Why Is Low-Risk P2P Lending Labelled As “High Risk”?
Mike Carter of the 36H Group has passed detailed data on P2P lending companies' lending results to the FCA to demonstrate why this type of investing should be moved into a different, low-risk category. That's according to P2P Finance News.
4thWay collects a huge amount of evidence from P2P lending companies and so we already know for ourselves how incredibly stable investing is in this space. It's been around for 17 years and every single year it's had resoundingly positive overall returns for investors, compared to 1-in-3 down years for the stock market after all investing costs are considered.
So why, then, does the Financial Conduct Authority (FCA) lump P2P lending in with “high-risk investments”?
I think there are possibly five reasons, although none of them are about a high risk of losing money:
1. Being unable to sell your loans early
The regulator often puts a lot of emphasis on the ability to sell investments at all times. It gives the impression of treating the risk that you can't always sell quickly as weightier than the risk of actually losing money. This seems to 4thWay's specialists to be an inversion of reality.
The thing is that the ability to sell – so-called “liquidity” – is the flip side of a coin. On the other side of the coin is stability. It's not realistic to expect both from an investment.
The ability to sell investments in any weather comes at the cost that you might have to sell at a great loss. That's one of the reasons the stock market is so volatile. You can sell your shares when you like, but you'll have to do it at a steep loss if you do so at the same time as many other investors. Share investors minimise this risk by having investing horizons of at least 10 years, allowing time for a recovery after downturns.
P2P lending is usually investing at interest rates set by the platforms and then you generally get all your money back. You don't normally pay more or less when buying into or exiting your loans. And spread across a variety of loans you're not likely to lose money to bad debts.
That all means stability in performance and capital preservation. But it comes at the cost that sometimes you won't be able to sell your loans early, if you want to do so before the borrowers repay naturally. In other words, you might be forced to continue earning interest on your P2P investments for longer than you intended.
This risk is easily dealt with by lending less money when you know you're going to need some of it back within one or two years.
That's why 4thWay's specialists believe that if share investing and P2P lending had both started two or three decades ago, share investing would be called “high-risk investing” while P2P lending wouldn't!
2. Uneducated investors
Good data on the stock market stretches back to the 19th century and tens of millions of people hold share investments, most typically in pensions or share ISAs. The argument, therefore, is that the path to this market is so well trodden that people generally know what they're doing when investing in shares, but they can't do so when investing in P2P lending. The lack of education makes it “high risk”.
4thWay's specialists argue that there must be far more people buying shares without knowing what they are doing and without sensible strategies than there are those making similar mistakes in P2P.
In both industries, the information and support in learning how to invest and choose investments is there for all investors who have the inquiring minds and emotional control to look for it.
3. Lenders aren't spreading across enough loans and lending accounts
The FCA hasn't discussed this very much at all. But even if lack of diversification is not a big item on its list, it's probably the one item that is the best try if you're determined to argue that P2P lending is high risk. There are a lot of lenders who aren't spreading their money across enough investments.
However, this happens a huge amount in share investing and elsewhere too. So unless you relabel all those investments as high risk, it makes no sense here either. (The FCA is looking to improve risk warnings, so enforcing warnings on diversification – which it currently isn't even consulting on doing – would surely be a sensible step.)
4. Lack of understanding at the FCA
The FCA has had a very steep learning curve with this industry and there are quite a few signs it still has a little way to go, including:
- At no point has it publicly acknowledged that it has recognised P2P lending's stable investment profile.
- Risk warnings focus on an individual platform level, when the warnings should be at the level of the overall industry, or at least similar kinds of lending within the industry – perhaps combined with warnings that you need to diversify across lots of accounts. After all, if you just invest in one thing it is usually going to be a high risk thing to do, regardless of what it is.
- As there have been a couple of platforms fail and end up with a poor-quality loan book, the FCA might have spent an inordinate amount of time focused on those and therefore it tars the entire industry with the same brush. But it doesn't do this with share investment funds, even though a good number of them also fail spectacularly.
- The FCA has a very narrow definition of P2P lending and treats other investments differently that are – from the investors' point of view and from the risks side – basically identical in all key ways to P2P lending. This separation shows that it doesn't fully understand either P2P lending or the other investments, or both. They should be treated the same.
Any regulator that has a lot of pressure to protect people from poor investments is going to err on the side of caution to protect itself.
The downsides of not being strict enough can cause the FCA a lot of grief if something were to go wrong and there was a scandal. Meanwhile, the downsides of being too strict are minimal to the regulator in terms of national news coverage. What journalist is going to know it's being too strict?
Muddying the waters…
The 36H Group is part of Innovate Finance, which also lobbies for equity crowdfunding. Mike Carter was also quoted by P2P Finance News as saying that equity crowdfunding is also low risk. I would love to see the evidence for this, because personally I believe buying shares in startups is the riskiest kind of investing that you can do this side of investment scams.
Equity investing is inherently riskier than money lending and startups are the most likely to fail and leave you with nothing. Equity crowdfunding certainly has its place, and I'm glad it exists, but it's nothing like the same. It's like the opposite end of the spectrum versus P2P lending.
So Carter has risked muddying his message to the FCA with what, to me, seems like an absurd claim!
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