P2P lending and how it’s regulated

Peer-to-peer lending, (often abbreviated as P2P lending) is a form of debt financing whereby individuals and businesses lend money using online platforms that connect investors and borrowers rather than using traditional intermediates, such as banks.

P2P lending is not a new concept (companies like Zopa in the UK and Prosper and Lending Club in the US have been around for over a decade) and was fostered in the years following the 2007-2008 financial crisis when technological advances were creating new opportunities for P2P lending while banks were tightening their lending practices.

P2P lending companies generally provide an online platform where individuals and businesses apply with information about themselves and loans they are looking for. Loan requests are then assessed and uploaded to the platform where they can be reviewed by individual or institutional investors who can examine details such as who the borrower is, the amount of a loan, the interest rate of the loan and what it will be used for. Investors can then decide if they will fund all or a portion of a loan. Once enough investors commit to funding a loan, the loan is approved and the system will usually generate loan documentation and fund the loan electronically. Most P2P lending companies generate revenue by charging origination fees to borrowers on funded loans as well as ongoing loan servicing fees to investors and/or borrowers.

P2P lending has a number of benefits. As most P2P lending companies operate online, lower overhead and transaction costs can translate to reduced borrowing costs for borrowers using P2P lending products compared to getting a loan from the bank. Banks also have capital requirements that impact their cost of funding which is not the case for most P2P lending companies. Particularly in the case of personal loans or business loans to small or medium-sized businesses, this means borrowers may be able to access loans banks have traditionally been reluctant to offer due to the size of the potential return against the cost of funding and servicing the loan. For investors, P2P lending services provide the opportunity for direct access to yields on loans made through the P2P lending platform, as opposed to lower deposit returns available by depositing their money with a bank. P2P lending services are also attractive to both investors and borrowers for being convenient, easy to use and capable of processing and funding loans quickly.

On the other hand, P2P lending is not without risk, particularly for investors who may not be comfortable with the ability to assess the creditworthiness of borrowers using P2P lending services, to monitor those borrowers for warning signs of default or to collect from borrowers who have defaulted. In many cases, investors may be relying on the credit analytics and default management services provided by the P2P lending company without much independent analysis. In these cases, there is both borrower credit risk and platform integrity risk to investors.

Internationally many P2P lending companies have shown to be successful alternatives to bank lending, but in Canada the industry has grown slowly. The slow growth of the Canadian P2P lending industry is partly due to the cautious approach regulators have taken to P2P lending services.

Canadian securities regulators have taken the position that loan arrangements entered into using P2P lending platforms may be “securities” and P2P lending companies could be trading in securities and therefore must register as dealers with securities regulators in the provinces where they operate. Further, if their services also involve issuing new securities, P2P lending companies must either file a prospectus (a comprehensive and expensive legal disclosure document) in respect of those securities or be able to rely on an exemption.

P2P lending companies in Canada have worked to fit themselves into the regulatory model by registering with regulators and sidestepping the prospectus requirement using existing exemptions. For many this has meant restricting investing opportunities to a limited class of institutional investors and high-net worth individuals who qualify as “accredited investors”— see Vault Circle which provides working capital loans to small businesses by providing accredited investors in BC and Ontario with access to “investor notes” issued by an affiliated company. Others have worked with regulators to find different approaches to access a larger market of borrowers and investors– see Lending Loop, which calls itself Canada’s “first fully regulated peer-to-peer lending platform focused on small business” and currently operates as an exempt market dealer distributing “payment dependent notes” to facilitate loans made using its platform, such notes being issued by an affiliated company on a prospectus-exempt basis relying on what is called the offering memorandum exemption.

Regulators have said they are committed to working with P2P lending and other FinTech companies so those companies can learn how to operate in the regulated space and possibly inform how regulations can be adjusted to make that space more accessible. This commitment is shown in a number of initiatives launched by the regulators aimed at supporting and informing FinTech businesses, including the CSA Regulatory Sandbox, the BC Securities Commission “Tech Team” and the Ontario Securities Commission’s LaunchPad.

Even with these recent developments, navigating the Canadian regulatory landscape governing P2P lending remains complex, as companies work to fit within a regulatory model that has been slow to keep pace with the new products P2P lending companies can offer. That said, the future is looking brighter as interest in P2P lending services remains high and regulators are expressing their commitment to working with P2P lending companies so they can offer their services to Canadians looking for different ways to borrow and invest.