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Growing Pains: The Changing Regulation of Alternative Lending Platforms

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The Palgrave Handbook of Technological Finance

Abstract

We review the legal and regulatory framework covering alternative (“peer-to-peer” or “marketplace”) lending platforms in the UK, the US, China, and more briefly other countries. The main regulatory concerns are (i) enforcing consumer credit rules for unsecured personal lending; and (ii) protection of uninformed retail investors from mis-selling and platform failure. Alternative lending was first established with little regulatory oversight, but there has been substantial reregulation—first in the US via the 2008s decision that platform investments are securities; subsequently in the UK, China, and other countries. We anticipate further reregulation to protect retail investors, limiting the funding of loans from the “crowd.” Promoting credit supply through alternative lending platforms requires also institutional investor participation and embracing the use of technology in platform regulation (“RegTech”).

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Notes

  1. 1.

    A summary version of some material from this chapter is previously published in (Chen et al. 2020), along with a more detailed discussion of the experience of P2P lending of China.

  2. 2.

    (Perkins 2018) Figure I provides useful visual illustration of the different lending models. His classification of “marketplace lending” as embracing both alternative lending platforms and balance sheet lenders is useful, but it is not universally accepted.

  3. 3.

    http://www.p2pmoney.co.uk/companies.htm lists 133 platforms as of early Nov 2018, including 30 that had stopped doing P2P or were no longer in operation.

  4. 4.

    http://p2pfa.info, Ratesetter data from https://invest.ratesetter.com/aboutus/statistics.

  5. 5.

    See (HM Revenues & Customs 2015). The objective of this policy is described as “To increase the choice and flexibility available to ISA investors, encourage the growth of peer-to-peer lending and improve competition in the banking sector by diversifying the available sources of finance.”

  6. 6.

    Also the Autumn Statement of Dec, 2014 amended the calculation of interest income on investment in loan-based crowdfunding for individual tax liability, from gross interest to interest net of any portfolio loan losses.

  7. 7.

    (Neuwirth 2017; Megaw 2018). Project overruns in property development make relatively high payment arrears normal in this lending.

  8. 8.

    (Wardrop and Ziegler 2016; Milne and Parboteeah 2016; FCA 2018) describe the evolution of these arrangements. Other forms of crowdfunding not FCA regulated but not authorized are donation-based crowdfunding, where there is no expectation of a return; and “pre-payment or reward based crowd-funding,” where the return is the offer of a products or services e.g. concert tickets or access to a computer game, https://www.fca.org.uk/firms/authorisation/when-required/crowdfunding.

  9. 9.

    Platform based investment in business invoice e.g. www.marketinvoice.com is also classified as a loan-based crowdfunding, but not marketable to unsophisticated retail investors.

  10. 10.

    (Davidson 2016). Difficult to update as the FCA does not maintain a published list of authorized platforms.

  11. 11.

    https://www.fca.org.uk/firms/gabriel/crowdfunding-data-guide, using an XML or Excel proforma covering their financial position and loan performance, client money held, complaints and details of loans arranged each quarter (there is currently no regulatory reporting of charging arrangements).

  12. 12.

    Summarized in (FCA 2016b).

  13. 13.

    See (FCA 2016c).

  14. 14.

    The complexity of this maze is documented in the annual summaries of the US regulatory framework for marketplace lending published by the law firm Chapman and Cutler LLP, of which the latest is (Manbeck and Franson 2018).

  15. 15.

    Madden v Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015).

  16. 16.

    A long standing related discussion in law and regulatory scholarship concerns the degree to which the checks and balances of US state and federal regulation address the problems of “regulatory capture,” and how the various US regulatory agencies may best be organized and governed to support outcomes that are not excessively favoring particular interest groups (see Baxter 2011).

  17. 17.

    The discussion of the following paragraphs is largely based on (Manbeck and Franson 2018).

  18. 18.

    See for example (Wilmarth Jr. 2004). An insightful panel discussion of dual banking and preemption is summarized by (Davis and Rice 2006).

  19. 19.

    (Cadwalader 2018) provide insightful discussion, focusing on two prominent cases, one brought in Massachussets against Kabbage Inc. the Alternative lending platform for small business loans and Celtic Bank Corporation, Kabbage’s loan originator; another in Colorado against Avant and Webbank. They find that “In determining the ‘true lender,’ courts have developed two different approaches, with the choice of approach invariably dictating the result. Certain courts focus on the fact that the bank is the party to the loan agreement and is the entity that actually disbursed the proceeds. These courts conclude that the bank is the true lender and that federal preemption applies. Other courts, however, conduct a broader analysis, focusing on the origination and underwriting of a loan, as well as any material interest in the extension of credit, if any, the bank retains after origination. These courts conclude that the finance company is the true lender and, therefore, federal preemption does not apply.” See also (Lo 2016b) for similar argument.

  20. 20.

    The Madden case has proved to be a useful natural experiment for economists investigating the impact of alternative lending on the supply of consumer credit, see (Honigsberg et al. 2017; Danisewicz and Elard 2018).

  21. 21.

    This perspective is forcefully argued by (Davis 2018), in a white paper commissioned by the MarketPlace Lending Association representing the major alternative lending platforms.

  22. 22.

    (Lo 2016a) reports from press coverage that “Even as the industry grew, lenders bore painfully high default rates—Prosper was charging off more than 20% of loans issued before 2008, while LendingClub fared better, but still had 8.5% of its pre-2008 loans in default.”

  23. 23.

    This and follow paragraphs are again based substantially on (Manbeck and Franson 2018).

  24. 24.

    As explained by (Manbeck and Franson 2018) “the term ‘accredited investor’ includes most institutional investors and individuals who (i) individually, or with their spouse, have a net worth exceeding $1 million exclusive of the value of the person’s primary residence (and subject to certain adjustments for “underwater” mortgages), or (ii) individually had an income in excess of $200,000 in each of the two preceding years, or had a joint income with spouse in excess of $300,000 in each of those years, and have a reasonable expectation of reaching the same income level in the current year.”

  25. 25.

    See.

  26. 26.

    Since 2011, increasing number of P2P lending platforms have abruptly collapsed due to financial difficulties, leading to the CBRC issued “Circular on Risks Associated with Peer-to-Peer Lending” on August 23, 2011. However, instead of providing specific rules on P2P lending, the Circular merely identifies a number of risks associated with P2P lending as a result of lack of regulation and supervision, such as illegal funding, fraudulent activities.

  27. 27.

    Until April 8, 2018, banking and insurance industry was regulated by the China Banking Regulatory Commission (CBRC) and the China Insurance Regulatory Commission (CIRC) respectively. These two regulatory bodies were then merged to form the CBIRC.

  28. 28.

    The division of regulatory responsibilities was first made by the 2015 Guiding Opinions.

  29. 29.

    More specifically, this responsibility is assumed by an agency called Financial Work Office.

  30. 30.

    Article 4 and Article 5.

  31. 31.

    Article 40.

  32. 32.

    Article 40.

  33. 33.

    Its power includes investigate and punish violations, and crack down on financial crimes involved in online lending.

  34. 34.

    By January 2019 no single platform had completed the procedure.

  35. 35.

    According to Mr Greg Gibb, Chief executive of Lufax, see (Weinland and Ju 2018).

  36. 36.

    Issued by the Supreme Court on August 6, 2015.

  37. 37.

    Above this four times limit will be regarded as usury.

  38. 38.

    Article 5.

  39. 39.

    Article 12.

  40. 40.

    Article 14.

  41. 41.

    2017 Guideline on Information Disclosure, Article 2; Chapter “Innovations in Alternative Finance in Historical Perspective” specifies the content of the required information.

  42. 42.

    2017 Guideline, Article 9.

  43. 43.

    2016 Interim Measures, Article 31.

  44. 44.

    2016 Interim Measures, Article 31.

  45. 45.

    Ezubao was once one of the biggest platforms, by December 8, 2015, its trading volume totaled at 74.568 billion yuan, involved investors 909,500, see (Caiing 2018).

  46. 46.

    Criminal Law, Article 192.

  47. 47.

    Article 176.

  48. 48.

    While we have looked at Europe, some countries and Asia and North America, we have made no effort to review the regulatory framework in Latin America.

  49. 49.

    Three sources provide convenient comparative reviews of the law and regulation of crowdfunding in different countries: (European Crowdfunding Network 2017) for Europe, Norther America and Israel; (European Commission 2017) for the 28 EU countries and for responses to an OECD survey on regulation of loan based crowdfunding (Havrylchyk 2018). In preparing this section we have also consulted (Havrylchyk 2018; Ahern 2018; Pranjivan 2017; Klöhn 2018; Ferrarini 2017; Milne 2018).

  50. 50.

    For more detailed review see (Milne 2018).

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Authors and Affiliations

  1. School of Law, University of Sheffield, Sheffield, UK

    Ding Chen

  2. Crawford School of Public Policy, Australian National University, Canberra, Australia

    Anil Savio Kavuri

  3. School of Business and Economics, Loughborough University, Loughborough, UK

    Anil Savio Kavuri & Alistair Milne

Authors
  1. Ding Chen
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  2. Anil Savio Kavuri
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  3. Alistair Milne
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Correspondence to Alistair Milne .

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Editors and Affiliations

  1. University of Cambridge, Cambridge, UK

    Raghavendra Rau

  2. University of Cambridge, Cambridge, UK

    Robert Wardrop

  3. University of Chicago Booth School of Business, University of Chicago, Chicago, IL, USA

    Luigi Zingales

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Chen, D., Kavuri, A.S., Milne, A. (2021). Growing Pains: The Changing Regulation of Alternative Lending Platforms. In: Rau, R., Wardrop, R., Zingales, L. (eds) The Palgrave Handbook of Technological Finance. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-65117-6_19

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