Fariz Abdul Aziz examines the Securities Commission’s peer-to-peer financing framework.
Peer-to-peer (“P2P”) lending or sometimes also known as “marketplace lending” or “crowdlending”, is the practice of matching lenders directly with borrowers via an online platform without the need of going through a traditional financial intermediary, such as a bank or other financial institution.
The P2P lending process will vary by platform, but it generally involves the following steps:
(1) a prospective borrower submits an application to the platform operator for consideration;
(2) the platform operator obtains a credit report on the applicant and uses this information to assign a risk grade to the proposed loan and sets an interest rate corresponding to the assigned risk grade;
(3) if accepted, a loan request is posted on the platform operator’s website, where investors can review all loans or search for specific loans that meet their desired risk/return characteristics;
(4) if there are enough investors to fund the loan, the borrower sells investment notes associated with the specific loan to each lender that has agreed to fund the loan in the principal amount of that commitment; and
(5) the platform operator receives a fee on the loan, as well as origination and servicing fees.
P2P lending started in the UK and the first company to offer P2P loans was Zopa
which targeted the personal loan segment. Since its founding in February 2005, Zopa has reportedly lent more than £1.42 billion in personal loans. Funding Circle was the first site to use the process of P2P lending for business funding in the UK and now operates in both the UK and US markets. As of January 2016, Funding Circle has reportedly facilitated over £1 billion in loans to small and medium-sized firms.
The stellar growth of the P2P lending industry globally has primarily been propelled by the comparatively lower overheads which P2P lending platforms are able to operate on as a result of operating entirely online and outside the traditional banking system. This results in P2P lenders being able to offer more attractive interest rates to borrowers vis-à-vis
traditional financial institutions whilst still earning the same or higher returns compared to savings and investment products offered by banks - even after payment of the fee charged by the P2P lending platforms.
THE P2P FRAMEWORK
As part of its effort to nurture and facilitate market-based innovation in “FinTech” (finance technology) under its aFINity@SC initiative, the Securities Commission Malaysia (“SC”) released the region's first comprehensive regulatory framework for P2P financing, the Guidelines on Recognized Markets (“RM Guidelines”) on 13 April 2016. The RM Guidelines supersede the ‘Guidelines on Regulation of Markets’ previously issued by the SC and will regulate the operation of both equity crowdfunding platforms and P2P financing platforms.
This article highlights some of the key requirements which an entity will have to comply with in order to be registered as a P2P platform operator (“P2P Operator”) as well as the provisions that will apply in relation to raising finance on a P2P platform by an issuer (“Issuer”).
The P2P Operator
A P2P Operator must be a body corporate established in Malaysia and have a minimum paid-up capital of RM5 million.
The RM Guidelines imposes a number of obligations on the P2P Operator, including:
(1) ensuring that it has a risk scoring system in place relating to the loan;
(2) undertaking a risk assessment on prospective Issuers, including conducting background checks to ensure fit and properness of the Issuer, senior management and controlling owner. In this regard a P2P Operator is held accountable for the risk scoring mechanism and methodology employed;
(3) establishing one or more trust accounts in a licenced institution designated for the deposit of funds raised through the P2P platform and for monies received as payments to investors;
(4) ensuring the disclosure document lodged by an Issuer is verified for accuracy and made accessible to investors through the P2P platform; and
(5) having in place processes to monitor compliance with anti-money laundering requirements.
P2P Operators and their officers are expressly prohibited from providing any financial assistance to investors to invest through the P2P platform. P2P Operators are also prohibited from providing any financial assistance to Issuers although officers of a P2P Operator may invest in an Issuer through the P2P platform provided that appropriate controls are put in place to manage any potential conflicts of interest.
P2P Operators are also subject to the general rules relating to recognised market operators imposed under the RM Guidelines, such as the requirement that their directors and officers be fit and proper persons, the appointment of a responsible person and general reporting requirements.
Only locally registered sole proprietorships, partnerships, limited liability partnerships, private limited and non-listed public companies are permitted to be Issuers. The following are expressly prohibited from being Issuers:
(1) commercially or financially complex structures;
(2) public listed companies and their subsidiaries;
(3) companies with no specific business plans or whose business is to acquire unidentified entities (i.e. a blind pool); and
(4) entities which propose to use funds raised to provide loans or make investment in other companies.
P2P platforms operated by the SC’s registered P2P Operators only facilitate businesses or companies to raise funds and exclude individuals from seeking personal financing.
An Issuer is not permitted to be hosted concurrently for the same purpose on more than one P2P platform. However, an Issuer is allowed to list on a P2P platform and an equity crowdfunding platform subject to the appropriate disclosures being made.
Limits and restrictions on funds raised.
Although there is no limit on the amount of funds which an Issuer may raise on a P2P platform, an Issuer is required to state an initial target amount and will only be able to keep the amounts raised if such amounts exceed 80% of the initial target amount. Any amount raised which exceeds the initial target amount shall not be kept by the Issuer.
P2P Operators are required to encourage retail investors to limit their investments on a P2P platform to a maximum of RM50,000 at any period of time. However, a sophisticated investor (i.e. any person falling within Part 1 of Schedules 6 and 7 of the Capital Markets and Services Act 2007) or an angel investor (i.e. an investor accredited by the Malaysian Business Angels Network as an angel investor) is not subjected to any investment limit.
Investors who invest through a P2P platform operated by the SC’s registered P2P operators are buying securities in the form of an investment note or Islamic investment note, which will be issued by the businesses or companies. The issuer of the investment note or Islamic investment note is obliged to pay the investors over a time period, with interest or profit.
SOME POTENTIAL ISSUES
Default in repayment
Investors in P2P lending, like investors in other types of lending, are exposed to the risk of default by the Issuer in repayment. Whilst the RM Guidelines provide that a P2P Operator is required to have in place policies and processes to manage any default by an Issuer, including using their best endeavours to recover amounts owing to investors, no minimum standards are imposed. Based on the business models of P2P operators outside Malaysia, it is probable that P2P Operators will receive their profits the moment the underlying loans are disbursed and therefore they are unlikely to share the downside risk when Issuers default. P2P platform operators in other jurisdictions have responded to regulatory obligations to facilitate recovery by imposing additional charges to manage the recovery process or by setting up provision funds which all investors are required to contribute to.
A possible solution may be for security to be provided by Issuers although the RM Guidelines do not provide any guidance on the form and mechanism for such arrangements to be put in place. Furthermore, there are practicable difficulties and costs in managing the security as there may be a large number of investors pooling together to provide the funding to an Issuer.
Is repayment secured against bankruptcy of the P2P Operator?
Perhaps the biggest worry is that a badly managed P2P platform might collapse, taking investors’ money with it. The bankruptcy of a P2P platform has in fact happened before in the case of Trustbuddy, a P2P lending platform based in Sweden that started in 2009 and was even listed on the NASDAQ OMX Nordic before it was forced to cease business.
To mitigate such risks, the RM Guidelines require monies raised from investors and payments received from Issuers to be placed in a trust account. If these requirements are complied with, such funds will be ring-fenced from the creditors of the P2P Operator. However, the position may be different if the P2P Operator fails to comply with these requirements and leaves the funds in its own accounts.
THE PATH FORWARD
The SC has announced that parties who are interested in establishing and operating P2P platforms may submit their applications to the SC from 2 May 2016 to 1 July 2016, the latter of which will be the closing date for the initial batch of applications. It has been reported in the local media that significant interest has been generated with over 100 parties interested in submitting applications to operate a P2P platform. Local media have also earlier reported that the successful applicants for registration as P2P Operators will commence operations in early 2017.