Client money rules to change for loan crowdfunding platforms
Compliance with FCA regulation can be expensive and time-consuming. The FCA regulates platforms dealing in P2P lending, but not B2B, so, if a platform does both, individual investor money has to be kept segregated from B2B investment.
The purpose of the rule is to protect consumer funds from being misused, however, the “consumer” in a loan crowdfunding situation could be an individual or a business. The FCA has recognised that the status quo does not offer the best consumer protection possible.
The FCA has proposed changes to allow P2P investment to be held in the same client account as B2B investment, which it hopes will tackle the knock-on effects of the current system:
- Compliance with two sets of rules relating to client money creates delay and expense. Increased operating costs for the platform (eg personnel, banking, accounting), inevitably are passed onto the consumer;
- High operating costs deter businesses from entering into the market altogether, which is detrimental to competition; or alternatively,
- Platforms operate regardless but do so in breach of the rules, potentially putting consumer investment at risk, and themselves at risk of enforcement action being taken;
- In an insolvency situation, if P2P and B2B money is held together, the P2P money is subject to a set of rules which do not apply to the B2B money. Separating the money is then time-consuming,leading to delay in returning the money, losing goodwill of consumers and causing additional expense for the platform in the meantime.
The new rules proposed are:
- P2P and B2B money can held in the same client account;
- The platform has to elect to do so, by notifying the FCA, and its lenders;
- he FCA rules for P2P money will then apply equally to B2B investment, simplifying the processes; and
- The election will apply to ALL B2B monies held by that platform.
The crowdfunding community should take note of these proposals. If implemented, competition could increase due to start up platforms emerging in the market, and existing platforms dealing only in P2P lending expanding to include B2B investment (for the definition of P2P and B2B see below in “The detail”).
For platforms already fully compliant, (keeping P2P money separate from B2B), no changes are necessary. However, they may wish to assess whether holding investor monies together could be beneficial from an operational costs perspective.
The FCA has invited comments by 11 February 2016.
“Operating an electronic system in relation to lending” is a regulated activity pursuant to Article 36H of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001/544 and broadly speaking covers P2P lending (not B2B). P2P lending is defined as where the investor and/or borrower is:
- An individual;
- A partnership consisting of two or three persons not all of whom are bodies corporate; or
- An unincorporated body of persons which does not consist entirely of bodies corporate and is not a partnership.
P2P lender’s money is protected by rule 7 of the FCA Client Asset Sourcebook (CASS 7) which says that client money must be segregated form the firm’s own money and other money (including in relation to unregulated B2B agreements).
CFPS will be permitted to hold P2P and B2B money together, bringing B2B monies within the scope of CASS 7, by electing to do so. If an election is made, then all B2B monies held by that CFP have to be held in this way (not just in relation to some of its B2B loans)
NOTE: If CFPs are able to segregate P2P and B2B money accurately at present then there is no need for them to elect and they may continue with their current systems if they wish).
Once the election has been made, all lenders would need to be notified of the change.
The draft amendment to CASS rules recommends a months’ notice is given to the FCA of the election.
CFPs will also need to keep a record of the decision to make the election.
- Where money is held by a CFP, but is not yet invested, this money should also be held under CASS rules (unless it is subject to terms between the CFP and lender that it is never to be invested in a P2P agreement).
- Where loan repayments are made by the borrower to the CFP, the position will stay the same as is currently permitted: all repayment money can be held together in a client bank account on receipt by the CFP, and any B2B monies are removed at the CFP’s next daily reconciliation.
- Some CFPs would like to segregate B2B monies, however, the proposal as the FCA has presented it is that when an election is made to allow both P2P and B2B monies to be held together, this should apply to all B2B monies. In the event that a firm would like to keep certain B2B monies separate, it can use an express trust, which means that B2B lending would be held separately under the terms of a trust deed and any distribution will be governed by the same (so wouldn’t be subject to the pooling and distribution rules within CASS).
Article written by:
Senior Associate at Rampart Corporate Advisors Limited