Online dating services for borrowers and lenders are almost upon us, so what will they mean?

By Gareth Vaughan

Around four applications for licences to run online peer-to-peer lending services are expected to be lodged with the Financial Markets Authority (FMA) over the next month or so.

Licences granted by the FMA will enable successful applicants, effectively as intermediaries, to run websites matching borrowers with lenders and charge fees for doing so.

As Elaine Campbell, the FMA's head of compliance monitoring puts it; "It's a bit like an online dating service. Essentially what they are doing is introducing people wanting to lend money to people wanting to borrow money."

The principal purpose will be to match lenders with borrowers seeking loans for personal, charitable, or small business purposes.

Brave new era

The development of peer-to-peer lending, alongside crowd funding, is part of a new era for New Zealand's financial markets following the passing of the Financial Markets Conduct Act. Campbell says the FMA hasn't yet received completed peer-to-peer licence applications, but has received expressions of interest from people keen to provide this "intermediary" service.

Crowd funding licences will be for entities acting as an intermediary between companies making an offer of shares and investors by providing the facility where the offer can be made to the public. The FMA's expecting about 12 applications for crowd funding licences.

The FMA expects to receive completed peer-to-peer and crowd funding licence applications by the end of April or mid-May. And once it has done so, Campbell says decisions on whether licences are granted will take weeks, rather than months.

Having sprung up during a time of low interest rates, including bank deposit rates, peer-to-peer lending has developed a significant presence overseas through the likes of LendingClub in the US, and RateSetter in Britain. RateSetter now says it plans to be operating in Australia by mid-year.

Not surprisingly peer-to-peer lenders have appeared on banks' radar screens. In Australia Westpac recently invested A$5 million in Australia’s first peer-to-peer lender SocietyOne, in a move the Australian Financial Review suggested was the first equity stake taken by a bank in a peer-to-peer lender anywhere in the world. SocietyOne is currently only open to "sophisticated" investors.

One peer-to-peer firm eyeing a licence from the FMA is Harmoney. Its website says as iTunes changed how people buy music, and Trade Me changed how we buy used goods, peer-to-peer will revolutionise personal loans, "liberating" personal lending by challenging the banks.

"The four Australian owned banks now dominate NZ personal loans. They have the profits to show for it too. For people borrowing money for things like cars, holidays and home renovations, P2P means lower interest rates without the patronising attitude. For investors with $500+ in savings in the bank, it means interest rates of 9% plus, not 3-4%," Harmoney says.

That highlights a clear targeting of a slice of the $108.3 billion sitting in bank term deposits. And it may sound like peer-to-peer platforms will be deposit takers and should be prudentially regulated by the Reserve Bank as deposit taking banks, finance companies, building societies and credit unions are. But there's a subtle difference.

"The primary role of peer-to-peer lending services is to match borrowers to lenders, rather than borrowing and lending money themselves. As such they are not, in general, deposit takers," a spokeswoman for Commerce Minister Craig Foss says.

The FMA's asking licence applicants whether they are a registered bank, non-bank deposit taker, or licensed insurer because it has a statutory duty to consult the Reserve Bank if such entities apply. But the FMA isn't aware of any bank, non-bank deposit taker, or licensed insurer that intends to apply for a peer-to-peer or crowd-funding licence.

Who decides what the interest rates are?

In terms of who decides what interest rates will be charged and paid via peer-to-peer platforms, Foss' spokeswoman says the service providers, plus their borrower and lender users, will determine this. Loans must be legally binding and enforceable.

Peer-to-peer service providers must have "adequate and effective" processes and controls for conducting background checks on borrowers and assessing the risks of non-payment, such as via a credit check. They will also have to publish information about the rate of default by borrowers in a "fair, clear and transparent" manner. And they must have a clearly disclosed, and effective, debt collection process.

In a world of increasing regulation for banks, finance companies, insurers and KiwiSaver schemes, the peer-to-peer regulatory regime looks more light handed.

Directors and senior managers of peer-to-peer operators have to be "fit and proper persons." The FMA will assess good character based on integrity, probity, trustworthiness and reputation. Factors it'll consider include any convictions or involvement in dishonesty, deceit, theft or fraud. They're required to describe how they'll attract clients to their service, and demonstrate how they will meet requirements for written client agreements with lenders, fair dealing obligations, and provide a disclosure document to lenders.

"You may also have other legal requirements to meet, for example under the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 and the Privacy Act 1993," the FMA's guide to applying for a peer-to-peer lending licence says.

"Clear" eligibility criteria  for borrowers must be published on  the website, with an effective fair dealing policy needed to exclude misleading or deceptive borrowers. All fees paid by borrowers in connexion with their loan must be clearly and prominently displayed.

Campbell says there needs to be disclosure around who the person seeking to borrow money is and what the loan's for.

"And the platform needs to disclose whether they have done any (due) diligence about that person. For example, what credit checks have they done? Because essentially it's very similar to a loan you would get from the bank. So essentially what we're looking at is how is that loan agreement framed up?"

Ticket clipping to be clearly disclosed

"We don't regulate how they're making their money. It just needs to be disclosed," Campbell says.

The provider must also have adequate systems and procedures in place to ensure a borrower doesn't borrow more than the $2 million annual limit. But there's no limit in terms of how much someone can lend through a peer-to-peer service.

"Platforms themselves may wish to specify their own limits on how much you could lend, and that would be something we would look at as part of the licence process. Whether they are looking at having lending caps," Campbell says.

Some providers may actively promote loan fractionalisation, which is where a lender's money is split among several borrowers thereby reducing risk. Interest payments will be taxable at the investor's normal tax rate. Losses from borrower defaults won't be able to claimed unless an investor's primary business is trading/investing.

"What we're licencing is the intermediary, the person who is running the platform itself. In respect of their role they are essentially providing the vehicle by which lenders can be matched with borrowers," Campbell says. "This legislation focuses on making the licenced intermediary company ensure customers get a fair description of the risks involved in the service that they're signing up to."

Providers are also asked to describe how debt is created and recorded between borrowers and lenders. Whether loans are secured or not will be up to the lender, says Campbell. And providers must also belong to a dispute resolution scheme. Campbell describes risk disclosure as one of the key parts of the licencing criteria.

Below is an example from LendingClub of what it calls "prime consumer notes" and its risk grading and pricing.

Governance

In terms of a peer-to-peer lending provider's financial resources, the FMA says they must have a "sufficiently strong" balance sheet. They must be able to pay their debts as they come due, and maintain an appropriate level of liquid assets to cover "reasonably expected" contingencies. And "generally" providers will be required to have positive net tangible assets. Professional indemnity insurance is also required.

Then there's governance. A "high-level body" responsible for overseeing compliance with licence obligations and ensuring appropriate risk management is needed. There's also some FMA interest in related parties being overseen by this "high level body."

"The FMA has just been made the primary conduct regulator in relation to fair dealing," says Campbell. "So we're going to be able to take any action against false, misleading or unsubstantiated representations that are made by either the fund raiser or the licenced intermediary themselves."

"So essentially the purpose about the licencing of the intermediary themselves is ensuring they take a primary role in ensuring that investors receive clear information about the risks involved in any loan that they might make to somebody using that service."

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