All the materials for the ACCA Alternative Finance Conference 2013 are to be posted here: www.accaglobal.com/en/research-insights/access-finance.html

1. REGULATING
PEER-TO-PEER AND
ALTERNATIVE FINANCE
ACCA Alternative Finance Conference 2013
Simon Deane-Johns
Keystone Law

2. Agenda
• Peer-to-peer finance
– Types
– How they work
– Common features
– Operational risks and controls
• Other forms of alternative finance
– Supply chain finance
– Marketplace finance
• Regulatory barriers and options for removal

3. Types of P2P Finance
Crowd-
investing
Debentures Crowd-
Crowd- investing
investing Other (e.g.
Equities invoices)
Crowdfunding P2P Payments
(e.g. Foreign
Donations/rewards
exchange)
Crowdfunding P2P lending
charities/social Consumers/SMEs
Microfinance

4. How P2P Finance Works
Transaction Flow
Offer/acceptance => Loan agreement
Lender Borrower
Share/debenture
Offer/acceptance => Investment agreement
Investor Entrepreneur
Platform Operator
platform agreement platform agreement
Lender/Investor’s Platform Operator’s Borrower/Entrepreneur’s
Bank Bank (Seg. Account) Bank

5. How P2P Finance Works
Funds Flow
Loan agreement
Lender Borrower
Share/debenture
Investment agreement
Transfer request
Investor Entrepreneur
Transfer request
Platform Operator
platform agreement platform agreement
Funds Transfer Disburse Loan/Investment
Funds Transfer Repayment/dividend
Lender/Investor’s Platform Operator’s Borrower/Entrepreneur’s
Bank Bank (Seg. Account) Bank

6. Common P2P Features
• Platform operator not a party to instrument agreed between participants
– Segregates participants’ funds rather than treating them as own assets;
– Margin stays with the participants;
• Online only –> low cost –> lower fees
• Low minimum commitment
– Accessible to retail customers (may be subject to questionnaire and/or cap);
– Aids diversification of small investment amounts;
– Finance from many in small amounts at outset –> no need to securitise;
• Centralised data aids risk assessment, performance analysis, enforcement

7. Standard Operational Risks
• Lack of adequate internal controls, governance
– Financial mismanagement, operator insolvency;
– Internal fraud;
– Lack of system integrity/availability;
– Lack of business continuity;
– Failure to manage/respond appropriately to customer complaints;
– Unclear, unfair or misleading promotions/communications.
• Basic credit or investment risk
• Money laundering, external Fraud

8. Common P2P Operational Controls
• Senior management systems and controls;
• Minimum working capital;
• Segregation of participants’ funds;
• Clear, fair and not misleading service terms/communications/promotions;
• Secure and reliable IT systems;
• Fair complaints handling;
• Orderly administration if platform ceases to operate;
• Appropriate risk assessment, AML and anti-fraud measures
• Extra measures appropriate to specific instruments

9. Other Forms of Alternative Finance
• Supply chain finance
– Funding the early payment of single invoices or batches of invoices
– Shifting the credit risk from supplier to buyer
– Crowd-funding individual invoices?
• Marketplace finance
– As part of end-to-end e-commerce marketplace service
– Independently of marketplace service
– Crowdfunded?

10. Regulatory Barriers - Overview
• Exclusive framework limits types of products, suppliers, intermediaries
and activities
• Reinforced by guarantee of bank liabilities, Financial Services
Compensation Scheme, personal tax rules and savings incentives
• Related silos of officials/regulators with powers focused inwardly, and
no overriding supervisory powers, responsibility or accountability for
how the ‘system’ works as a whole, either internally or in terms of
external impact
Exclusive, rigid, self-reinforcing, officially-endorsed marketing environment
creates super-normal profits for incumbents and limits innovation and
competition

11. Barriers for Platforms
• Confusion over what is lawful
– Slight change in facts has big consequences, EU Directives overlap
– Different rules for ‘promoting’ vs ‘offering’ a security;
– Unregulated operators may still face rules on public offers and promotions;
– Expensive in terms of advice + regulatory creep
– Slows time to market
• High net worth investor limits
– Limits accessible market, liquidity
• Incumbent competitors heavily subsidised
– State guarantee of bank liabilities,
– Financial Services Compensation Scheme
– personal tax rules and savings incentives

12. Barriers for Entrepreneurs
• Confusion over what is lawful
– Which platform to list on?
• High net worth investor limits
– Limits accessible market, liquidity
• Disincentives for ‘ordinary’ lenders/investors to engage with alternative
finance and diversify
– Inhibits trend towards customers directly supporting projects
– Limits accessible market, liquidity

13. Barriers for Lenders/Investors
• Confusion over what is lawful
– Lending or investing in the course of a business?
– Easier to give or gamble money away than to receive repayment with
interest or a share in the business!
• Disincentives to engage with alternative finance
– Not available via ISAs
– Can’t deduct bad debt before tax, distorting effective tax rate (unlike a bank)
– Inhibits diversification beyond cash deposits and some regulated
bonds/shares
– Deprives consumers of return on savings

14. Regulatory Options
• New regulated activity of “operating a Platform”
– Rules similar to Operating Principles of the P2PFA;
– ‘hybrid’ businesses and small firms (e.g. Payment Services)
• Specific exemptions - clarify meaning of “business” - remove EU
overlap - ease rules on promotions, offers to public via Platforms;
• Issue permissive guidance where changes can’t easily be made;
• ISA-status on instruments available via regulated Platforms;
• Remove bad debt tax distortion for instruments available via
regulated Platforms.
• Ensure framework is joined-up and permeable/responsive

15. Thank you
Twitter: @sdjohns
Blog: Pragmatist
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