P2P lending in the EU will no longer be the 'wild west'
P2P Investing is becoming better regulated within the EU. That is a long overdue and welcome thing from our perspective. There have been far too many cases of low quality or completely fraudulent sites being established in the past. That has impacted not just the investors who have lost money in those sites, but also the industry as a whole.
From November of this year, all P2P sites operating in the EU will need to be licensed ‘Crowdfunding Service Providers’. There will be a public register of sites that are fully regulated. Sites will be required to comply with the relevant EU legislation, which can be found here (Regulation 2020/1503).
Below, we have listed the 8 most important ways we think these new regulations will improve the P2P industry and improve your experience as an investor. It was not possible to cover all the new rules, as the legislation is extensive and covers many areas. If you would like to learn more, Law firm Arthur Cox has also provided a good analysis of all the key requirements here.
How will the new regulations make P2P investing better?
Improved loan information
We have often highlighted the poor quality of information provided by many P2P sites. Too often, the only information provided has been a basic description of what the borrower does, a few photos, and the basic terms of the loan. Frequently, loans to companies have been listed without basic financial information such as profit histories and a balance sheet being provided. Under the new laws, commercial borrowers will be required to submit 'key investment information sheets' that outline all the relevant information about each loan, including all specific features and risks. P2P platforms are required to ensure all the information is 'clear, complete and accurate'. Borrowers must provide links to their most recent financial statements, and 3 years of key financial figures. Borrowers must disclose if they have defaulted on loans in the previous 5 years,. Platforms need to provide significantly more detail about the terms of the loan. Required disclosures include the fees to be paid by the borrower, risk mitigations, and the servicing plan in the event of a default.
Protection of cash
The new laws require P2P sites to either become a regulated 'payment service provider' or to outsource the processing and custody of cash to a third party provider of these services. While some larger sites, such as Mintos, plan to obtain the necessary licences, we expect that many more sites will instead work with providers such as Mangopay and Paysera. Why does this matter? Firstly, it ensures that investor funds are properly segregated and professionally managed. If a P2P site fails, investors will be able to access their cash balances quickly and easily. There is also less potential for cash to be stolen due to the additional security measures adopted by payment service providers and limited access to the cash deposits by staff at P2P sites.
No conflicts of interest
Conflicts of interest have led to many bad things happening in the P2P sector over the last 5 years. Some loans made to related parties were clearly fraudulent. In other cases, loans to connected parties have been made without disclosing the connections between the site and the project owners. Under the new rules, no loans can be made that have links to the P2P site, its shareholders, employees, or people linked to them. These rules are likely to cause problems for some sites that were created to provide funding for sister companies within a group. However while these rules may result in some sites restructuring or disappearing, overall we think the ban on conflicts is a very positive move.
Deterrent to criminals
There's no doubt that criminals are attracted to unregulated or under-regulated financial industries. The P2P lending industry has unfortunately had many scams take place over the past years. That's because, to start a site, all that was needed was to create a credible looking website and advertise widely. Now, only regulated sites will be able to lawfully operate in the EU. While in theory scammers could attempt to obtain a licence, we think the amount of effort, cost and transparency required to obtain a licence is likely to act as a big deterrent. Other activities that remain unregulated, such as crypto, ICO's, and NFT's will likely be more attractive.
'Living wills' are mandatory
The EU has adopted some rules introduced by the UK several years ago, requiring sites to publish a 'business continuity plan', often referred to as 'living wills'. This requires companies to put in place arrangements to ensure that in the event of a failure of the company, there will be continued provision of 'critical services' and 'sound administration of agreements'. There are various ways for sites to comply with these requirements. Sites can hire what is known as 'backup servicers', or they may enter into agreements with other similar sites to take over each other's portfolios in the event of an insolvency or other disruption event. Platform failures are one of the most important risks for P2P investors - these measures should help to reduce the time and cost associated with recovering investments from failed platforms in the future.
Most (but not all) P2P sites have provided historic performance data. But the new regulations now specify minimum disclosures that go beyond what most sites currently provide. Sites must now provide 36 months of default histories. While most sites currently do this, they are now also required to publish both expected and actual default rates for each risk grade. This should be very interesting, as few sites have been willing to provide guidance on expected defaults so far. In addition, P2P sites are now required to publish valuations of loans if they expect the borrower to default, and also once the default takes place. No sites have done this up to now - instead they have typically provided just commentary on the loan status, and often this has only been available to investors in that loan. These new rules will help investors better understand what the expected returns are, and whether the sites are achieving their targeted returns over time.
Up to now, the regulation of P2P investments in Europe has differed widely between countries. While some countries such as Germany had very strong regulations that didn't work well for P2P, others such as Estonia had virtually no effective regulations at all. As a result, several scam sites were created and run from there. The EU regulations will ensure that there are minimum standards applied across the EU. Regulators in each country will also need to increase the resources allocated to oversight of the P2P industry.
Public register of approved companies
Later this year, the European Securities and Markets Authority ('ESMA') will begin to publish a list of approved Crowdfunding Service Providers (CSP's). P2P sites will not be allowed to operate legally in Europe after November 2022 unless they hold a CSP licence. Checking that a site holds this licence will be an important part of due diligence that investors should undertake before making any investments with a new site. ExploreP2P will only list sites that have received a CSP licence (or the UK equivalent).
Where to invest
Thinking of adding to your P2P investment portfolio? Then check out our bonus offers page, that contains a list of all the promotions currently being run by P2P sites that would like you to become a new investor.
Our comparison tables list all the reputable sites that are available to investors, by category. You can also find our current Top-10 list of P2P sites.