Regulate To Accumulate

An FCA paper was released this week that unsettled large swathes of the fintech sector.

The paper states that the regulator is looking to apply the same restrictions to peer-to-peer lenders that it does to high-risk investments, such as equity crowdfunding. This is big news in alternative finance.

Since the ‘08 crisis, P2P has emerged as a mainstream funding source for businesses and a boon for savers wanting a little more bang for their buck. 2016 saw £1.2bn of loans made to small businesses via P2P platforms, making up 15% of all SME loans by banks, proving that P2P is truly significant, no longer a fringe movement. It’s now a mature, vital part of UK financial services.

To maintain growth, P2P leaders say competition and the ability to attract investors are of utmost importance, which is why the paper was met with consternation. Paul Smee, P2PFA chair, said: “Peer-to-peer lending needs to make its full contribution to the growth of the UK economy and we will be working to ensure that new regulatory requirements do not get in the way.”

To label regulation as “getting in the way” is disappointing. It’s a rebuttal we’ve come to expect from some in the fintech community, one that’s made by “innovators” who feel like men in suits are cramping their style. It’s a response I’m uncomfortable with.

The fintech sector is yet to prove its resilience through a full business cycle. P2P is no exception. It rose from the ashes of the financial crisis and has grown in a climate of cheap money and astronomical growth throughout the fintech sector. The first true test will come when the next – inevitable – downturn hits.

With that in mind, the FCA is being smart, looking to anticipate and test before a turn in the business cycle. Of course, no one can predict the next cyclical setback, but with rates rising and markets nearing the end of a decade-long bull run, it seems reasonable to be prudent.

We forget there was a host of financial innovation in the mid-2000s, with high interest Icelandic bank accounts, mortgage backed securities, and many more shiny innovations and toys that were played with in response to a low rate environment that left savers with an appetite for yield. Whilst they were thought to be uncorrelated to the business cycle, the crisis taught us different. Global mortgages began to correlate and we had armageddon.

Of course, P2P is different. It has done a fantastic job providing savings and fundraising opportunities for borrowers and savers via secure, modern platforms at low cost. But investing in SME loans is not the “right” strategy for all savers, just as spread betting, angel investing and other high risk investment opportunities aren’t appropriate for everyone either.

The FCA is providing a service to the P2P sector. By proactively stress-testing and assessing how it might perform in a downturn, it’s preventing a scenario where a lot of people might lose a lot of money and an industry could be tarnished forever, potentially beyond repair. It’s better to act now than in a time of strife.

It’s vital that fintech never considers itself outside of the regulatory framework. Great businesses and business models are being set up everyday that are exciting and fresh, but they must be willing to comply with regulatory norms. Working with regulators breeds long term success, industry-wide. Working against them brings industry-wide risks.

Our sector needs to recognise that financial service providers sit under the guidance of a regulator, who is there to look out for the interests of consumers, even if the existing letter of the law doesn’t, as yet, take them into account or provide any rules.

Strong fintech companies build models that accommodate that reality and work to improve as and when the regulator updates the framework. The weak – those that don’t last – will enjoy flash-in-the-pan growth before burning out when a downturn hits, defenceless and siloed because they refused to cooperate and embrace regulation.