The Treasury has announced that peer-to-peer lending will fall under the Financial Conduct Authority for its regulations, adding credibility and boosting recognition for the alternative finance model.
The decision, which will formally be announced in the next Financial Services Bill and implemented by April 2014, is something supporters of peer-to-peer lending have been campaigning for for some time, believing a regulated sector would inspire confidence from investors.
However, the Huffington Post UK understands that under the current proposals, there are no plans to bring peer to peer loans under the scope of the Financial Services Compensation Scheme. which covers the failure of financial firms.
Peer to peer lending has also helped kick start a number of small businesses which have struggled to obtain finance from traditional lenders, such as high street banks.
It works by encouraging people to invest money into start up businesses; helping small businesses to get the money they need to start or expand their company and generating a return for the original investors.
Liberal Democrat peer Lord Sharkey said during the second reading of the Financial Services Bill in June that while innovation in the provision of traditional retail financial services was "obviously important", the non-traditional peer-to-peer lending sector needed regulation.
"Alternative funders are in favour of regulation. They recognise the dangers to their business model of a scandal generated by some rogue entrant to their market," he said.
"This is not a theoretical danger or a distant prospect and is certainly not a trivial problem. There is nothing to stop such an event occurring and permanently destroying confidence in the peer-to-peer model."
Peer to peer lenders welcome the news
In the UK, Ratesetter, Funding Circle and Zopa are the best known peer to peer lenders.
Samir Desai, chief executive and co-founder of Funding Circle, told the Huffington Post UK: "We welcome this announcement and look forward to working closely with the government and the Financial Conduct Authority over the coming months to help build a regulatory blueprint.
“The economy continues to face some very tough times, but peer-to-peer lending has prospered over the last two years and established itself as the credible alternative to the banks.
“At a time when bank lending continues to remain flat, Funding Circle is helping thousands of British people to earn inflation-beating returns by lending money directly to growing businesses fizzing with ideas, energy and ambition."
Simon Dixon, founder of peer to peer crowdfunding platform Banktothefuture.com, told Huff Post UK: "As an industry, we have been encouraging the FSA to recognise the peer to peer lending as a great way to get finance to SME's. It is testament to the growth of our industry that the FCA wants to regulate our industry. We met with all other providers and regulators today to discuss how we can move forward with this transparent form of lending."
And Ratesetter wrote on its blog on Thursday: "We welcome the prospect of legislation that would give us the ability to become a regulated entity, putting us on a level playing field with other financial services. It would enable us to participate within an accepted framework and be accepted as a credible sector in the financial world.
"It is evidence that the government thinks we are a credible model which allows consumers and businesses to benefit; it is support for the self-regulatory activity that we have undertaken that sets out to ensure consumers are protected; it opens the door, in the longer term, to create regulated and tax-efficient products based on peer-to-peer lending."
Jeff Lynn, chief executive of Seedrs - a crowd funding platform currently regulated by the Financial Services Authority -told Huff Post UK that regulation of the wider alternative funding platforms would bring a sense of trustworthiness to regular consumers.
"We spent three years building our platform and seeking operations out to become regulated by the FSA before we opened our doors because we wanted people to trust us," he said.
"The question of what happens if a platform fails is where regulation becomes critical. The FSA analyses our systems, controls and cessation of business plans. We have rigorous procedures in place, including the segregation of all investors' money so that in the event of us going bust, their money would be safe."
The government has made a series of positive supporting statements about the adoption of alternative funding regimes to help kickstart small businesses - the department for business, innovation and skills announced earlier this year it would invest up to £100 million through non-traditional lending channels that lend directly to small businesses, including peer-to-peer lenders.
The Financial Conduct Authority is one of two new financial regulators which will begin operating in 2013 - it is responsible for requiring firms to put the well-being of their customers at the heart of how they run their business, promoting effective competition and ensuring that markets operate with integrity.
UPDATE:
The Treasury has issued this response:
“The government is keen to promote innovation in financial services and wants to support new entrants to the market, like peer-to-peer lenders.
“It's clearly very important that consumer credit providers are properly regulated, which is why, as announced in November, we confirmed the regulation of peer-to-peer platforms will be transferred to the new Financial Conduct Authority along with other consumer credit regulation.
“Both the Treasury and the Financial Services Authority will be issuing consultations early in the new year on further detail of the consumer credit transfer, which will cover peer-to-peer platforms."