In­vest­ment or casino bet: how safe is peer-to-peer?

Sev­eral in­no­va­tive lenders are stuck in reg­u­la­tory limbo, finds Adam Wil­liams as he in­ves­ti­gates a fast-grow­ing sec­tor

The Daily Telegraph - Your Money - - FRONT PAGE -

Dis­il­lu­sioned with low in­ter­est rates at high street banks, hun­dreds of thou­sands of hard­pressed savers have turned to peer-to-peer (P2P) in­vest­ment in re­cent years. Yet there are on­go­ing con­cerns over the level of risk and qual­ity of some providers, prompt­ing the City watch­dog to im­ple­ment new rules to en­sure in­vestors are not short-changed.

P2P lets in­di­vid­u­als lend money to com­pa­nies and oth­ers, earn­ing in­ter­est from the bor­rower. It is of­ten seen as a halfway house be­tween cash sav­ings and tra­di­tional in­vest­ment, but the risks in­volved are more akin to the lat­ter.

While cash sav­ings of up to £85,000 are pro­tected through the Fi­nan­cial Ser­vices Com­pen­sa­tion Scheme, any money di­rectly in­vested in P2P is at risk if the bor­rower on the other side fails to re­pay.

There is ad­di­tional dan­ger if the plat­form it­self col­lapses and, given the fledg­ling in­dus­try has yet to weather a fi­nan­cial cri­sis of any kind, in­vestors must also be aware of this “plat­form risk”.

Even though the Fi­nan­cial Con­duct Author­ity (FCA) has reg­u­lated the sec­tor since 2014, a num­ber of providers have yet to be fully au­tho­rised de­spite their re­peated at­tempts. As many as five ac­tive firms have so-called “in­terim per­mis­sions” and are able to take con­sumers’ cash, even if they have lit­tle chance of be­ing fully au­tho­rised in their cur­rent state.

A Free­dom of In­for­ma­tion re­quest sub­mit­ted to the FCA by Tele­graph Money showed that firms have re­peat­edly ap­plied for au­tho­ri­sa­tion but have with­drawn their ap­pli­ca­tions when it be­came clear there was lit­tle prospect of suc­cess. Of the 388 ap­pli­ca­tions for au­tho­ri­sa­tion sub­mit­ted since Oc­to­ber 2016, 312 have been with­drawn but none re­jected.

Re­ject­ing the firms’ ap­pli­ca­tions out­right would force them to cease trad­ing im­me­di­ately and would put in­vestors’ cash at risk, an out­come that the reg­u­la­tor would find dif­fi­cult to jus­tify, no mat­ter how un­suit­able the firms are.

How­ever, the FCA is cur­rently undertaking a ma­jor re­view into the en­tire P2P sec­tor and is con­cerned about the way some firms con­duct their busi­ness. Such are the risks in­volved, it wants ev­ery­day cus­tomers to be lim­ited to in­vest­ing 10pc of their cash in this way.

It fears that cus­tomers are be­ing left in the dark about what they are re­ally in­vest­ing in, and how much risk that in­volves. One fi­nan­cial ad­viser likened in­vest­ing through cer­tain P2P com­pa­nies to gam­bling in a casino.

Ju­lia Groves of the Down­ing Crowd plat­form said high-qual­ity firms were “cry­ing out” for greater su­per­vi­sion of the in­dus­try to help weed out any bad prac­tice.

Hid­den risks

The P2P sec­tor has bal­looned in re­cent years and, while no cross-in­dus­try data ex­ists, it is thought around 200,000 ac­counts have been opened.

De­spite their short ex­is­tence, many firms have over­hauled their busi­ness mod­els since launch. Orig­i­nally, providers let in­vestors choose ex­actly where their money would go, with cus­tomers choos­ing projects or in­vest­ment op­por­tu­ni­ties that ap­pealed to them. To­day the vast ma­jor­ity of P2P com­pa­nies “auto pick” for their cus­tomers, choos­ing which in­di­vid­u­als to in­vest in on their be­half.

How­ever, there are fears that this poses a con­flict of in­ter­est for some firms, who are re­spon­si­ble for both pric­ing the risk of dif­fer­ent loans, and then al­lo­cat­ing in­vestors’ cash be­tween them.

De­spite its ap­peal to many tra­di­tional savers, Blair Cann of M

Thur­low & Co, a fi­nan­cial ad­viser, said he would not rec­om­mend P2P to his clients, who typ­i­cally have an av­er­age at­ti­tude to risk.

“You are in­vest­ing in in­di­vid­u­als who, in many in­stances, were un­able to get a loan else­where,” he said. “Some providers may be less risky but we don’t like it on prin­ci­ple.

“If I had high-risk clients who were will­ing to go for P2P in­vest­ing or go to the casino and bet the lot on red, then we may be ac­tive in the mar­ket.”

Lack of dis­clo­sure has re­peat­edly been high­lighted as an is­sue by the reg­u­la­tor. Many P2P providers do not clearly dis­play how risk is cal­cu­lated, or the fees they charge bor­row­ers. This can make it im­pos­si­ble for in­vestors to make in­formed choices.

“A key con­cern is the sig­nif­i­cant gaps be­tween the rate the bor­rower pays and the in­ter­est rate lenders earn on their money,” added Ms Groves. “In­vestors should choose a provider that clearly dis­closes fees and, bet­ter still, makes those fees con­tin­gent on per­for­mance.”

Ian Gatenby, 60, was at­tracted to P2P by the high re­turns on of­fer. The con­sult­ing en­gi­neer from Wem, Shrop­shire in­vested £50,000 with Oc­to­pus In­vest­ments but be­came wor­ried that 8pc of bor­row­ers were late re­pay­ing their loans.

“It wor­ries me about how safe the loans are, given they are in­di­vid­u­als you don’t get to see,” he said. “It is blind faith that the provider is do­ing its job prop­erly.

“In fu­ture I’d find some­where else to put my money.”

Oc­to­pus told Tele­graph Money its sys­tems were ro­bust and said it in­vested its own money in ev­ery P2P loan.

The reg­u­la­tor is also con­cerned that in­vestors may be­lieve they are pro­tected against losses when a plat­form has a “pro­vi­sion fund”. These small funds cre­ate a false sense of se­cu­rity for in­vestors. Rather than pro­tect­ing in­vestors’ cash in the event of a wide­spread col­lapse, these funds would only be able to cover mi­nor losses.

One of the big­gest plat­forms, Zopa, de­cided to close its pro­vi­sion fund last year, cit­ing changes in tax rules that made it eas­ier for in­di­vid­u­als to off­set any losses.

To pro­tect in­di­vid­u­als, the reg­u­la­tor has pro­posed a limit on how much ev­ery­day in­vestors can pour into P2P.

Those who are not ex­pe­ri­enced in­vestors or high net worth in­di­vid­u­als would be barred from in­vest­ing more than 10pc of their wealth in this way.

Ms Groves said: “A quick ‘so­phis­ti­ca­tion’ test is not hard to do when you first sign up to a crowd­fund­ing site. For those who don’t pass, this just isn’t an ap­pro­pri­ate in­vest­ment.”

The FCA’s in­dus­try con­sul­ta­tion will close later this month, with the reg­u­la­tor ex­pected to pub­lish its fi­nal rules in spring 2019.

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