European Commission heading for new regulatory regime for P2P finance, but what are the problems it’s looking to solve?

Data collated by the University of Cambridge shows that year-on-year growth in the provision of alternative finance – predominantly crowdfunding – has been running at an impressive pace within the EU. To illustrate, since 2014 it grew by 92% to reach a value of €5.4 billion in 2015. If this is indeed the case one could be forgiven for thinking all was well within the EU from a crowdfunding perspective. However, the European Commission (EC) has recently indicated it will come forward with legislation in this field during Q1 2018.

Why the need for such an intervention? The EC’s own Inception Impact Assessment – released October 30 – on this topic spells out why action is needed. The €5.4 billion figure mentioned above looks a touch less impressive when compared with a total online alternative finance volume for the Asia-Pacific region (mostly China) of €94.6 billion and for the Americas (mostly the US) of €33.6 billion.

EU policymakers active in this field have often looked enviously across the Atlantic primarily  at what they see as a more desirable split between market and bank-based finance. If alternative finance availability within the EU is somewhat limited by comparison with US and Asia-Pacific levels, that presents a problem. The fact the rate of growth in this market is slowing down exacerbates that still further.

If these are the problems then what are the solutions? For the EC to generate added value from an intervention it must have identified barriers to firms cross border expansion that can only be addressed via supranational, rather than solely domestic action. The IIA on this point contends that: “Continued low levels of cross-border flows may be partly attributed to differences in national regulation, which increases transaction costs.”

That alone may not have been enough to warrant the sort of legislative initiative that is being prepared, but if we look a little closer market fragmentation is only half of the story. Lord Adair Turner, the former head of the UK Financial Services Authority during the financial crisis of 2008 – the predecessor of the existing Financial Conduct Authority – claimed last year that Peer-to-Peer loans could be the source of losses that would “make the worst bankers look like absolute lending geniuses.”

Whether or not the EC itself holds views quite as strong as that remains to be seen. Still, it is fairly clear in stating: “The biggest risks [in this market] perceived are loan defaults or business failures, fraudulent activities or the collapse of platforms due to malpractice.”

So if the case for action is justified on the grounds of consumer protection, as well as competitiveness, what exactly can we expect? The IIA offers up four possible options but as the first two involve either sticking with the status quo or non-legislative guidance it is safe to say these can be disregarded as realistic possibilities. As a consequence we are facing either a series of amendments to a number of different legislative regimes, or a new standalone framework for crowd and Peer to Peer finance being released early next year.

It will be touch and go as to whether the final cut of such an initiative – whatever its final form – can be agreed before the end of this EC mandate.  Yet it is important for the EU as a whole to stake its credentials in the wider FinTech space with action now, as the debate begins to shift from observation to action. Hence, the significance of this initiative.

Nevertheless the EC may have to tread carefully, as a heavy handed intervention could conceivably have a chilling effect on the markets growth. It will also be mindful of recent – optional – regulatory frameworks that have not enjoyed significant market take-up. This can be seen in efforts to stimulate EU venture capital markets with the “EuVECA” brand, whose legislative review was brought forward in light of disappointing registration numbers. The long term investment fund (ELTIF) wrapper has also, most would agree, enjoyed a somewhat steady start to life since it went live in late 2015.

What is clear however is that the EC sees a problem here to fix. Whether the solution prescribed can genuinely catalyse greater market activity will become all the more clear once a legislative proposal arrives, but a definitive judgment can only be made on whatever emerges from the EU’s legislative machinery.

Michele Morena