As one of the first countries in Asia to publish a regulatory regime, Malaysia is opening up to entrepreneurs, institutions and global operators to facilitate the ease of business credit through P2P lending. Ranked 18th on the World Banks’ Ease of Doing Business league tables, Malaysia is positioning itself as the conduit for global players to setup in Kuala Lumpur as gateway for serving P2P lending markets across Asia. Malaysia has one of the highest levels of financial inclusion in the world at 92 per cent and the country has taken advantage of mobile phones and online banking to expand access.
The recently published Securities Commissions (SC) of Malaysia’s rules on the operation of a Peer-to-Peer platform sets out the minimum requirements for the compliant operation of a Loan based crowdfunding platform in Malaysia.
Given the recent publication of the SC’s rules, we have undertaken a comparison of the regulatory requirements imposed on Malaysian P2P platforms with their UK counter parts. The comparison highlights a number of differences first both in the rules that must be followed to operative a platform as well as the minimum standards imposed on operators operating the platforms in Malaysia. Whilst the comparison identifies a number of differences between the two bodies of regulation, this is not unexpected give the differences in maturity of the two markets. P2P in its earliest form began in 2005 in the UK, with the UK regulator announcing its intention to regulate the sector in 2013. The UK’s early P2P regulations were very similar to those now produced by the SC.
The SC in their production of their regulations have clearly done their research into the rules implemented by many platforms and regulators around the world in helping them draft their first guidelines, and have arguably used the UK’s regulations as their closest reference. A strategy that appears to have been widely adopted in their regulation of other financial markets as well.
Below is a more detailed review of the UK and Malaysian regulation.
The first noticeable difference in the platform operator rules is the requirements by the SC for a platform to have a minimum paid-up capital of RM5 million (approx. £80,000). The UK regulatory body the Financial Conduct Authority (FCA) does not impose a minimum capital requirement for the start-up of a platform. The FCA instead imposes a capital adequacy Requirement (CAR) on platforms once they are trading and authorised by the regulator. A platform’s CAR requirement is based on the trading performance of the platform weighed against its loan book. The SC’s decision to incorporate a minimum capital level on start-up platforms could be seen as a possible reaction to the recent debate in the UK and USA about the possible implementation of Capital requirements on P2P platforms similar to those currently applicable to banks. This being said, the requirement of RM 5m is not prohibitively high and may not be seen by many market entrants as a particularly high barrier to entry, particularly by those supported by financial institutions familiar with far more prohibitive capital requirements.
Whilst the FCA does not have a start-up paid up capital requirement, recent feeling and expectation in the UK is that the FCA will potentially move to more onerous Capital Requirements similar to those imposed on many other financial institutions.
Investor Communication and Transparency
It is interesting to note that the SC has decided to enforce a specific requirement on P2P operators to use ‘an efficient and transparent risk scoring system’ and to ‘carry out a risk assessment on issuers’. The FCA imposes no such requirement on platforms, although the majority of platforms do incorporate a risk rating identification system for the benefit of lenders, the platforms do not openly publish their system or processes as these are closely guarded as valuable IP of the platforms. In the absence of a specific requirement to have an ‘efficient and clear risk scoring system’ the FCA would expect platforms to assess their market and client needs and ensure that they operate with in the FCA’s Principles for Business (PRIN), most notably in regard to risk modelling, Principles 5,7 and 9. It’s worth noting here that the SC operate similar principles in terms of Fund Management Companies, see Guidelines On Compliance Function For Fund Management Companies.
The language used by the SC of ‘efficient and transparent’ is surprisingly vague and may be intentionally left as such to allow platforms the space to develop naturally allowing the SC room to review practices and later set what they deem to be appropriate transparent and efficient processes.
In its list of Operator Obligations, the SC appears intent on ensuring that the platform operators acknowledge and respond to the need to maintain transparency between the investors and the Issuers and to make investors aware of the nature of their investment. This can be seen in rules 13.05 (d-f).
Interestingly, rule 13.05 (d) requires operators to ‘carry out investor education programmes’. The FCA again poses no requirement on platforms to ‘educate’ their investors but it does impose standards of disclosure and business conduct in its Handbook. The FCA expects platforms to take measures to ensure that they are open and transparent about the nature of the investment products it offers and that information is clearly displayed and prominent for investors (COBS 2.2.1 and 2.2.2).
Carrying out educational programmes in the form of videos and blog posts, as well as informative events, are good ways to encourage a higher level of customer engagement, but also assist in building the trust of investors in the platform. Rebuildingsociety.com has benefited greatly from publishing a number of blogs about its journey, the types of investment it offers, the internal processes it uses to ensure the efficient and safe operation of the platform. Transparency is greatly valued by both the investors and the regulators.
Anti-Money Laundering and Financial Crime Prevention
As expected, the SC has incorporated the need and responsibility of platforms to ensure that they carry out sufficient Anti Money Laundering (AML) and Financial Crime (FC) Prevention practices as part of their normal operating processes. AML and FC are increasingly sensitive areas. Whilst the SC’s Guidelines on Recognized Markets does not set out specific instructions and guidance on the expected processes and levels of due diligence required by platforms, platforms should look to the SC’s ‘Guidelines On Prevention Of Money Laundering And Terrorism Financing For Capital Market Intermediaries’ which was developed from Section 83 and section 66E of the Anti-Money Laundering and Anti-Terrorism Financing Act 2001 (AMLATFA) and section 377 of the Capital Markets and Services Act 2007 (CMSA). This document sets out the SC’s expectations of platforms in relation to AML and FC prevention.
The SC’s guidelines on AML and FC prevention are broadly similar to those of the FCA set out in SYSC 6.3, in that advocate a risk based, profiling approach to AML and FC prevention processes and require firms to incorporate enhanced Due Diligence practices where individuals are profiled to be higher risk.
Incorporating a comprehensive and platform specific AML and FC prevention Policies and processes is very important in ensuring a platform and its staffs’ compliance with these rules. In drafting policies and processes for P2P platforms in the past, it has been shown that the most effective policies that become tools for the staff to use in their work are those that incorporate practical examples that may be experienced by them in their operation of the platform. The FCA’s standards of training and expectation of platform staff in regards to AML and FC prevention are significantly higher than those of the SC. The FCA requires that all staff and senior managers receive training at the point of induction into the firm and then attend training on at least an annual basis to ensure staff are up to date and competent.
I believe that as the P2P industry grows in Malaysia the SC will seek to impose higher levels of expectation on P2P platforms in regards to AML and FC prevention practices as well as staff training and competence. Platforms that start out in the industry adopting a higher level of practice, more aligned to that of the UK regulation will set themselves in good stead for future changes.
Interest Rate Cap
One of the most notable rules imposed by the SC is the cap on the rate of financing on platforms. This is probably a pre-emptive measure to prevent market abuse, which has occurred in other P2P territories.
The FCA does not offer any guidance or regulation of the maximum or minimum rates that can be offered by investors on platforms to businesses. This being said, it would not be surprising for the FCA to move into the area of offering guidance and implementation regulation on the treatment of businesses and the rates at which they can borrow.
Currently the FCA regards businesses entering into P2P investments to be sophisticated, (in comparison to consumer borrowers) and as such should be able to align the cost of finance with the needs of the business and its ability to repay.
Operation Management of a Trust Account
The management of client funds is one of, if not the most sensitive parts of P2P regulation in the UK. The FCA handbook, refers to Client money in the CASS section, and has extensive rules on the way in which client money should be segregated from a firm’s money, the manner in which a client account should be set up with a bank to the way in which P2P platforms should carry out their reconciliation of the client account. The FCA seek to ensure that client money is adequately protected at all times so that in the event of a platform failing, the client funds will be adequately separated from the firm and will be able to be returned to investors and not get caught up in liquidation or administration processes.
The FCA CASS rules for P2P, evolved from existing rules, and the FCA have sought to collaborate closely with platforms as to the appropriateness of the rules and to bring about an industry standard of how client money should be treated.
From a UK regulatory perspective, it is surprising to see the Malaysian equivalent of the CASS rules, being far more light touch in its approach. The SC’s rules on client money/operation of a trust account are clearly intended on ensuring client money is safeguarded and segregated from a platforms own funds, but do not go so far as giving specific instruction on how platforms should go about the safeguarding. I believe that the SC will look to very quickly bolster these rules and offer more instruction to platforms once they have had an opportunity to understand the needs and ways in which platforms operate, as seen by the FCA’s approach. A first step to bolstering their guidelines the SC may look at introducing many of the rules they have imposed on Fund Management Companies, see Guidelines On Compliance Function For Fund Management Companies. The SC’s guidelines for Fund Management Companies very closely resembles the FCA’s handbook, albeit it in less detail, but more focused on a specific sector. The Guidelines, have made use of the FCA’s Principles of Business and offer more guidance on the management of client money.
P2P operators starting out in Malaysia may be best placed reviewing these guidelines as well as the FCA requirements relating to client money in an effort to future proof their processes and also offer their clients the peace of mind that they operate to a higher standard than is expected by the SC, without additional cost. For example the requirement to produce a daily reconciliation is a healthy discipline for all finance businesses.
Permitted and Non-Permitted Issuers
The FCA does not specify state whom can or cannot borrower through a P2P platforms and as such platforms servicing individuals to PLC’s have emerged, allowing the market to diversify and offer niche lending products.
The SC has in regulating the P2P sector been very careful to preclude platforms from providing consumer finance. Whether the SC intend to open up P2P to consumer finance is unknown, however their decision to initially limit it to business finance is arguably a wise decision whilst the market is in its infancy.
This being said, it is interesting to note that the SC has not chosen to put any other criteria on businesses borrowing, as the FCA has sought to in its differences between an Article 36H and Article 60C credit agreement.
The FCA, in stipulating a difference between the two, provide additional protection to consumers as well as businesses by ensuring that platforms apply a higher level of care and consideration where the borrowing party is borrowing less than £25,000.
Going forward, the SC may seek to implement a borrowing threshold whereby a higher degree of regulation is applicable to protect against any abuse of vulnerable borrowers. For example, a business that under SC regulations is able to borrower through a P2P platform that can service a loan of over RM5 million is likely to be more sophisticated than a business that only meets the criteria to borrower RM1 million, but both would be subject to the same SC regulations, whereas the 2nd smaller business may be more likened to a consumer, and would need a higher level of protection by the SC.
Platforms in Malaysia should carefully consider their lending risk appetite and reconcile this with the types of businesses that they want to assist, as it would not be surprising if the SC imposed a higher level of regulation on platforms offering lower levels of finance to smaller businesses.
The SC in their rules have also set a restriction on Issuers (borrowers) from borrowing from more than one platform at the same time, but allows them to run a concurrent campaign on an equity crowdfunding platform. Whilst the FCA does not impose any similar restriction, platforms themselves have applied this rule to their loan agreements. This being said, despite the transparency of a P2P agreement, it is a rule that is difficult to monitor and relies primarily on the borrower’s integrity and disclosure as well as on investors to spot any potential breaches of the rule through their use of multiple platforms. It will be interesting to see how Malaysian platforms go about monitoring this expressed rule by the SC and whether the SC will require the platforms to monitor each other to ensure Issuers do not abuse the system, or whether the rule will be allowed to be covered by a contractual obligation on the Issuer.
Gaps in the Current SC Guidelines…
A comparison of the SC’s guidelines with those of the FCA on P2P platforms, shows noticeable gaps in the SC’s regulation of the sector at present. However, given the Malaysian markets’ infancy this is unsurprising, in fact the SC’s guidelines are very much aligned with the FCA’s initial guidelines published in 2013. Over time, as the regulator has grown to understand the sector more, they have gradually strengthened regulation on the market, and continue to do so.
Notable gaps in the current SC guidelines are around the treatment of Financial promotions in regard to investments available on the platform, the lack of emphasis placed on training and competence and organisation and management of the platforms.
Interestingly, the SC have covered all these points in their Guidelines On Compliance Function For Fund Management Companies and as such would suggest that the rules that apply to Fund Management Companies in Malaysia may soon be applicable to P2P platforms in Malaysia.
Starting a platform in Malaysia?
Whilst the P2P industry in Malaysia is only just fledgling, the P2P sector in the UK and USA, are arguably in their adolescence. Recent controversy in the USA over a P2P platform has sent a wave of doubt and skepticism across all markets, causing many investors and skeptics to question the future of P2P platforms as well as the suitability of regulation governing the platforms. Whilst early innovator platforms in the UK and the USA were able to grow with support and excitement of investors, at what was seen as the answer and future of finance following the 2008 financial crisis, platforms starting out in countries such as Malaysia will do well to learn from the mistakes made by existing platforms across the world, as well as look to the regulation imposed on platforms in more developed markets. Doing so will allow the platforms to potentially grow quicker, put in place strong policies, processes and systems and controls, all of which will provide them with a competitive advantage against competitors in their home markets.
Perhaps one of the most attractive features of the Malaysian framework is the light touch enforcement, the soft start to a regulatory regime is start-up friendly. P2P Platforms looking to become global players will establish a base in Asia and with Malaysia recognising the need to make business credit easier, its certain to move up the league table for ease of doing business.