Andrew Bailey, Esq.

,
Chief Executive: Financial Conduct Authority,
25, The North Colonnade,
LONDON E14 5HS
26 July 2016
Dear Mr Bailey,
I write, further to your oral evidence to the House of Commons Treasury Select Committee last
week, with particular reference to your answers to questions asked by Chris Philp MP, raising
concerns about the risks associated with peer-to-peer lending; a potential incentive mismatch
related to fee structures within the sector; and the issue of reserve funds.
Peer-to-peer platforms exist solely because they create value to consumers on both sides of the
platform: investors are able to earn fair predictable risk adjusted net returns that can outperform
other investment products, whilst borrowers can access fast and flexible finance. Platforms offer
borrowers a form of investment, and explicitly are not an alternative form of savings account:
peer-to-peer products are not positioned as a deposit and nor is there an implicit guarantee.
In responding to one of Mr Philps questions, you cited the differential risk profile between a
deposit contract and that for asset management; it is important that potential investors
understand where peer-to-peer platforms exist on that spectrum. Parliament has recognised that
peer-to-peer lending is distinctive and constitutes a new form of financial services activity
designated in the Regulated Activities Order and recognised as different from both bank deposits
and conventional equity investment products. In considering its approach to peer-to-peer finance,
I would hope that the Financial Conduct Authority would start from first principles, based on
risks and benefits to consumers, recognising that it is neither about banks nor about asset
management. Such an approach would be consistent with policies, publications and
pronouncements made by the Authority.
Whilst it is the case that, within the peer-to-peer lending sector, there are different asset classes
each with their own risk-return profile, overall, peer-to-peer platforms offer a lower risk profile
than stocks and shares with less volatility. Individual platforms, as well as the sector in general,
acknowledge responsibility in ensuring that potential investors are aware of the particular risks
of this form of investment, and are committed to the principles of fairness and clarity.
The Peer-to-Peer Finance Association has been consistent from its outset in arguing for, and
embracing, an appropriate level of regulation to facilitate innovation and the development of this
form of alternative finance, whilst providing protection for consumers. Platforms continue to
work closely with the Financial Conduct Authority on the full authorisation process, and current
regulatory requirements are supplemented by the Associations own Operating Principles,
requiring all members to commit to high standards of business practice as well as exemplary
levels of transparency: details of every single loan originated in the marketplace must be
published. The value of this openness enables individual platforms to be judged on the basis of
the credit risk performance of the entirety of their loan books.
As the growth of the peer-to-peer lending sector and the base of investors and borrowers has
expanded so rapidly, the challenge of ensuring that all participants are fully cognisant of the
nature of the opportunities and risks have intensified, and a process of familiarisation for
consumers is recognised as critical. The sector accepts its responsibility for ensuring that those
investing in peer-to-peer products understand the nature of their investment, and appreciate the
degree of risk incurred. The Association audits the websites of individual platforms frequently,
and feedback is provided. All members are required to publish in full the details of their loan
books to ensure that investors are able to hold platforms to account on credit assessment.
I believe that a degree of mis-understanding has arisen in respect of the structure of fees within
the sector. It is Mr Philps contention that there is a mis-alignment of incentives where those
operating peer-to-peer lending platforms receive fees upfront based on the volume of loans
originated. In your response to Mr Philps question (Question 61 of the session), you suggest that
structuring lending through taking fees upfront creates uncertainties. A significant part of the

fees charged for peer-to-peer lending are earned over the course of the life of the loan, and are not
paid at the outset. Peer-to-peer lending platforms recognise the importance of ensuring that
incentives are not skewed merely in favour of writing loans, irrespective of their long-term
performance: an increasingly significant amount of income comes to the platforms during the
later period of the life of the loans. Platforms do not engage in maturity transformation
The existence and use of reserve funds in peer-to-peer lending is not universal, and specific to
those platforms who have designed them into their business model. Where a peer-to-peer lending
platform decides to create a reserve fund, it is important that investors understand that this does
not infer a guarantee for their investment.
Mr Philps final proposition (Question 62) advocated co-investment of a proportion of a peer-topeer lending platforms loans to concentrate attention on making good credit decisions. As
indicated above, the peer-to-peer lending sector has embraced a level of transparency which is
unrivalled in financial services, and it is possible to make judgements about the calibre of credit
decisions made by each individual platform in respect of their entire loan book through material
which is already published. I would argue that ensuring that investors are empowered to
appraise a peer-to-peer lending platforms credit decisions and performance obviates any
requirement to mandate co-investment. I would observe that it is not a requirement for asset
managers to co-invest, despite incurring greater levels of risk within their investment portfolios.
The Peer-to-Peer Finance Association welcomes the Financial Conduct Authoritys recentlyannounced post-implementation review of crowdfunding rules as an opportunity to ensure an
appropriate balance of regulation between protecting investors and borrowers, without stifling
innovation and competition. It is important that consumers are able more easily to differentiate
between the various levels of risk in the multitude of alternative finance investments and make
informed decisions which reflect their own preferred exposure: for example, an equity-based
crowdfunding product for a start-up enterprise carries a very significantly-greater level of risk
compared with most peer-to-peer lending products. The regulatory regime should reflect these
divergent risk profiles.
I look forward to continuing to contribute to the on-going debate about where the appropriate
balance of regulation should lie. Consumers should receive appropriate levels of protection, but
they also value the improvements which innovation in customer service, credit risk management,
good value products as well as cost and product transparency which have accrued through the
evolution of peer-to-peer lending: opening up this form of loans to retail investors, previously the
exclusive domain of financial institutions.
I hope this is helpful, and am copying this letter to Chris Philp MP, and to Rt. Hon. Andrew
Tyrie MP, as Chairman of the House of Commons Treasury Select Committee.
Yours sincerely,

Christine Farnish
Independent Chair: Peer-to-Peer Finance Association