Bump in the road: What does platform failure mean for investors?
The peer-to-peer industry suffered a platform failure last month, in the full glare of media attention. Back in 2011, P2P platform Quakle failed. This time around, it was Sweden-based TrustBuddy, which was shut down by the Swedish regulator, with lenders’ money frozen.
The reasons for the failure of these platforms have been widely reported. Quakle is thought to have been brought down by accepting too many poor quality borrowers and not attracting enough lenders. TrustBuddy, on the other hand, is reported to have misused lenders’ capital. New management brought in found “serious misconduct” within the company, and the Swedish regulator required it to suspend its services. The reported allocation of new lender capital to existing bad debt, with some loans unassigned to particular borrowers or lenders, suggests that the previously voiced concerns of some around the lack of client money segregation on some platforms were well grounded.
NECESSARY CAUTION
Both high-profile failures will remind investors of where and why they should be cautious within the P2P and crowdfunding sectors. First, remember that alternative finance industry investors don’t benefit from the same protections as those with savings accounts with a regulated bank or building society. Customers of traditional deposit-taking institutions are protected under the Financial Services Compensation Scheme, currently up to a limit of £85,000, but this does not extend to P2P investments.
Second, remember that the light-touch and incremental approach to platform regulation led to a boom in the authorisation of new platforms over the last two years, particularly in the crowdfunding space, and there is no guarantee that providers of platforms offering other products – like minibonds, for example – are any less varied in term of experience, quality control or attitude to risk.
And if you are accessing an equity-based model, the platform you’re using could suffer the same fate. Equity-based platforms still hold client money, and must therefore comply with the FCA’s Client Money and Assets rules.
Third, you wouldn’t invest without carrying out due diligence on your chosen company. But you should also consider the strength and reliability of the platform itself. In our experience, most platforms take their obligations and responsibilities seriously. But how far have you looked into the regulatory compliance and good practice of the platform you’re investing through? Do you know, for instance, how your investment would be dealt with if the platform were to go bust?
HOPEFUL FUTURE
As the UK government prepares for the inclusion of debt-based P2P and crowdfunded investments in its consumer tax wrapper, in the form of the innovative finance Isa, investors need to be alive to the risks across this new and fast-moving sector. Those using a product labelled as an Isa may assume that it is a safe and protected investment. Retail investors particularly need to take care in choosing a provider, and shouldn’t assume that their money will necessarily be safe. After all, like a stocks and shares Isa, the innovative finance Isa is an investment.
But on a more positive note, a few high profile failures, while potentially disastrous for the investors and companies involved, will hopefully accelerate the evolution of an effective regulatory framework in all jurisdictions – backed by effective monitoring and enforcement.
Imposing a greater burden of regulation on what is seen as a nimble and innovative sector is resisted by some – rushing in stringent regulation could mean that barriers to entry for new platforms could be too high, stymying the growth of the industry. But fortunately, the UK is leading the way in creating regulation tailored to the sector, including rules on client money segregation. The hope is that this will help to weed out some of the weaker players and build investor trust in the stronger ones that remain, justifying government backed initiatives, such as the innovative finance Isa, and the sector’s continuing exponential growth.