The lack of an industry-funded compensation mechanism along the lines of the Financial Services Compensation Scheme (FSCS), which stands behind the banks, has long been used by some sections of the media, Independant Financial Advisers and sundry other critics as a stick with which to beat the P2P crowdlending sector.
In the absence of such a safety net, people are warned that they could lose all their money and this has frequently been used as an argument to deter investors who might feel tempted to consider Alternative Finance as a means of earning a decent return on their money.
To what extent these warnings have stifled demand, it is impossible to say, but thank goodness enough people have braved them to help make the sector a rip-roaring success for both borrowers and lenders alike. Nevertheless, the question remains: does the industry need some sort of backstop to move into the mainstream?
The subject came up again recently at the recent Lendit Europe conference in London where a number of prominent industry representatives spoke out against the idea of a Compensation Fund, arguing, for a variety of reasons, that such a scheme would not be appropriate.
One reason put forward was that, however you structure the scheme, it is likely that the largest operators would have to put up the most money. In other words, the big and successful would have to subsidise their weaker and possibly less risk averse rivals. As a commercial argument, it has logic in its favour, but from a moral standpoint it is less defensible: there is the matter of the common good.
Far more powerful is the argument that consumers should be equipped in the first place to understand the difference between ‘savings’ and ‘investments’. The FCA, of course, is under no illusions about the difference – as it has forcefully pointed out to any P2P providers that have made the mistake of slipping the word ‘savings’ into their marketing material. P2P is an investment, pure and simple.
Angus Dent, the CEO of ArchOver, argues: “It is up to the lender to judge what level of return they are looking for and the security they seek. The information is all there and the lender must make his or her decision accordingly.”
The crucial point is that you can’t realistically expect an annual return of, say, 7% to provide the same level of security as a return of 0.5%. There is unquestionably an inherent risk with the 7% and, yes, people’s capital could be at risk.
So, can it forever be ‘caveat emptor’ and what if the platform itself fails?
Angus continued: “If the facilitator – for example, ArchOver – runs into difficulties, it doesn’t mean the loan itself has gone bad. Lenders should still be able to recover their money. The FCA has rightly insisted that all P2P facilitators have proper run-off plans, plans that are funded and which are regularly reviewed and updated to meet the changing needs of the business. This is all part and parcel of receiving full permissions from the FCA.”
As ever, it is a matter of communication and education. We are seeing risk adjusted returns of 4%-6% consistently reported over time, provision funds are a common feature and other platforms offer investor security in assets or insurance - yet mass market acceptance is still some way off.
One wonders if an FSCS ‘lite’ is needed to bridge the divide – one that leaves default risk with the lender, but protects against platform malpractice or mismanagement. In this way, the FCA and the industry would be seen to be putting some tangible backing to the authorisation that is so hard earned and that investors are so encouraged to look out for.