities engaged in by the operator or its staff or agents (ii) have in place adequate arrangements for the management of conflicts of interest affecting lenders/investors arising from the operator’s, or their staff or agents’, provision of financial services.

    In the United Kingdom, one of the “Principles for Businesses” applying to all authorized firms would require a peer-to-peer lending operator to manage conflicts of interest fairly, both between itself and its customers and between customers.

    The new EU regulation on crowdfunding (including peer-to-peer lending for business purposes) requires an operator to maintain and operate effective internal rules to prevent conflicts of interest and to take all appropriate steps to prevent, identify, manage, and disclose conflicts of interest between the operator, their shareholders, their managers or employees, and other related parties and their clients, or between one client and another client.

  • General conflict-mitigation obligations on operators: A key mitigant would be to require marketplace lending operators to implement adequate policies and procedures and effective organizational and administrative arrangements designed to prevent conflicts of interest from harming the interests of their clients.
  • Targeted obligations regarding fair loan pricing and fees and charges policies consistent with consumers’ interests.
  • Creditworthiness assessment obligations on operators regardless of whether they are the lender of record.
  • Restrictions on operators or associates investing in loans facilitated by their platforms.
  • Best interests duties.

Fraud or other misconduct: Consumers may suffer loss due to:

  • poor conduct or outright misconduct by marketplace lending operators, including by their staff, their management, or service providers acting on their behalf.
  • Negligence or lack of competence of marketplace lending operators, their staff or agents.
  • Due to a customer’s lack of ability, or information, to be able to assess the competence and integrity of the marketplace lending operator with which they are considering dealing.

Note: Such risks are not unique to marketplace lending, but various aspects of marketplace lending’s development, and its relative novelty, can contribute to their increase. See Country Example

The EBA made the point that it might be difficult for lenders/investors and borrowers in a particular jurisdiction to find independent information about the reputation of platforms where operators do not require regulatory permissions to operate platforms and are not subject to legal information or disclosure requirements.

In China, prior to recent reforms, it was frequently highlighted that there had been low barriers to entry, meaning the quality of sector participants varied significantly, creating major risks for participants. By the end of 2017, following a significant tightening of regulation (which some have criticized), 3,600 platforms had already discontinued operations, as many had difficulty in meeting clients’ demands for cash withdrawals or had management abandon the business.

  • Licensing/registration, vetting and competence requirements (but mere registration, simply involving recording information about entities without any form of entity vetting, is unlikely to be sufficient to address relevant risks). EBA notes

    The EBA notes that additional measures could comprise checking that the individuals managing a platform meet appropriate standards for competence, capability, integrity, and financial soundness. This should be the case both when first applying for authorization and on an ongoing basis while they continue to be authorized.

    The Reserve Bank of India requires peer-to-peer lending operators to ensure that they meet fit and proper criteria at the time of their appointment as well as, importantly, on an ongoing basis. Periodic reporting to the regulator on such matters is required as well as supporting declarations and a deed of covenant.

  • Subjecting marketplace lending operators to obligations to have in place adequate risk management and governance arrangements. See Country Examples

    In the United Kingdom, peer-to-peer lending operators are subject to several overarching obligations (known as the “Principles for Businesses”) that apply to authorized firms, one of which is that they must take reasonable care to organize and control their affairs responsibly and effectively, with adequate risk management systems. Drawing from this principle, the FCA expects operators to have effective processes to identify, manage, monitor, and report the risks they might be exposed to and to have appropriate internal risk-control mechanisms.

    Mexico’s Financial Technology Institutions Law similarly makes demonstrating implementation of controls for operational risk a key aspect of being authorized as a peer-to-peer lending operator, as well as more specifically fraud prevention.

  • Obliging marketplace lending operators to segregate client funds and deal with them only in prescribed ways could also assist in addressing risks of loss in this context (see related discussion under e-money).
  • Some authorities and commentators had considered compensation funds as a potential mitigant. However, their adoption for marketplace lending does not seem to be widespread, so it is difficult to discuss emerging approaches as to their structure or operational arrangements.

Platform / technology unreliability or vulnerability: Consumers frequently face some risk of harm or loss from:

  • Interruptions or failures in a financial service providers’ systems and processes; in a marketplace lending context, the risk may be significantly higher, given the extent to which lenders/investors and borrowers rely on an operator’s systems and technology.
  • Platform malfunctions or delays, unavailability of systems, networks, or data and loss of data integrity.
  • Third-party fraud due to vulnerability to cyber risks, especially where services have been outsourced.

Note: A working group of BIS’ Committee on the Global Financial System noted that fintech credit platforms may be more vulnerable than banks to certain operational risks, such as cyber risk, due to their reliance on relatively new digital processes.  The extent of such risks to platforms is likely to depend on a number of factors, including the platform operators’ level of sophistication, mechanisms used for storing client information, and the robustness of cybersecurity arrangements.

  • General risk management and governance arrangements requirements for operators.
  • Targeted risk management and operational reliability requirements for technology-related risks and outsourcing. See Country Example

    The RBI’s rules for marketplace lending operators set out obligations for operators to ensure sound and responsive risk management practices for effective oversight, due diligence, and management of risks arising from outsourced activities. Ensuring that operators remain legally responsible to consumers for outsourced functions can also assist—as provided, for example, by the new EU regulation on crowdfunding (including peer-to-peer loans for business purposes).

  • Specific competence requirements relating to technology-related risks. See Country Examples

    In Indonesia, OJK requires a marketplace lending operator to meet obligations with regard to its information technology and the security of that technology, risk management, and resilience to system interference and failures. Detailed requirements prescribed by OJK include rules on establishment of a disaster-recovery center, acquisition and management of information technology, and incident management and implementation of security measures.

    China’s Interim Measures for the Administration of the Business Activities of Online Lending Intermediary Institutions require registration, testing, and implementation of marketplace lending platforms’ information systems that are appropriately reliable and secure. The Interim Measures specify a range of matters that must be addressed by operators, such as firewalls, intrusion detection, and data encryption as well as broader concerns with regard to information-technology risk management and resourcing.

Business failure or insolvency of platform operator:

  • A consumer lender/investor may risk losing their committed loan principal, or repayments owed to them, that are being held or administered by a marketplace lending operator who goes insolvent or fails.
  • Borrowers can also face risks of losing funds under such circumstances.
  • Individual lenders/investors may suffer loss in the event of a marketplace operator’s business failure even if their assets are ring-fenced from the operator’s insolvency. See Country Example

    Both the International Organization of Securities Commissions and the European Commission have highlighted research that points to business failure and platform collapse as some of the biggest perceived risks for investors and, to some extent, borrowers, associated with peer-to-peer loan. Business cessation can mean that even individual loans that remain viable may not continue to be administered properly, causing corresponding loss.

    As the UK FCA explains, even if the platform fails, existing loans and investments still need to be administered: repayments or dividends need to be allocated appropriately among lenders/investors, and late payments by borrowers have to be followed up on. This is even more difficult and complex where an individual’s investment is across a portfolio of loans to which rights are also held by others.

  • Operators required to segregate consumers’ funds and deal with them only in prescribed ways. See Country Examples

    • A range of regulators have mandated that marketplace lending platforms administer segregated accounts within which to hold investor and borrower funds. Both the RBI in India and OJK in Indonesia have mandated that marketplace lending platforms operate escrow accounts for this purpose. The Indian regulator requires separate escrow accounts (to be held in trust with banks) for funds received from lenders/investors pending disbursal to borrowers and funds collected from borrowers. All fund transfers in each direction are required to be undertaken through bank accounts. The Indonesian regulator requires having “virtual” accounts for each lender/investor as well as each borrower. In Korea, new marketplace lending legislation also requires that operators keep investment funds and loan repayments separate from their own funds and hold these at a bank or other appropriate institution.
    • The European Commission’s new regulations for crowdfunding (including peer-to-peer lending) would allow marketplace lending operators, or their third-party providers, to hold client funds and provide related “payment services” only if the relevant entity is a regulated payment service provider. Otherwise, the marketplace lending platform arrangement would need to operate on the basis that client funds are dealt with through regulated third-party payment service providers.
  • Client money-handling requirements that specify how, and within what time frames, funds must be transferred to lenders/investors from borrowers (for example, as repayments are made) and to borrowers from lenders/investors (for example, at loan-funding stage). See Country Example

    For example, the Brazilian authorities require—in addition to the keeping of escrow accounts—that funds be transferred to lenders/investors within one day of funds being paid by borrowers and to borrowers within five days of funds being made available by lenders/investors, and to be segregated until such transfers are made.

  • Operators required to have in place business continuity and resolution arrangements when the operator can no longer manage the business. See Country Examples

    In France, platform operators are required to enter into a contract with a third-party payment institution to ensure such business continuity. To address relevant risks in the case of permanent, rather than temporary, platform failure, the EBA suggests that the platforms should be required to have resolution plans in place, to allow loans to continue to be administered.

    In the UK the FCA requires a marketplace lending operator to have arrangements in place to ensure that peer-to-peer loans will continue to be managed and administered on an ongoing basis and in accordance with the contract terms even if the platform ceases to carry out those functions. The FCA has issued detailed rules and guidance, including requiring operators to prepare and maintain a manual containing information about their operations that would assist in resolving the platform in the event of its insolvency – a so-called “P2P resolution manual” - similar to that required for so-called living wills required for systemic important financial institutions.

  • Recordkeeping requirements to support business continuity. See Country Example

    • For example, marketplace lending operators in the United Kingdom are subject to general requirements, as authorized firms, to keep orderly records of their business, including all the services and transactions undertaken. These must be sufficient to enable the FCA to monitor their compliance with all client obligations. Relevant to the risk discussed here, the FCA points out that such recordkeeping must adequately reflect and support the complexity of its business model, expressing an expectation that the granularity of information about individual clients’ investments holdings should be immediately retrievable.
  • Vetting and competence requirements on operators and related parties.
Platform Lending

Additional risks for borrowers

RisksPossible regulatory approaches
Borrowers not receiving adequate information to understand rights and obligations under peer-to-peer loans, including if marketplace lending is not adequately covered by existing credit disclosure/transparency requirements.
  • Apply credit-disclosure requirements to operators even when they are not the lender of record.
  • Address gaps in existing borrower-disclosure regimes.
  • Borrower disclosure approaches already in the context of digital microcredit.