Peer-to-peer (P2P) lending is a type of micro-financing activity conducted through an online platform, by matching people who have money to invest with people who are looking for a loan. Different forms of P2P lending have emerged, e.g. business lending and consumer (including student) lending.
How does P2P lending work?
P2P lending typically involves a service provider, through an online platform or a mobile application, acting as a middleman to link investors (or lenders) with borrowers looking for capital. P2P lending service providers typically leverage technology to attain cost advantages compared with traditional brick and mortar financial institutions, such as lower overhead costs, and can therefore work with lower interest margins.
Borrowers can apply for loans via a P2P lending platform, which typically sets the terms of the loan, such as interest rates and repayment terms, and may also conduct credit checks on borrowers. Investors are invited via the platform to fund such loans, and once the funding target is met, the loan is offered to the borrower. Thereafter, the platform may also provide investors with associated services, such as dealing with repayments and interest payments from borrowers, and handling default payments. P2P lending platforms' revenue model typically involves earning an interest spread of the loans and/or charging borrowers and investors fees for using the platform's services.
For example, a borrower submits a request to a P2P lending platform to borrow $30,000 for one year to settle credit card debts while another borrower wants to get a $50,000 two-year loan for buying a car. Investors can then review the online profiles and select the loans that they want to finance.
Risks associated with P2P lending(Note)
Investing in P2P loans may offer comparatively higher returns on capital (than for example, bank deposits) but it also comes with higher risks. Investors may stand to lose all of their investments. Some of the key risks include:
Default risk of the borrower
A loan through a P2P platform exposes the investor to the risk of borrowers failing to make timely interest and loan repayments. In certain cases borrowers may fail to repay at all, thereby causing the loss of the entire investment.
The creditworthiness of borrowers would be an important factor to consider in investing in P2P loans. Background credit checks conducted by P2P platforms may not be as rigorous or consistent with that of established credit agencies, and overreliance on credit risk models used by the platforms carries risk. P2P platforms may also have lower thresholds on the creditworthiness of borrowers that are able to obtain loans via their platforms. Oftentimes, higher credit risk borrowers who are unable to get a loan from traditional banks turn to P2P borrowing.
Liquidity risk/lack of secondary market liquidity for the loans
Some P2P platforms may allow investors to sell their loan investments before the loan is fully repaid, but the investor's ability to sell their loan depends on another investor's interest in that loan. Investors may find it difficult to sell their loans if the borrower is experiencing any kind of strain, for example negative news reports or a repeated late payment history. Some P2P lending platforms may also suspend loan sales to protect new investors from investing in a loan where there is a known issue.
Risk of conducting unlicensed activities
Some platforms may contend that they do not engage in regulated activities because they only offer loan services and provide information services. However, the Securities and Futures Commission (SFC) may take a different view and consider that the licensing requirements under the Securities and Futures Ordinance (SFO) are triggered. Platforms/platform operators carrying on business in regulated activities under the SFO without a licence is an offence under the SFO. Please refer to the section below "How is P2P lending regulated in Hong Kong?".
Investment proposals on platforms may lack standardisation and provide less detail than securities in the public markets, making it harder for investors to understand the risks. For example, there may be limited information on how due diligence is conducted on borrowers, methods for modelling credit risk, or a lack of clear and comparable default data on loan portfolios. Investors may not know the borrower's profile from the platforms (sometimes even after the investment is made), and the information available may not be properly verified either.
Risk of collapse, fraud or malpractice by the platform
In recent years, certain cases of platform fraud, collapse and closure have materialised and caused investor losses.
A few platforms have started offering loan investments on a cross-border basis. It is often unclear in such cases under which law the investors can seek redress in case of fraud, default or bankruptcy by the borrower or the platform. Even if a platform is licensed offshore, investors may have difficulty enforcing their rights and interests if anything goes wrong.
Cyber-attacks may come in various forms, such as hacking, overloading a platform's infrastructure, confusing accounts, identity theft and/or stealing information including personal data.
Some platforms/users of platforms may be involved in illegal activities, such as fraud by parties making offers on the platform, money laundering or other illegal commerce that could lead to regulatory actions including suspension by relevant law enforcement agencies.
How is P2P lending regulated in Hong Kong?
The term "securities" is defined widely under the SFO, and its meaning extends beyond shares in a company. The term may also include debentures of a company and interests in a collective investment scheme. Therefore, depending on the manner in which a P2P platform structures its business, its activities may involve dealing in or advising on securities, which are regulated activities under the SFO. In such a case, the platform/platform operator may need to be licensed under the SFO before it is permitted to carry on a business in such activity.
In addition, depending on the specific structure and features of the arrangement, the investment offered on the P2P platform may be subject to the restrictions on offers of investments under the SFO.
Due to the risk associated with P2P lending, the SFC may consider that certain P2P lending platforms are not suitable for retail investors and may only approve licensing applications with a condition that the P2P lending platforms should limit their services to professional investors.
Other Hong Kong laws and regulations may also apply, e.g. P2P lending platforms and the operators may need to apply for a money lender's licence from the Companies Registry.
Key points for investors to take away
If you are an investor and interested in participating in P2P lending:
Check if local or cross-border
Check where the platform is incorporated/operating from. If it is operating from outside Hong Kong, Hong Kong investors will face additional cross-border issues when trying to recoup their investment in case of fraud, default or bankruptcy.
Check if licensed or not
Where a platform states that it is licensed by the SFC, you can check the public register on the website of the SFC to verify the platform's licensing status. Investors should be aware that only if the platform is duly licensed would it be covered by oversight by the SFC and by the SFO and the regulations which the SFC administers.
Also, where a platform states that it is a licensed money lender in Hong Kong, you can check the public register on the website of the Companies Registry to verify the platform's licensing status.
Understand the investor limitations. The platform may have a limitation (e.g. legal restriction or licensing condition) that only professional investors can invest in the products and services advertised.
Read any terms and conditions
Read the terms and conditions of the platform, any documentation that you are asked to sign, and any data privacy waivers very carefully.
Understand the safeguards
Understand how the platform is operated and the safeguards it adopts to protect your interests, including your investing interests as well as your data security interests.
Understand the risks
Understand the risks associated with P2P lending and carefully assess whether your personal circumstances allow you to take on the risks involved.
Make informed investment decisions
Be reminded that making uninformed investment decisions based on unverified information is highly risky and may lead to a total loss of your investments. You should not invest in any financial products or activities that you do not know or understand. You should seek professional advice if in doubt.
Reference has been made to two IOSCO papers: