PEER TO PEER LENDING REPORT

Accredited for CPD by CISI, CII, PFS OPENING STATEMENT

Welcome to this in-depth report on Peer to Peer Lending. (“P2P”).

TISA has long been interested in the potential Individuals can earn competitive interest Editorial of Peer to Peer Lending (P2P) and lobbied from peer to peer lending, albeit with risk, Daniel Kiernan successfully for P2P to be included within ISAs. and borrowers can be matched directly with Lisa Best willing lenders, either directly or through a Peer to peer lending enables lenders to be pool of lenders. This can be more flexible than Ryan Zeng matched directly with borrowers, whether borrowing through traditional banks, both individuals or businesses through online in speed of offer and lower fees, and interest services. Peer to peer lending companies rate. Borrowers do not have to pay for the Creative operate entirely online, so they can operate traditional infrastructure of banks, including with lower overheads and provide the service Mar Alvarez lots of High Street premises. more cheaply than traditional financial institutions like banks. Competition ecourages traditional banks to improve their offerings to savers (lenders) Sub-editing As a result, lenders can often earn higher and borrowers. In the meantime, savers can returns than from banks, while borrowers can Daniel Kiernan get better rates, and the opportunity to get borrow money at lower interest rates, even involved in backing businesses, though many Lisa Best after the P2P lending company has taken a savers choose not to. Borrowers get access to Ryan Zeng fee for providing the service and carrying out cheaper and more flexible finance. appropriate credit checks on borrowers. Peer to peer lending, then, is a new and Many peer to peer loans are simply unsecured interesting type of asset class, in the same way Research personal loans, though increasingly, that corporate bonds were in the in the 1990s. Lisa Best businesses, such as property companies, are Then, corporate bonds were new for retail using peer to peer as a convenient way to Ryan Zeng investors. Now, in corporate bond funds, they borrow. Interest rates can be set by lenders are an important and essential part of any Alan Sheehan who compete for the lowest rate or fixed by investor’s portfolio, offering diversification of Adrian Scales the intermediary company on the basis of an risk, low volatility (compared to stocks and Katie McCarthy analysis of the borrower’s credit. shares) and better yield than available from bank deposits. On some services, lenders manage the risks of bad debts by choosing which borrowers to Currently, most P2P lending is direct from Marketing lend to, and manage total risk by diversifying the individual to the P2P platform. But as their investments among different borrowers. Michelle Powell the market develops, we expect that many Other models involve the P2P lending advisers will see P2P as an important asset company maintaining a separate, ringfenced class to be considered for inclusion in client fund, which pays lenders back in the event Print portfolios. We believe that this will give more the borrower defaults. Peer to peer lending savers access to P2P, as advisers will increase DISCLAIMER PUBLICATION Palina Limited companies that become insolvent can the professionalization of the market. also place lenders’ money at risk. And, P2P This report is provided for general The information has been compiled investors are not covered by the Financial Therefore this guide has been produced as information purposes and for use from credible sources believed Services Compensation Scheme (FSCS). part of a series of educational papers that will only by investment professionals to be reliable, however it has not be published to improve the understanding of and not by retail investors. been verified and its accuracy and So, why do we like P2P? this important and growing market. completeness are not guaranteed. Reliance should not be placed on the The primary reason is that P2P introduces information, forecasts and opinions set The opinions expressed are those of choice and competition, for savers (lenders) out herein for any investment purposes Intelligent Partnership at the date of and borrowers. and Intelligent Partnership will not accept publication and are subject to change any liability arising from such use. without notice. JEFFREY MUSHENS

Intelligent Partnership is not authorised No part of this publication may Technical Policy Director and regulated by the Financial Conduct be reproduced in whole or in part Tax Incentivised Savings Association (TISA) Authority and does not give advice, without the written permission information or promote itself to of Intelligent Partnership. individual retail investors. Copyright © Intelligent Partnership 2017 3 CONTENTS

INTRODUCTION INDUSTRY MILESTONES THE INVESTMENT CASE RISKS & CONTROLS WAYS TO INVEST & ADVISE FINAL CONCLUSIONS

39 RISKS & CONTROLS 39 FRAUD 40 DEFAULTS 41 ORIGINATION 43 PLATFORM MELTDOWN 10 INDUSTRY MILESTONES 52 FOCUS ON PLATFORMS 43 LIQUIDITY 13 INSTITUTIONAL MONEY 54 BUSINESS MODELS 44 INTEREST RATES 14 REGULATION 55 ACCESS TO DIRECT 45 LACK OF TRACK RECORD LENDING STRATEGIES 18 INNOVATIVE FINANCE ISA 30 INVESTMENT CASE 47 P2P IN A RECESION 59 AGGREGATORS 19 GOVERNMENT SUPPORT 30 YIELDS, RISK & RETURNS 72 FINAL CONCLUSIONS 03 OPENING STATEMENT 48 REGULATION 62 WAYS TO INVEST: 21 BANK TIE UPS 33 OTHER ASSET CLASSES CONCLUSIONS 73 SWOT 07 INTRODUCTION 49 OTHER MACROECONOMIC 22 MARKET DATA 34 AUTHENTIC AND POSITIVE RIKS 63 ADVISING ON P2P 74 APPENDIX I: REFERENCES 08 WHAT IS PEER TO PEER LENDING? 28 CONCLUSIONS 37 CONCLUSIONS 50 CONCLUSIONS 70 LENDINGWELL 78 CPD AND FEEDBACK

* Please note: unless otherwise stated, all charts and graphs have been provided by Intelligent Partnership Published February 2017

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4 5 INTRODUCTION A GROWING NEW ASSET CLASS

Peer to Peer (P2P) lending the information advisers need to when/if the firm becomes publicly traded or a third party deems it has grown rapidly since understand the asset class and make INTRODUCTION an informed decision about the merits suitable for acquisition, making the foundation of Zopa, the (or otherwise) of adding P2P to their the risk associated with this form world’s first online lender, in investment proposition. of crowdfunding much higher. Crowdfunding investors are not 2005. The global market has ACKNOWLEDGEMENTS & THANKS purchasing an income stream with a defined term, stated interest rate been calculated to have an We couldn’t do this without the help and and repayment of principle at the estimated worth of over $180 support of a number of third parties who end of that term (bullet loan), or have contributed to writing this report. billion, and the UK market periodic repayments of principal and Their contributions range from inputting interest (amortising loan) as they are transacted just over £3 billion into the scope, sharing data, giving us with a P2P loan. in 2016. their insights into the market, providing copy and peer reviewing drafts. REGULATORY DEFINITIONS Growth in the sector is far from over, So a big thanks to: Cormac Leech of with analysts predicting the UK market Confusingly and perhaps Victory Park Capital Advisers, Orca alone will continue to expand at a unhelpfully, the FCA has decided to Money and Liberum. Their input is CAGR of over 40%, with total lending use “Crowdfunding” as an umbrella invaluable, but needless to say any set to reach £30.3bn by 2022. term that encompasses both issuing errors or omissions are down to us. equity and P2P lending. They Of course, there are lots of reasons We also carried out our own extensive subdivide the sector into “Equity behind this extraordinary growth, but research, examining brochures, Based Crowdfunding” and “Loan the biggest driver is the returns on investment prospectuses, and trawling Based Crowdfunding”, but these offer. P2P lenders can earn annualised through websites to verify data and terms are rarely used within the net returns ranging between 5% and identify the latest trends. industry. Therefore, in line with the 7% and often higher. These returns are rest of the sector, we’ll use the terms comparable with the highest yielding The report is made possible by our P2P lending, marketplace lending or equities and bonds, and easily beat sponsors, LendingWell, who have online lending. the returns on high street deposits supported us by helping to meet estimated at an average of 0.62% production and printing costs. by the Bank of England1 November LEARNING OBJECTIVES Inflation Report. DEFINITION OF TERMS By the end of the report readers However, P2P is still a new asset class P2P lending has already developed will be able to: and many advisers are understandably its own specialist language, jargon wary of recommending that their and acronyms. They will be explained Get up to date on the size and clients invest in something that doesn’t throughout the report, but for the sake of growth rates of the market and have a long track record and that they clarity a few key terms are discussed here. what drives them themselves do not fully understand. This This report is about Peer to Peer Discover how government lack of understanding and reluctance can lending (P2P lending). This is support, regulatory reform, also be extended to the para-planners, sometimes referred to as Market institutional investment and compliance departments, PI brokers and Place Lending (MPL) or online lending. growing track record are bringing back office teams that support advisers. Some people who are new to the P2P into the financial mainstream sector confuse P2P lending with This report will address that problem Evaluate the risks and mitigants crowdfunding. Crowdfunding is a directly, giving readers a thorough of investing in P2P loans in varying similar activity inasmuch as it raises overview of the market, helping market conditions them to understand the diversity capital online from numerous investors of business models within the P2P who can invest very small amounts, but Review the routes to investment sector, outlining the risks and benefits, crowdfunding platforms issue equity, and due diligence considerations not debt. Investors are purchasing a highlighting the different ways to Get an understanding of the small share in a company in the hope invest in P2P and pointing to resources current fees and charges that may that it will be worth more at some that can help advisers who want to apply in the P2P universe learn more. The intention is to provide point in the future. This is likely to be

6 7 WHAT IS PEER TO PEER LENDING? BRIEF OUTLINE

P2P lending is the practice of matching Services Compensation Scheme borrowers and lenders through online (FSCS), also referred to as the deposit platforms. The platforms are not guarantee scheme that protects INDUSTRY MILESTONES banks or traditional financial services money in savings accounts at banks institutions, instead they utilise new from losses up to a limit of £85,000 technology to secure numerous per banking group. investors who are prepared to lend their funds at a range of interest rates. P2P AND THE FUNDING GAP The loans issued are often comprised Another driver behind the growth of of scores or even hundreds of P2P has been the banks’ retrenchment different investors, from individuals to from lending post the financial crisis institutional investors. The minimum of 2008. The British Business Bank investment threshold is £10 for many has found that nearly 100,000 SMEs platforms, while the average amount and approximately £4bn worth of invested per lender runs into several applications for debt are estimated thousand. to be rejected each year. P2P lending Borrowers range from private is an important alternative source of individuals (P2P Consumer Lending), finance for these SMEs and is playing small businesses (P2P Business an increasingly important role in this Lending), to property developers or section of the economy. individuals raising mortgages (P2P Real Estate Lending). Some platforms SUMMARY specialise in one of these borrower P2P lending is an asset class that segments and some cover multiple is here to stay. The returns are segments. attractive, lending volumes are The platforms have different operating increasing and awareness is growing. models to mitigate against the risk The sector is regulated, loans can of loss of capital. Some only do now be held within an ISA and asset backed lending, some operate institutional investors are enforcing contingency funds and some provide higher standards of professionalism. insurance coverage. Some platforms Advisers can’t afford to ignore this operate as pure marketplaces, development, and it’s hoped that this matching borrowers and lenders for report will help educate them about a fee, and some invest off their own the sector. balance sheets.

So, there is a lot of diversity within the P2P sector. These models and the pros and cons of each are discussed in more detail throughout the report.

WHAT P2P IS NOT

P2P is explicitly not an alternative to a savings account. There is more risk involved because lenders are exposed to any potential borrower defaults, they do not have the liquidity that comes with a savings account and the funds are not covered by the Financial

8 9 INDUSTRY MILESTONES “The advantage of peer to peer loans for lenders is that they can generate higher interest rates that exceed the interest that could be earned from banks and other financial institutions.” – HMRC DEVELOPMENT

The P2P lending industry has been PEER TO PEER BUSINESS LENDING AS A PERCENTAGE OF NEW LOANS TO SMALL volume in consecutive quarters since ANNUAL P2P LOAN ORIGINATION (£M) around for longer than many people the association began reporting the BUSINESSES IN THE UK realise, and has achieved some key statistic in 2014. Nevertheless, the Q2 £3,500m milestones that indicate that it is figure is only marginally less than that maturing and becoming more and 14% of the fourth quarter of the record £3,000m more accepted into the mainstream. year of 2015, the Q3 figure of £701 12% million showed a bounce back, and LOAN VOLUMES 10% industry reports forecast that UK £2,500m P2P lending will grow at a 45% five- 2015 saw very significant increases 8% year compound annual growth rate, in the volume of loans made by the £2,000m reaching £16 billion by 20203, whilst peer to peer sector, with the total 16 Liberum predicts a potential market amount lent at around £2.4 billion. £1,500m 4% volume of £30 billion by 2025. This amount was split between P2P business lending and P2P consumer 2% NUMBER OF BORROWERS AND £1,000m lending, with P2P business lending LENDERS continuing its reign as the largest model 0% by volume of the UK online alternative 2012 2013 2014 2015 According to the P2PFA, the total £500m finance market: It generated £1,490 number of active borrowers using its million of lending in 2015. Of this SOURCE: PUSHING BOUNDARIES, THE 2015 UK ALTERNATIVE FINANCE REPORT, NESTA, FEBRUARY 2016 members’ UK platforms almost doubled £0 total, £609 million was attributed to in 2015 alone, rising year-on-year from 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 The remainder of 2015 peer to peer loans, £909 million, were made to individual property-based debt transactions, approximately 140,000 to approximately consumers, a notable 66% year on year increase from the 2014 figure of £547 largely to property developers. 275,000, as of Q4 20154. And despite the SOURCE: P2PFA 2 million . Again, average loan size of £6,583, reflects the audience of borrowers, dip in the value of new loans in 2016, the P2P business lending volume in perhaps looking to buy a car or consolidate credit card loans. In fact, overall volume number of borrowers with a loan has 2015 represented a near doubling By far the largest number of peer to peer lending platform users are currently growth in the last five years has been very impressive. continued its upward trajectory - rising of the 2014 figure and most of the individual consumers - over 213,000 of whom became borrowers through a by around 30,000 per quarter, to reach beneficiaries of these loans were SME platform in 2015. Nevertheless, the total number who actually applied is over more than 392,000 by Q4 2016. firms with a trading history. In the THE DEVELOPMENT OF ONLINE PEER TO PEER LENDING MODELS 1.3 million as those who were actually accepted total only 15.84% of those who real estate sector, this largely took This makes it clear that uptake of P2P applied. This suggests much more stringent credit scoring and underwriting than the form of capital for mostly small lending services is spreading amongst some might expect. It also indicates that it is not just a case of platforms charging £3,500m to mid-sized property development the population, which is increasing the high interest rates to high risk borrowers and offering high returns to investors, companies, financing both residential number of loans originated. with minimal probability of being paid out. £3,000m and commercial developments. Nesta and the University of Cambridge £2,500m % OF LOAN APPLICATIONS ACCEPTED BY SUB SECTOR (2015) Centre for Alternative Finance estimates that P2P business lending (excluding real £2,000m 15.84% 22.7% 27.5% estate lending) supplied the equivalent of 13.9% of new bank loans (£881 £1,500m million), to small businesses in the UK in 2015 (based on BBA’s 2014 baseline £1,000m figure of £6.34 billion). The average size of a P2P business loan at £76,280, is a £500m BUSINESS SUB good indicator of the smaller size of the CONSUMERS SECTOR REAL ESTATE entities accessing these funds. £0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 There are signs of the industry maturing with the Peer to Peer Finance SOURCE: PUSHING BOUNDARIES, THE 2015 UK ALTERNATIVE FINANCE REPORT, NESTA, FEBRUARY 2016 Association (P2PFA) reporting that CONSUMER-UNSECURED SME UNSECURED ASSET-BACKED UK P2PFA lenders lent £658 million in Around 10,000 UK small and medium sized enterprises (SMEs) raised funding via P2P business lenders in 2015. However, PROPERTY SECURED INVOICE FACTORING Q2 2016, down 8% from £715 million between 2013 and 2015, on average, only 22.7% of loan applications were approved in this sub sector. This may surprise those in Q1 2016 - the first time there has with the perception that every young or small company can get money thrown at it by reckless online lenders. And each loan not been an increase in new loan SOURCE: P2PFA required an average of 347 lenders prepared to fund it; given the average loan value, this gives a possible mean contribution as low as just £220 per investor.

10 11 “Data suggests that marketplace lendings’ annual risk-adjusted returns are competitive with equities. Specifically, while direct lending has underperformed the S&P 500 index over the past 20 INSTITUTIONAL MONEY years, it has not had any negative return years and has been much less volatile.” – Deloitte INCREASING INTEREST

P2P real estate lending had a slightly LAUNCHES AND CLOSURES OF UK P2P PLATFORMS AMOUNT % OF ACTUAL INSTITUTIONAL FUNDING ACROSS PEER TO PEER MODELS (2015) higher acceptance rate of an average There is plenty of evidence of the of 27.5% of loan applications in 2015, PLATFORMS LAUNCHED PLATFORMS CLOSED NON-INSTITUTIONAL FUNDING INSTITUTIONAL FUNDING rising involvement of traditional perhaps reflecting a higher level of financial institutions such as funds, £1000m acceptable asset backing with loan to 25 family offices, banks, governmental value ratios often falling between 65% and non-governmental organisations and 70% - a decent security buffer 20 in peer to peer lending: for investors. These funds financed £800m in excess of 600 UK commercial and 26% of all P2P business loans in residential developments in 2015, 15 2015 were funded by institutions mostly by small to medium sized 32% of all P2P consumer loans in property developers. (This is a crucial £600m 2015 were funded by institutions sector given the ongoing UK housing 10 crisis, and it’s forecast to continue5.) 45% of all platforms surveyed for the 2015 Nesta UK Alternative Finance The average number of lenders £400m 5 Industry Report stated that their required to cover loans for this platform had had some institutional model in 2015 was 490, based on an 10 0 involvement (28% in 2014, 11% in 2013 ) average loan amount of £522,333, £200m giving a mean ‘per investor’ amount 2005 2008 2009 2010 2011 2012 2013 2014 2015 2016 In peer to peer real estate lending, of £1,066. Since this loan amount is the level of institutional funding SOURCE: P2PMONEY.CO.UK (NOT INCLUDING GRADURATES WHICH WAS TAKEN OVER IN 2014) almost seven times that generally participation can be as high as 75% on loaned out in peer to peer business some platforms11. £0 TOT Q1 Q2 Q3 Q4 TOT Q1 Q2 Q3 Q4 TOT Q1 Q2 Q3 Q4 loans (without real estate), it’s not Research, reported at the Lendit landscape. That said, 2014, the year with Institutional investment in 2015 is surprising that more lenders providing Europe conference that 12 firms the highest number of new platforms P2P CONSUMER LENDING P2P BUSINESS LENDING P2P REAL ESTATE LENDING telling, showing a progression across more funds are needed to back it. Yet, had received full FCA permissions to was the year in which the FCA took over the year and suggesting a trend that SOURCE: PUSHING BOUNDARIES, THE 2015 UK ALTERNATIVE FINANCE REPORT, NESTA, FEBRUARY 2016 taking into consideration the financial operate a P2P platform and a further regulation of consumer credit, including will continue. reach of institutional investors, even 39 were still operating under interim P2P firms, and the imposition of more funds through marketplace lending which can successfully leverage their £1,066 is a very low commitment permissions. A number of new firms stringent rules began. But it was also the This is not surprising given the as a means to open up new routes participation, with Deloitte suggesting and demonstrates the potential for had also applied for authorisation8. year with the most platform closures. higher-risk adjusted, lower volatility, for SMEs to access funding, whilst that, “partnerships with banks will extremely diversified, large portfolios6. At the time of publishing in December predictable absolute returns than some traditional banks are also using help marketplace lenders to increase 2016, at least one additional platform available elsewhere, the potential arrangements with peer to peer awareness (and possibly trust) among The interest and participation in was granted full authorisation by the AVERAGE PEER TO PEER LOAN AMOUNT (2015) for substantial diversification and lending platforms as an entree to borrowers and investors, gain scale marketplace lending has continued FCA. the transparency of the P2P market. business which was previously not and possibly lower their customer to flourish in 2016; the number of £600,000 The modest default rates are also financially viable. This is discussed acquisition costs.”15 investors who had lent more than £1 This points to more than fifty P2P attractive, even if most platform’s in more detail later in the Industry at the end of the second quarter of platforms currently open. Deeper liquidity and more robust £500,000 performance history is too short to Milestones section of this report. 2016 grew to 150,000, a 6% increase stability could also result from the We can see that the number of new reliably inform future performance12. from Q1 2016 and nearly 30% year- In February 2016, Stian Westlake upsurge in institutional investment platform launches peaked in 2014, with £400,000 That said, Zopa’s performance through on-year growth7. And by the end of Q4 from Nesta said, “Banks can learn in the peer to peer loans universe, a drop of over 50% in the number that a full credit cycle, including the global 2016, the number had risen to almost about both cost-effective loan as some predict that the majority of took place in 2015. The figures show a economic crisis of 2007-09, retaining 170,000. £300,000 origination and data-driven due growth will come from credit funds 50% drop in new platforms between positive returns for lenders is well- diligence from the P2P platforms. I investing in securitised assets or 2015 and 2016, although there are documented. NUMBER OF PLATFORMS £200,000 think most of the banks are sniffing secondary loans, rather than from perhaps ten more that are planned in around for acquisitions.” And KPMG’s investors lending directly to specific According to the FCA, at July 2016 there 2016 and beyond9. PROS OF INSTITUTIONAL Warren Mead said 2016 would be individuals; the creation of this were over 100 crowdfunding platforms £100,000 INVOLVEMENT The lower levels of new entrants in the year when “alternative financial secondary market for loans would in the market (including those providing the last two years may well reflect a The British Business Bank (BBB), options finally join the ranks of certainly improve liquidity, whilst equity based and donation based maturing sector, as well as increasing which has invested close to £200 the mainstream.”14 Moreover, the the longer investment horizons of offerings) or seeking authorisation. CONSUMERS BUSINESS REAL ESTATE barriers to entry for those without million through P2P lending13, is now involvement of more entities such institutional investors such as pension

In October 2016, Christopher Woolard, the funding, expertise and ability SOURCE: PUSHING BOUNDARIES, THE 2015 UK taking part in this alternative finance as pension funds and professional funds means they are in a position to FCA Director of Policy, Risk and to navigate the changing regulatory ALTERNATIVE FINANCE REPORT, NESTA, FEBRUARY 2016 route which is becoming less and financial players is likely to bring provide enduring and steady funding less alternative. The BBB is deploying significant positives for the platforms to the sector16.

12 13 “The British Business Bank, have invested nearly £200 million in P2P platforms, often by topping up the remaining unfunded portion of near-fully funded loans. Such funding is not only financially “Peer to peer lending platforms have a proud record of embracing regulation.” – Christine Farnish, CBE, but also symbolically important. Arguably, it has boosted public confidence to participate in the Peer to Peer Finance Association market.” – The Bank of England

CONS OF INSTITUTIONAL INCREASING INSTITUTIONAL INVESTMENT DEVELOPMENT OF P2P LENDING REGULATIONS INVOLVEMENT

Having said that, institutions do have a reputation for moving their PROS x CONS money quite frequently, sometimes OCTOBER 2013 1 APRIL 2014 1 OCTOBER 2014 being rather flighty and moving their GREATER MAINSTREAM AWARENESS FCA PUBLISHED FCA TOOK OVER REGULATION FCA STARTED CONSIDERING investments on a whim. This is not a INSTITUTIONS CHERRY CONSULTATION PAPER 13/3 OF CONSUMER CREDIT APPLICATIONS FOR FULL beneficial feature in an asset class that PICKING DEALS WHICH OUTLINED THE FCA’S FROM THE OFT AND AUTHORISATION FROM may not always be highly liquid. DEEPER LIQUIDITY PROPOSALS TO REGULATE IMPLEMENTED NEW RULES FIRMS WITH INTERIM LOAN-BASED AND EQUITY- FOR CROWDFUNDING BASED PERMISSIONS. Another potential negative for other BASED CROWDFUNDING. ON POLICY STATEMENT 14/4. potential investors is the resources MORE PROFESSIONALISM/EXPERIENCE and skill that institutions possess which may allow them to identify and ‘FLIGHTY’ MONEY monopolise the best deals. This could ACCESS TO MORE CLIENTS/LOAN ORIGINATIONS make it important that individual investors/advisers know what advantages or disadvantages they SOURCE: INTELLIGENT PARTNERSHIP 1 APRIL 2016 MARCH 2016 FEBRUARY 2015 face when considering a peer to peer lending deal, so that they can make an step on the road to mainstream to investors clearly and be honest FULL FCA CONSUMER CREDIT POLICY STATEMENT PS16/8 FCA PUBLISHED A REVIEW informed decision. acceptance. about the risks associated with the REGIME CAME INTO EFFECT, PUBLISHED SETTING FINAL OF THE REGULATORY REGIME investment. REPLACING THE INTERIM RULES RE THE SEGREGATION FOR CROWDFUNDING Nevertheless, platforms are aware of Until 2014, the regulation of the peer PERMISSION REGIME. OF CLIENT MONEY ON LOAN- AND THE PROMOTION OF this issue and a recent report which to peer lending space was under the All P2P lending platforms must BASED CROWDFUNDING NON-READILY REALISABLE looked at platform members of the control of the Office of Fair Trading’s ensure customers’ investments and PLATFORMS, THE SECURITIES. IT DECIDED NO P2PFA, found that some P2P platforms Consumer Credit legislation. However, loan repayments are held completely INNOVATIVE FINANCE FURTHER RULES CHANGES have put in place controls to achieve from April 1 of that year, the FCA separate from the company’s own ISA, AND THE REGULATED REQUIRED BUT IT WOULD fair treatment of different types of took over regulation of consumer assets and have a third party to take ACTIVITY OF ADVISING ON CONTINUE TO MONITOR THE investor (e.g retail and institutional). credit and with it, oversight of the over loan administration to protect PEER-TO-PEER AGREEMENTS. GROWING MARKET. This involves random allocation of loans crowdfunding universe - both equity customers’ money in the event the across different groups of investor types and loan based. Since that time, platform suffers financial problems. when auto allocation is used17. several FCA consultations, new Investors in loans sourced by P2P regulations and reviews have taken lending platforms were given access 8 JULY 2016 DECEMBER 2016 1 APRIL 2017 2019 REGULATION place and the regulatory landscape to the Financial Ombudsman Service has tightened up considerably. Regulation has been described as a (FOS) in cases where the platform FCA CALLED FOR FCA PUBLISHED MINIMUM CAPITAL FCA TO COMPLETE A INPUT TO THE INTERIM STATEMENT ADEQUACY REVIEW OF RETAINED driver that, “will allow the sector to That said, the FCA is keen not to does not resolve a complaint to the SCHEDULED POST- RE FEEDBACK TO THE REQUIREMENT FOR CCA CONDUCT attract even more institutional capital, smother the innovation of the sector, investor’s satisfaction. IMPLEMENTATION CALL FOR INPUT, FIRMS RUNNING REQUIREMENTS particularly in this low growth and low meaning that it continues to benefit All P2P lending platforms became REVIEW OF THE FCA’S HIGHLIGHTING LOAN-BASED AND DEVELOP interest rate environment. Attracting from a lighter touch and consequently, subject to the FCA’s dispute resolution CROWDFUNDING CONCERNS AND CROWDFUNDING RULE-BASED these types of investors is crucial to much lower regulatory overheads than RULES BY 8 STATING THAT IN Q1 PLATFORMS ALTERNATIVES. rules21. the scalability of platforms and is the traditional banks19. SEPTEMBER 2016. 2017 THERE WOULD INCREASES FROM only way through which the industry In order to assist with market BE A CONSULTATION £20,000 TO In April 2014, the Financial Conduct will be able to service the huge [SME] monitoring, all P2P lending platforms ON NEW RULES TO £50,000. Authority (FCA) introduced regulation ADDRESS THEM. lending gap.”18 are required to submit regular reports of P2P lending and equity based on their financial position, the client Marketplace lenders and the Peer- crowdfunding, by which the platforms money held, complaints and the loans to-Peer Finance Association also were required to adhere to new rules, arranged each quarter. “Consumers need to be clear on what they are getting into and what the risks of Crowdfunding are. recognise the positive impact of the most important of which were: regulation in giving institutions, All P2P lending platforms are Our rules provide this clarity and extra protection for consumers, balanced by a desire to ensure All P2P lending platforms must be funds, advisers and investors, required to hold capital reserves of 22 regulated and authorised by the FCA20. firms and individuals continue to have access to this innovative source of funding.” confidence in the strong independent at least £20,000, rising to £50,000 Christopher Woolard, FCA Director of Policy, Risk and Research governance applied to the sector. All P2P lending platforms must by April 2017, to help guard against – And the reality is that this is a critical present information about P2P lending financial instability.

14 15 “Peer to peer lending platforms recognise the importance of ensuring that incentives are not skewed “Before we began regulating the sector, it took an average of 28 months for new platforms to reach merely in favour of writing loans, irrespective of their long-term performance: an increasingly their first £25m in sales. In 2014, it took an average of 17 months for new platforms to achieve the significant amount of income comes to the platforms during the later period of the life of the loans.” same figure.” – FCA – Peer to Peer Finance Association

after a 30-day notice period. The emphasis on ensuring that consumers have recourse to the FSCS in the event At the time these new regulations P2P PLATFORMS VOLUME BASED CAPITAL REQUIREMENTS (APPLICABLE FROM 2017) were introduced, a full FCA review FCA is concerned with the promises interested in lending to individuals of unsuitable regulated advice if the was scheduled for 2016, although it of liquidity that platforms make to or businesses had access to clear advice was given after 6 April 2016 and £0 TO £50 MILLION 0.20% continued to monitor the industry - investors, and whether an expectation information, which would allow them they entered into a ‘P2P Agreement’. publishing a review of the regulatory gap exists between the two. to assess the risk and understand who Also, if either the platform or the bank regime for crowdfunding and the £50 MILLION TO £250 MILLION will ultimately borrow the money.”)27 in which the money is held (prior to 0.15% THE GROWTH OF INSTITUTIONAL investment) failed before the money promotion of non-readily realisable INVESTMENT DISCLOSURE STANDARDS securities in February 2015. At that was invested, the client money rules £250 TO £500 MILLION 0.10% time, the FCA decided that no further There are many institutional investors The FCA intends to increase its provide for the return of client money rules changes were required but in now involved in the sector and supervisory focus on standards to clients in the event of a firm’s March 2016, Policy Statement PS16/8 OVER £500 MILLION 0.05% also a number of investment trusts of promotion and disclosure by insolvency, or where a bank fails as was published setting the final rules with mandates to invest in P2P platforms. If necessary, the FCA will bank deposits are already subject to regarding the segregation of client SOURCE: ALTERNATIVE LENDING: A REGULATORY APPROACH TO PEER-TO-PEER LENDING, GRANT THORNTON securitisations. It is important that consider whether to mandate in detail FSCS jurisdiction under the Prudential money on loan-based crowdfunding P2P platforms manage effectively any the disclosures it expects and the Regulation Authority’s (PRA) rules. platforms, the Innovative Finance ISA, FINDING: The Intelligent Partnership 2015/16 Alternative Finance Report, found conflicts of interest arising from the time that those disclosures must be And, where a client has a claim for a and the regulated activity of advising that 93% of advisers were not aware that alternative finance platforms are treatment of institutional investors, provided. deposit, it may be protected by the so that retail investors do not end up FSCS under PRA rules. on peer to peer agreements. regulated. But in April 2016, the FCA added the regulated activity of advising on SUITABILITY CHECKS P2P agreements to the permissions of all those adviser firms which already had carrying a higher degree of risk. In July 2016, the FCA undertook The regulator is considering whether permission to advise on investments. This could have a positive effect in raising CHANGE IN THE INVESTOR BASE the review promised in 2014, with platforms should carry out suitability Interestingly, two items raised awareness amongst those firms on the involvement of the regulator in the sector. TOWARDS LESS EXPERIENCED the intention of scrutinising, “the checks for investors. Investment- in July 2016 in a hearing of the burgeoning sector to find out if There is anecdotal evidence that based equity crowdfunding platforms House of Commons’ Treasury confidence, something that the FCA investors/borrowers dependent on consumers who lend and invest suggests P2P investors in the are required to gauge the suitability Select Committee during the oral points out: “According to data supplied the same provision fund, which is money on peer to peer and similar past were relatively wealthy or of investors prior to allowing them to evidence of the new Chief Executive by AltFi, before we began regulating reduced when defaults occur, each crowdfunding platforms understood knowledgeable. The availability of invest. The FCA’s review suggests that of the FCA, Andrew Bailey, don’t the sector, it took an average of 28 investor on the platform may have the risks they were taking” — P2P investment through ISAs and it may consider the implementation of figure prominently in the FCA’s 2016 months for new platforms to reach some indirect exposure to the risk of especially as the industry attracts pensions, or at retirement using a similar set of rules for peer to peer review; Mr Bailey was questioned their first £25m in sales. In 2014, it other loans on the platform in which more “retail investors who are less money released from pensions, may lenders. (This may be directed at non- by MP Chris Philip who contended 23 took an average of 17 months for new they may not themselves be invested. experienced or knowledgeable” . create a change in the investor base advised retail investors.) that, “there is a misalignment of platforms to achieve the same figure.”26 (NB, platforms typically take a portion Rhydian Lewis, CEO and co-founder toward retail investors who are less incentives where those operating of borrowers’ fees to grow their P2P FINANCIAL PROMOTIONS at RateSetter, said, “This review is a The FCA’s 2016 review considers experienced or knowledgeable, who peer to peer lending platforms provision fund). fantastic opportunity for our industry how UK marketplace lending has trust the ISA ‘brand’, and who may not There is a concern over P2P financial receive fees upfront based on the to put beyond doubt the case for evolved recently and its Call for REGULATORY ARBITRAGE fully appreciate the risks involved. promotions which are not compliant volume of loans originated. In his opening up direct access to investment Input document noted a number of with the financial promotion rules response, Mr Bailey suggested that This pooling may result in collective ASSESSING THE QUALITY OF returns from the asset class of loans. emerging features and concerns that across all types of media (for example, structuring lending through taking investment schemes, but P2P CREDITWORTHINESS RATINGS OF Peer to peer investing is becoming very it may take action to mitigate with new unbalanced presentation of risks fees upfront creates uncertainties. platforms are not regarded as BORROWERS popular and it makes sense for the FCA legislation. and misleading comparisons with The P2PFA countered by letter operating collective investment to ensure it is appropriately regulated.” The FCA intends to work with firms savings accounts and banking). The that, “A significant part of the fees By December 2016 the FCA had schemes. If this is the case, the model Christine Farnish, CBE, of the P2PFA to evaluate the quality of their FCA is encouraging feedback to help charged for peer to peer lending collated responses to the Call for is similar to asset management and commented that, ‘Peer to peer lending creditworthiness assessments gauge whether the current financial are earned over the course of Input and issued an Interim Statement creates a risk of regulatory arbitrage platforms have a proud record of including the approach adopted in promotion rules for P2P promotions the life of the loan, and are not on the feedback, including plans to under which firms may conduct embracing regulation.”24 peer to peer business lending and are sufficient, and whether firms have paid at the outset. Peer to peer consult on new rules in early 2017 to business that looks similar to asset whether there is a need to impose a good enough understanding of the lending platforms recognise the Not only does regulation in general address some immediate concerns. management but under a regulatory new rules. (The FCA visited firms as rules. importance of ensuring that give the perception that markets are These are discussed in the Regulation regime that was not designed for asset part of its supervision of the P2P incentives are not skewed merely in fair and orderly25, but also, stricter section of the Risks & Controls section management business models. RECOURSE TO FSCS lending market and in 2015 stated, favour of writing loans, irrespective regulation raises the barrier for entry of this report. The points raised in the THE DEVELOPMENT OF MATURITY “Overall, we were encouraged by what At present, investors do not have of their long-term performance: into the market, so that platforms Call for Input were: MISMATCH PRODUCTS ON PLATFORMS we found during our visits, including recourse to the FSCS for the failure an increasingly significant amount must be more serious to participate, BROADER POOLING OF CREDIT RISK a good understanding of credit risk of borrowers to meet loan payments. of income comes to the platforms dissuading less scrupulous entrants Where borrowers borrow for loan and robust anti-money laundering Investors also do not have any during the later period of the life of looking for a quick buck. And the With investments spread across periods of, say, five years, but investors (AML) and Know Your Customer (KYC) recourse to the FSCS in the event that the loans.” 28 both loans and platforms as a whole invest in products which aim to allow tightening controls have been a good checks. The firms visited all placed an a P2P platform fails (they do currently thing, which has engendered consumer and shared provision funds, with all investors to take out their money

16 17 “Recent research found that peer to peer consumer lending platforms expect the IFISA to add “Simon Kirby who was installed as the new Economic Secretary to the Treasury after the Brexit over 26% to their annual volume.” vote has a history of supporting P2P.”

2016 which allow investors to place right. However, subject to certain with loans across several platforms to the Treasury said, “We believe that incurred in P2P lending investments, Mr Philip also advocated co- bonds and other ‘debt securities’ in conditions, these loans can be held unless they originally invested through peer to peer lending is a brilliantly to be offset against income. investment of a proportion of a the Innovative Finance ISA (IFISA31) within investments that are currently an aggregator wrap platform. This is innovative new form of finance – As a result, if a peer to peer loan isn’t peer to peer lending platforms’ wrapper from 1 November 2016. eligible for a stocks and shares ISA, because only one IFISA account will which we want to see continue to repaid, the lender can set the loss they loans to concentrate attention on The ISA represents a mass market such as investment trusts. be eligible for the IFISA tax benefits grow and evolve. P2P platforms and suffer on the loan against the interest making good credit decisions. Again, financial brand, with a diverse client per year. Consequently, unless fintech provide competition, ideas, The government has also decided that they receive on other peer to peer the P2PFA rebuffed this swipe, base among the young and old, the individual uses an aggregator and technology – making people’s requiring the transfer of peer to peer loans, before the income is taxed. writing, “the peer to peer lending rich and poor, sophisticated and platform, they will not be able to lives better and the markets more loans between ISA managers would Tax relief is available to peer to peer sector has embraced a level of unsophisticated, totalling a £500 create a platform diversified P2P effective”.38 impose significant burdens on peer lenders who: transparency which is unrivalled in billion market32. No wonder then, that portfolio within an IFISA wrapper. to peer businesses and potentially Simon Kirby who was installed as financial services, and it is possible participants in the P2P lending market are liable to UK Income Tax on their negative impacts on the consumer. Whilst some may be excited at the the new Economic Secretary to the to make judgements about the have high hopes for the positive peer to peer income As a result, loans held within ISAs do prospect of the IFISA, the FCA has Treasury after the Brexit vote has a calibre of credit decisions made by effects of the IFISA. not have to be transferable, although caused delays to the full operation history of supporting P2P. In 2012 he make loans through peer to peer each individual [P2PFA member] In fact, recent research found that where secondary markets exist, ISA of the P2P lending market in this welcomed the government’s move lending platforms that are authorised platform in respect of their entire peer to peer consumer lending investors should have the opportunity sphere because of problems to start lending directly to small by the FCA loan book through material which platforms expect the IFISA to add to sell their loan, where they wish to with issuing the fully authorised businesses and traders through peer is already published. I would argue are the legal lender at the time over 26% to their annual volume withdraw or transfer cash from their permissions that platforms are to peer lenders. Mr Kirby said, “Small that ensuring that investors are when it’s agreed that the loan has and peer to peer business lenders ISA (which must be transferable within required to hold in order to offer businesses are the lifeblood of our empowered to29 appraise a peer gone bad expect a 27% increase. Moreover, 30 days). Nevertheless, due to the the new IFISA. At July 2016, only 9 economy and it is essential that they to peer lending platform’s credit peer to peer business lending for real illiquid nature of P2P investments, the firms were fully authorised to offer have access to the finances they need However, it is not possible to offset decisions and performance obviates estate platforms are expecting a very government has indicated that the loan-based crowdfunding platforms to develop and grow.” peer-to-peer lending losses against any requirement to mandate co- substantial 52% growth in transaction transfer deadline of 30 days will only and the FCA were in the process of gains from other types of savings and investment. I would observe that The FCA has also taken its lead from volume as investors seek to utilise the apply if and when investments in the considering a further 88 applications investments, although the loss relief can it is not a requirement for asset the government, stating in July 2016 tax advantages available to them33. IFISA have been liquidated to cash. from firms. By September, the FCA be carried forward for up to 4 years. managers to co-invest, despite that, “Achieving more diverse and This has prompted some of the P2P The government stopped short of had only processed an additional 3 incurring greater levels of risk within accessible financing for individuals and From 6 April 2016, lenders who do not real estate lending platforms to lower requiring all peer to peer platforms authorisations. These include firms their investment portfolios.” small and medium sized enterprises normally need to submit a tax return their minimum investment thresholds to have an active secondary market operating in the market with interim (SMEs), as well as more rigorous will only need to declare any peer to in anticipation of the influx of retail because of the risk of placing permission, having previously been competition in retail banking services, peer interest that they receive through investors34. According to analysis by disproportionate costs on platforms licenced by the Office of Fair Trading The Regulator acknowledges that were reaffirmed as Government the same platform after bad debts to Yorkshire Building Society, that influx - particularly new platforms – and under the regime pre-April 201437. This higher consumer protection comes priorities in the 2016 Budget”39. And HMRC. This can be done by contacting could be of around 405,000 people because it is unlikely to be effective suggests that it may take some time at a price. In 2015, it’s cost-benefit the importance of these funding their local tax office. If the investor who choose to open an Innovative in ensuring consumers can liquidate before all of those keen to offer the analyses indicated that the new rules methods was acknowledged by the pays tax under Pay as You Earn (PAYE), Finance ISA35. without facing potentially significant IFISA in P2P lending are in a position will result in certain companies leaving Parliamentary Commission on Banking their tax code will then normally be losses. Consequently, there is also to do so. the peer to peer industry and that One note of caution though - many ISA Standards which stated that: “Peer adjusted to collect the tax due on the no requirement for guarantees that compliance costs will be permanently customers are risk averse and the IFISA to peer and Crowdfunding platforms interest earned. If tax has already loans can be sold at market value as GOVERNMENT SUPPORT higher for those that survive. will simply not be suitable for them. have the potential to improve the UK been deducted on the full amount of a condition of ISA eligibility. Peer to Nonetheless, the expected market There is also some concern that the The government has supported retail banking market as both a source peer to peer interest received, without peer platforms will therefore not be consolidation and greater consumer ISA label will attract retail investors who P2P lending since inception and in of competition to mainstream banks a deduction for bad debts, the lender required to provide a means by which confidence that this could bring are likely equate it with the security of a cash ISA, particular the distribution of funds as well as an alternative to them (…) can make a claim for repayment. 30 the investment can be liquidated (and to be good for the market as a whole . rather than the risk of an investment. through it to SMEs. It supports the The emergence of such firms could therefore transferred). Any claims to set relief for peer to peer This is an area where advisers could not sector via the British Business Bank increase competition and choice for bad debts from one platform against INNOVATIVE FINANCE ISA only ensure clarity to their clients, but, This simply mirrors the existing and the mandatory referral scheme lenders, borrowers, consumers and peer to peer interest received through with only 13% of the general population situation in which some P2P platforms 40 In the 2014 Budget, former Chancellor for high street banks, as well as by investors.” another platform, or to carry relief having a grasp of what the IFISA36 is, operate secondary markets and some George Osborne announced that aligning taxation so that the interest forward against peer to peer interest also add value by introducing it as an investors are able to access liquidity peer to peer debt investments would received from peer to peer loans is ALIGNMENT OF TAXATION received in future years, must be option to suitable clients. through them, but liquidity is not taxable in the same way as any other become eligible to hold within a On 6 April 2016, the way loan interest made through a tax return41. guaranteed. interest received. tax-advantaged Individual Savings P2P loans will not be included in from P2P lending is taxed and tax is In addition, interest earned on peer Account (ISA) from 6 April 2016. stocks and shares ISAs as eligible In terms of diversification, those who COMMENTS BY POLITICIANS reclaimed was regularised to match to peer lending loans is included in In addition, draft changes were investments in their own right - they want to hold multiple P2P investments taxation of any other interest received. the Personal Savings Allowance (PSA) announced by the Treasury in August can only be held in IFISAs in their own in an IFISA will not be able to do so At the LendIt Summit in October 2015, Until this time, UK tax law did not allow which was also introduced in April Harriett Baldwin Economic Secretary bad debts (i.e. borrower defaults)

18 19 “Partnerships with banks will help marketplace lenders to increase awareness (and possibly “Banks can learn about both cost-effective loan origination and data-driven due diligence from trust) among borrowers and investors, gain scale and possibly lower their customer acquisition the P2P platforms.” – Stian Westlake, Nesta costs.” – Deloitte

2016. Consequently, basic and higher support for challenger banks, non- continue, with a 2.0% return on capital However, this is the first time the EIB Funding Xchange)50. METRO BANK rate UK tax-paying investors can treat bank debt funds, online platforms, deployed, exceeding the target set has lent money via a peer to peer online Although delayed for a year, the Then, in May 2015, Metro Bank became income from peer to peer companies invoice and asset finance providers44. by government and the success of the service. The EIB said that this new scheme launched in November 2016. the first British bank to lend through in the same way as bank or building bank’s programmes to date47. In its engagement is recognition of the role of According to the Bank of England, Its success remains to be seen, but a peer to peer platform by lending society income42. So, basic-rate Small Business Finance Markets report, marketplace lending as an efficient way “The UK Government Department there is reason to be optimistic, as customer deposits through Zopa, taxpayers will be able to earn £1,000 in 2015/16, the British Business Bank for small business to access finance, for Business, Innovation and Skill Funding Options CEO Conrad Ford allowing consumers to take advantage interest on savings without having to certainly didn’t rule it out: “There is still and an important new channel to and, latterly, its subsidiary, the British stated, “Regulators have made it clear of the lower online digital fees55. limited diversity in the supply of smaller stimulate the real economy.49 pay a penny to HMRC (ie: a maximum Business Bank, have invested nearly that they will be watching closely, and business finance so new providers and Other tie-ups include JP Morgan’s saving of £200 each year). Their £200 million in P2P platforms, often Following the Brexit vote, a as no Chief Executive of a major bank new products need nurturing.”48 deal with On Deck Capital in December higher-rate taxpaying counterparts by topping up the remaining unfunded spokeswoman for Funding is going to enjoy being hauled in front 2015 to help make loans to some of will enjoy a corresponding threshold portion of near-fully funded loans. In the aftermath of the referendum by Circle said that the EIB has given of senior ministers, it will be a very the bank’s roughly four million small- of £500, which in turn also equates Such funding is not only financially but which the UK public voted to leave the assurances about its initial £100m foolhardy business banking executive business customers56 and another to a maximum annual saving of £200. also symbolically important. Arguably, European Union, the Bank’s Chairman commitment, but any further work that doesn’t very quickly fix things if Santander partnership with Kabbage. But, additional rate taxpayers are not it has boosted public confidence to Ron Emerson suggested that the on the partnership is now in doubt, the bank is not contributing their fair This is aimed at speeding up the eligible for any relief. participate in the market.”45 British Business Bank would have a although an EIB press release on share of referrals.”51 underwriting process so businesses can Furthermore, ISA earnings will not continuing input into UK alternative June 24 2016 states that “At present The Bank made £20 million available potentially access working capital of up count towards the Personal Savings finance when he wrote, “On 23 June the UK shareholding in the EIB BANK TIE UPS to SMEs through Funding Circle in to £100,000 online on the same day57. the United Kingdom voted to leave the remains and the EIB’s engagement Allowance, which covers income from December 2012 through the Business Marketplace lenders are increasingly European Union. This generates some in the UK is unchanged. At present, The benefits for platforms are clear - current accounts, regular savers, fixed Finance Partnership (BFP) and in March utilising private and public uncertainty for the Bank, as some of the EIB’s shareholders have not partnerships with banks will help them rate bonds and more. This means that in 2014 the Business Bank Investment sector partnerships to source our programmes rely on EU funding requested the bank to change its to increase awareness (and possibly the 2016/17 tax year, ISA earnings on up Programme committed a further both high-quality borrowers or guarantees, but also creates approach to operations in the UK. trust) among borrowers and investors to £15,240 of ISA cash or investments £40 million to Funding Circle. In for loan originations, investors opportunity for us to respond to the It is premature to speculate on the and gain scale58. Banks recognise the are tax free, along with up to £1,000 December 2015 the Bank announced and institutional funding. These changing environment, building on the impact of the referendum result on worth of new, young and dynamic of other personal savings allowance an initiative with Ratesetter to deliver partnerships help to raise public platform we have established. We are the EIB, including the bank’s future brands providing fast and efficient earnings. In 2017/18, up to £20,000 of finance to small businesses after awareness of the sector and could in close contact with our stakeholders relationship with the UK government service and a route to business they ISA cash or investments, plus another previous cooperation between the two have considerable implications for and are monitoring market conditions and its future engagement to would not otherwise have access to. £1,000 of other personal savings parties led to loans to almost 1,000 deal origination; attracting high to ensure that we respond as support long-term investment in allowance earnings will be tax free. creditworthy sole traders across the UK. quality borrowers, with potential appropriate.” the UK without clarity on the timing, OPENING UP BANKING The establishment of an ISA which to gather additional borrower data Another initiative has been the circumstances and conditions of a allows P2P loans to be held within EUROPEAN INVESTMENT BANK to enhance credit scoring and risk There is political momentum behind Local Business Lending Partnership withdrawal settlement.” management52. the push for a more open and it also signals a coordination of P2P scheme, established to stimulate local The UK is one of the main Nevertheless, the support of such a competitive UK traditional banking lending returns taxation with other economic growth and employment The following looks at just two shareholders in the European large, international financial institution sector and August 2016 saw the mainstream income generators. Like through improved access to business examples of bank and peer to peer Investment Bank (EIB), with a 16.11% for UK P2P lending still sends a clear publication of the Competitions and other ISAs, all interest and gains made finance, which has provided a multi- platform tie-ups: shareholding, and it remains one of signal of the kind of attention that it is Markets Authority (CMA) retail banking in IFISAs are completely tax free. million pound funding route for the four main shareholders of the EIB. worthy of. market investigation. This found that SMEs via the British Business Bank. SANTANDER AND RBS BRITISH BUSINESS BANK older and larger banks do not have to Numerous councils across the country In June 2016, it was announced that BANK REFERRAL SCHEME In June 2014, Santander became compete hard enough for customers’ have partnered with Funding Circle the EIB is to offer £100 million of loans The 100% government-owned, British the first high-street bank to refer its business, and smaller and newer banks to invest in SMEs in their area for to UK SMEs through the online lender The Small and Medium Sized Business Business Bank distributes finance to customers to an online peer to peer find it difficult to grow. Consequently, a return. They include Lancashire, Funding Circle. Funding Circle cites its (Finance Platforms) Regulations 2015, smaller businesses by deploying its lender for small business lending in a many people are paying more than Nottinghamshire, Gloucestershire, record of receiving investment from set the stage for the bank referral funds through partner intermediaries. sign that alternative finance providers they should and are not benefiting a diverse range of investors including scheme through which 9 designated, Currently it supports over £3.1 billion Leicestershire, Camden, Kirklees, are achieving mainstream acceptance53. national and local government from new services. Amongst the 43 Sefton, Newcastle, Rushcliffe and major banks are obliged to refer small of finance to UK SMEs and aims to help That was followed in early 2015 by the measures being implemented to Tandridge councils46. backing in the UK and support from business borrowers to other sources improve diversity of supply of finance Royal Bank of Scotland’s P2P lending remedy this and open up banking, is international organisations such as of funds if they are not prepared for smaller businesses by expanding This kind of involvement is likely to initiative by which customers, who the the requirement for banks to publish KfW, the German development bank. to lend. So the government is now bank is unable to financially help at their prices for smaller, non-complex legislating to guide borrowers to P2P the moment, were to be signposted to lending products and the largest banks lending, providing lender origination “Currently, the British Business Bank supports over £3.1 billion of finance to UK SMEs and aims both Funding Circle and Assetz Capital will also be required to develop online opportunities to P2P platforms to help improve diversity of supply of finance for smaller businesses by expanding support for as options of alternative sources of tools which allow small businesses designated by the Treasury (currently finance54. to input some information about challenger banks, nonbank debt funds, online platforms, invoice and asset finance providers.” Bizfitech, Funding Options and themselves and receive tailored

20 21 “Peer to peer and Crowdfunding platforms have the potential to improve the UK retail banking market as both are a source of competition to mainstream banks as well as an alternative to them “New risks have to be weighed against the desperate need for credit in Europe.” The Financial Times (…) The emergence of such firms could increase competition and choice for lenders, borrowers, – consumers and investors.”– Parliamentary Commission on Banking Standards indications of eligibility and price for TOTAL CUMMULATIVE LENDING this space and either partnering with, Securitisation is a key source of more consumers were successful in lending products. The CMA will insist or acquiring existing lending sites. funding for banks and non-banks borrowing from high street banks in the that banks share customers' financial They would have great synergies with where loans are packaged together second quarter of 2016. This may have Q4 2016 details with other "approved firms" lending sites — and be able to offer and sold on as bond-like products, led to fewer consumers approaching Q3 2016 in an attempt to create banking apps these loans to a lot more consumers62. allowing capital markets to fuel more P2P lenders during the period, leading Q2 2016 which give customers access to all of This type of involvement points to a lending. In April 2016, Deutsche Bank, to a decline in originations. It will be their financial details from multiple Q1 2016 serious and maturing international said that it expected securitisation “to interesting to analyse the behaviour of accounts. This could open up access Q4 2015 industry. play an increasingly significant role in banks in the wake of the uncertainty to potential clients for loan originators Q3 2015 providing efficient financing for lenders created by the Brexit vote to get a Nevertheless, some commentators such as P2P platforms. Q2 2015 on marketplace platforms”63, although, measure of how much tightening of reported a slow-down in the second Q1 2015 by September 2016, only two deals lending criteria takes place. A number of the remedies proposed quarter of 2016 and consequently had been done; one involving Funding by the CMA aim to empower small Q4 2014 reduced their year on year UK P2P Total business loan volume in P2P Circle and KLS Diversified and another businesses so that they are less Q3 2014 lending market growth predictions decreased by 9% in Q2 2016. But in which MW Eaglewood securitised dependent on their existing bank59. (which still stood at well over three without lenders that specialise in £0 £2bn £4bn £6bn £8bn £138 million of Zopa loan assets. In and a half billion of originated finance). property loans, business lenders’ Another potential driver towards a such a young market, larger financial The P2PFA figures for its 8 influential quarter-over-quarter volume was flat. more even playing field in banking- SOURCE: P2PFA institutions are very sensitive to new members mirrored this finding. Property lenders saw an aggregate related services, by allowing more risks such as lack of a performance decline in volume of 30%, which access to current account data to US VS. UK P2P MARKET PER CAPITA (2014) UK P2P is not accustomed to a quarter history through the full economic cycle dragged business lending down. It regulated entities, with the permission not outperforming the last and this and the controversy over Lending appears that uncertainty in the UK of a customer, is the Europe-wide shallowing of origination volume, from Club in the US has certainly not been property market caused by Brexit Second Payment Services Directive Q1 to Q2, was probably not related to helpful. But the FT’s comments on drove the decline. (PSD2). Due to come into force in the Brexit vote as there were only a few the issue in May 2016 are telling; “new 2018, this could mean that a P2P days for the result to feed through into risks have to be weighed against the This drag on overall performance lender is able to instantly review the US $0.70 origination figures. Instead, the reasons desperate need for credit in Europe. by the real estate sector marks a current account data that a bank for the slowdown are more likely to be The industry, like securitisation, will change in fortunes for this sub- UK $35.62 currently views as a matter of course connected to a variety of factors: be hoping to receive further support sector, in 2015, as it was the most from European policymakers keen to popular sector funded on peer to for its account holders. The result There are large permanent capital stimulate lending.”64 peer business lending platforms, would be to cut the huge information vehicles (PCV) now present in the advantage that banks currently enjoy aided in part by the increase in sector (A PCV is an unlimited life, open As has already been discussed and to facilitate more automation secured-lending particularly against SOURCE: BUSINESS INTELLIGENCE, 2015 or closed ended fund, that is typically earlier in this report, another driver for of the P2P underwriting procedure fixed assets such as property and structured as an investment company, the UK peer to peer lending market is by reducing manual processing of machinery. Nevertheless, a bounce although limited partnerships are expected to be the Innovative Finance documentation such as copies of bank The US market is more developed than that of the UK in terms of overall loan back in property market confidence also used) and these fund vehicles ISA, which has been touted as a statements60. volume, but the UK market is much larger on a per capita basis. In 2015, it was was evident in the second half of the are generally fully deployed. means of bringing a new wave of retail reported that the UK P2P lending sector was 72% bigger on this basis, with low year, with Rightmove reporting in Consequently, fundraising has not money into the sector. But to date, MARKET DATA consumer confidence in banks (even before the financial crisis), a high degree September that a third of the drop in taken place for some months and very few platforms have been issued of comfort with online platforms, and a positive regulatory environment all average house prices experienced in The peer to peer lending market started this significant driver to the sector’s with the full FCA authorisation to be helping to nurture the UK's P2P lending market61. the wake of the vote had already been with the establishment of Zopa in the origination growth has been quiet. in a position to accommodate this tax recovered. Moreover, in the same UK, the first P2P marketplace lender efficient wrapper. So, the upswing in Wider credit markets have offered time frame, UK real estate investment in the world. After several slow years incoming funds may be more gradual UK P2P FINANCE ASSOCIATION MEMBER LENDING better returns in 2016 than they trust shares had regained half of the of building awareness and business, than perhaps originally anticipated did in 2015, reducing the appeal average of 23% they lost from the day the sector has experienced very high as the regulator wades through the Q1 2016 Q2 2016 Q3 2016 Q4 2016 of marketplace lending to new after the referendum65. growth volumes over the last five years necessary administration. institutional investors. The events - both in the UK and elsewhere. So, in spite of the recent difficulties NEW LENDING £715,000,000 £658,000,000 £700,616,000 £843,917,664 of Brexit and the cut in UK interest The second quarter of 2016 saw and, although property lending could However, in 2016, commentators rates to 0.25% in August 2016 for the legacy lenders experiencing increased still be at risk in the short term due on the US market stated that they O/W LENDING TO INDIVIDUALS £270,070,000 £252,000,000 £271,138,000 £299,939,490 first time in seven years, suggest that demand for unsecured personal to the UK’s vote to leave the EU, it is would not be surprised to see massive credit market returns may not remain loans, according the Bank of England. predicted that it will recover in the internet consumer companies like as attractive. Credit scoring criteria also loosened, O/W LENDING TO BUSINESSES £445,350,000 £406,000,000 £429,478,000 £543,978,474 long term, continue to grow faster Google, Facebook or Amazon entering and an increased proportion of loans UK platforms have been looking than other segments and make up the were approved. This suggests that to generate securitisation deals. largest share of P2P activity in the UK in

22 23 “If we look at the largest two individual platforms, we can see that, over the 12 years in which it has “Longer term statistics show the advantage of P2P lending as an alternative to other fixed income been in operation, Zopa’s average actual default rate was less than half of that predicted – 2.15% products.” predicted versus 1.06% actual. Funding Circle also undercuts its predicted default rate.”

2020, followed by business lending and PEER TO PEER BUSINESS LENDING (REAL ESTATE) MARKET VOLUME BY QUARTER (2015) DEFAULT RATES ACTUAL TOTAL LOAN LOSSES SO FAR (AND EXPECTED LOAN LOSSES) AS A PERCENTAGE consumer loans66. Expected versus actual default rates OF VALUE BY PLATFORM FOR LOANS THAT ORIGINATED IN 2013/14 GROWTH RATES Even in the short term, loan is a key metric to look at as it gives an origination, although facing some £200 important indication of the accuracy MAIN BORROWER TYPE 2013 2014 limiting factors, is not unattractive; the 4% 23% of platforms’ projections which are P2PFA has published figures showing a informed by their risk assessments, £150 bounceback in Q3 2016. 22% and the reality of the potential yield. BUSINESS LOANS 4.1% (4.6%) 3.0% (4.4%) In the mid to long term, the upward Default rates vary depending on £100 trajectory of the UK market remains risk bands which are assigned to £ MILLION £ impressively steep: Business Intelligence borrrowers vetted through platform forecasts that UK P2P lending will grow £50 credit underwriting. In general, we 67 to a value of £16 billion by 2020 , whilst can expect that the platforms which Liberum predicts a potential market provide secured property loans will BUSINESS LOANS 4.1% (4.1%) 3.7% (4.0%) volume of £30 billion by 2025. £0 have very low bad debt rates, perhaps Q1 Q2 Q3 Q4 close to zero, thanks to the collateral RETURNS SOURCE: PUSHING BOUNDARIES, THE 2015 UK ALTERNATIVE FINANCE INDUSTRY REPORT, NESTA, FEBRUARY 2016 available. Consumer loans suffer a In terms of investor yields, research slightly higher rate at 2% to 3%, whilst business loans exhibit a higher rate. reveals that P2P lending is a desirable CONSUMER LOANS 1.7% (1.5%) 3.0% (2.2%) asset class. P2P LENDING ESTIMATED AVERAGE BORROWER RATE OF INTEREST All the same, the levels of borrowers AND INVESTOR RATE OF NET RETURN (2013-2016) who discontinue repayments is very Investor net rates of return have limited68. remained very stable over the last BORROWER RATE INVESTOR RATE three years and whilst there has been Oxera’s review of the eight platforms some divergence, the spread between CONSUMER LENDING BUSINESS LENDING that are members of the P2PFA gives 14% borrower and lender rates has also 10% an indication of the range of actual CONSUMER LOANS N/A 4.1% (4.6%) been quite steady. The spread between 12% defaults versus the predicted losses, 8% focusing on loans issued in 2013 and the rates stood at around 4% in the 10% second half of 2016 for business lending 2014. The proximity of the actual and 6% 8% and consumer lending, although there predicted rates gives us a sign as to 6% the effectiveness of each platform’s has been an increase from 2% for the 4% credit risk assessments. CONSUMER LOANS 0.7% (1.3%) 1.5% (2.1%) spread between lenders and borrowers 4% in the consumer lending segment. 2% 2% The results of the Loan Losses table Longer term statistics show the to the right, are generally impressive, 0% 0% advantage of P2P lending as an although, for the longer property 2013 2014 2015 2016 2013 2014 2015 2016 loans in particular, defaults will not alternative to other fixed income 0.2% (data 0.5% (data SOURCE: THE ECONOMICS OF PEER TO PEER LENDING, OXERA, SEPTEMBER 2016 yet have been fully realised for this INVOICE FINANCE products as seen in the graph below. unavailable) unavailable) period, so actual default rates can be expected to rise. P2P LENDERS VS SAVINGS ACCOUNTS RETURNS (2011-15) In fact, the P2PFA’s Christine Farnish INSTANT ACCOUNT (EX. BONUS) INSTANT ACCOUNT (INC. BONUS) FIXED RATE ISA FIXED RATE BONDS P2P put industry defaults at around 2% at 69 PROPERTY LOANS the end of January 2016 . N/A 4.1% (4.6%) 8% (buy to let mortgages) Nevertheless, if we look at the largest 6% two individual platforms, we can see that, over the 12 years in which it has 4% been in operation, Zopa’s average actual default rate was less than half of 2% that predicted – 2.15% predicted versus PROPERTY LOANS 0.0% (0.0%) 0.1% (0.1%) 1.06% actual. Funding Circle also 0% undercuts its predicted default rate JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN APR JUL OCT JAN over its six year history with an average 2011 2011 2011 2011 2012 2012 2012 2012 2013 2013 2013 2013 2014 2014 2014 2014 2015 2015 2015 2015 2016 of 3.92% predicted versus 2.75% actual. SOURCE: OXERA, THE ECONOMICS OF PEER TO PEER LENDING, SEPTEMBER 2016 SOURCE: MARKETPLACE LENDING A TEMPORARY PHENOMENON? DELOITTE, 2016 24 25 “Investors on UK P2P marketplaces should be prudent and diligent, since certain asset classes and “The near-certain prolonging of a low-yield period thanks to the post Brexit economic reverberations, originators will be more default-prone than others in a weaker economic environment. As such, with interest rates expected to remain lower-for-longer, could be a real positive for P2P platforms.” there should now be a flight to quality.” – Robert Stafler, Fintex Capital

FEES AND CHARGES long-term nature of P2P lending. This the shorter term. Indeed, Stuart Law, Moreover, a significant minority (7%) is supported by survey evidence which CEO of Assetz Capital, admitted that the of investors are more attracted to P2P WHAT’S NEXT FOR PEER TO PEER INNOVATION? Low overheads allow platforms to has found that, currently, investors’ platform’s credit team would have to be lending, among other alternative asset charge lenders little or no fees with There have been a number of recent launches of products that have the general perception of P2P lending “even more careful” going forwards. classes, as a result of it. all of the costs passed over to the potential to expand the peer to peer lending model and in the next sections, is that it carries risk, is suitable for borrowers. Looking at the spread In fact, in the immediate aftermath of The reaction of banks to the economic three of them are discussed: only longer term investments and between the lender and borrower the leave vote, LendInvest tightened turbulence resulting from the Brexit that liquidity is required to exit early rates will give an indication of how its lending criteria for loans worth decision will certainly play its part in through secondary markets71. much the platform is taking. more than £3 million, adjusting the how the marketplace lenders fair. The cap on loan to values (LTV) for these prospect of bank interest rates on OCTOPUS CHOICE Direct fee comparisons with banks BREXIT loans to 65%. The company also business loans rising to offset greater can be problematic because of the Currently, there is no pan-European temporarily paused lending on new perceived risk in difficult times (making varying products on offer, but asset In April 2016, Octopus Investments launched a new P2P lending platform regulation that specifically covers peer second charge applications73. banks less competitive) combined management fees, with an initial called Octopus Choice. Octopus states that the new platform was tailor- to peer lending. This suggests that there with the potential of reduced lending fee and an ongoing management/ However, the near-certain prolonging made for financial advisers, with a strong focus on assisting advisers and will not be any Brexit effect on current volumes may drive more demand servicing fee, mirror the structure of of a low-yield period thanks to the aligning with their interests and those of their customers in an attempt to legislation, as could be the case with towards P2P loans. At the same time, many P2P platforms. This means that post Brexit economic reverberations, make asset backed lending more retail friendly. The platform gives investors other asset classes where managers with even lower base rates, banks are broadly equivalent comparisons can with interest rates expected to the opportunity to buy Dragonfly loans (Dragonfly is a subsidiary business very quickly called for simplification and lowering their savings account rates be made and based on an analysis of remain lower-for-longer, could be under the Octopus brand which originates buy to let and bridging finance.) stripping of EU imposed complexities even further, with Santander slashing its the 8 P2PFA platform members, there a real positive for P2P platforms. The investor chooses the amount that they wish to invest, and those funds from regulations. This should translate 123 account rate from 3% to 1.5% and is a similar variation and level of fees The spread between the net yields are then spread across a diversified portfolio of secured Dragonfly loans. The to little disruption in this area. Natwest warning business customers applicable to the issuing and holding available on leading platforms and target rate of return is between 5% and 6% and Octopus handles all allocation that it may introduce negative interest of corporate bonds: Christine Farnish, Chair of the Peer to base rates, is likely to prevail for and management responsibilities. rates76. In this environment, since P2P Peer Finance Association, says that the longer. Over the past years, yield has Loan Origination Fees: 0% to 6% of platforms are largely independent of Octopus has selectively adopted the front end of the marketplace lending fundamentals of P2P lending will not be been hard to come by in the wider loan value, with the higher amounts monetary policy and Bank of England model, marrying that medium with its existing strengths to create an affected: “Inevitably the UK now faces a market and those platforms focused generally applied to smaller loans base rates, (except insofar as they affect intriguing new form of investment. The company also finances solar sites and difficult period of economic and political on safer loans should be in a position bank rates and therefore marketplace healthcare infrastructure and has suggested that these operations could well Ongoing Fees: 0.7% to 1% p.a70 uncertainty. But I would urge observers to continue to offer comparatively lending’s comparative competitiveness), come with a peer to peer front-end attached down the line, depending on to remember that none of this short- attractive yields74. For those working These figures show that ongoing fees they may be in a position to deliver advisers’ appetite78. term turmoil changes the fundamentals hard to seek out desirable, stable make up a potentially hefty portion more lending to quality businesses and of P2P lending. People will still need yields at reasonable risk, the asset of the overall income of platforms those with robust loan security, and also to borrow, save and invest. And P2P class could be very interesting. They – perhaps a third to half or more, provide more interest to lenders. lending’s clear consumer and economic certainly haven’t been getting that depending on loan origination charges. benefits are not going to go away.”72 from central governments, with UK gilt However, Brexit and any subsequent HARGEAVES LANSDOWN And since more and more platforms yields in particular offering record low knocks to business confidence could only charge the borrower fees, there is Robert Stafler, Chief Executive of Fintex yields post referendum. impact the demand for lending significant incentive for the platform to Capital, institutional credit investor Wealth manager, Hargreaves Lansdown is developing a cash management from companies who decide not to ensure the borrower repays the loan focused on European marketplace In fact, Partners Group which has portal and peer to peer lending service due for launch in early 2017 and proceed with expansion plans during for the whole loan term. lending said, “investors on UK P2P over 850 institutional investors intended to lend to both consumer and SME markets. uncertainty/market downturn. Under marketplaces should be prudent worldwide and $55 billion in assets these circumstances, logic suggests It will give access to a new pool of assets that it can look to add to its existing SECONDARY MARKETS and diligent, since certain asset under management, stated three that the larger platforms with greater one-stop system which already offers a wide range of investments. This classes and originators will be more months after the vote that, “There is Two thirds of the 39 platforms on which financial reserves, will be in a better integration with other asset class investment offerings on a single platform is default-prone than others in a weaker risk of further volatility relating to the Intelligent Partnership collected data, position to weather any drops in loan a logical, but new next step for the marketplace lending industry. economic environment. As such, there uncertainties around Brexit, however, had a secondary market. The depth of origination rates. Although, some should now be a flight to quality.” Like this environment is also expected to these markets is uncertain, but their market participants theorise that well- Christine Farnish, he foresees that be a source of investment opportunity existence is encouraging to those who structured P2P platforms can sustain there will continue to be a place for for private debt investors with a are interested in longer term loans but themselves on a loan book from as P2P platforms but that, in order to longer-term view”.75 have liquidity concerns. little as £7.5 million - £10 million77. ensure they can continue to deliver Post referendum research by ThinCats Be that as it may, research has found performance in the weaker economy If the UK does slip into recession, has also identified that 30% of those relatively low usage of secondary that is now expected, platforms with which is by no means certain, there surveyed said they had been put off markets (largely less than one quarter riskier assets may want to de-risk some will at least be an opportunity for the investing in more traditional asset of the platform loan book) which could of their originations, even if this is at P2P platforms to show how they hold classes following the Brexit vote. indicate that investors understand the the expense of some desired growth in up through a part of the economic cycle which is largely missing from their historic performance data. 26 27 “Key milestones such as regulation, the launch of the IFISA, the availability of market data and government support all show that this is an industry that is increasingly mainstream.”

DOWNING CROWD CONCLUSIONS INVESTMENT CASE The P2P lending industry has In March 2016 Downing LLP launched term, although transfers are allowed been around for longer than many its crowdfunding platform, Downing between members. people realise and has come a Crowd. The platform does not offer long way in a short space of time. Since the funding window is open equity, but is a slightly different The growth of the industry to date for several weeks, the speed of proposition to the standard P2P has been exponential and key investment is not as swift as in loans so far discussed; it offers milestones such as regulation, the the traditional P2P lending model investors the chance to lend directly launch of the IFISA, the availability and the very wide diversification to UK businesses via bonds secured of market data and government benefits of P2P lending across on their assets. The product targets support all show that this is an multiple loans/platforms are not advised clients and uses the bond industry that is increasingly available through this bond-based raise to access companies that mainstream. model. Nevertheless, as for some have exited Enterprise Investment standard P2P loan agreements, the Scheme funding with Downing and operational assets of the business are therefore known to Downing and being funded are provided as have a successful operating period security, with Downing Crowd taking behind them. a legal charge over them. New bond offers will come out For the provider though, there are regularly, and are likely to stay still legal advantages to P2P loan open for 2-6 weeks only. Downing agreements since they are not intends to launch bonds across caught by the Non Mainstream a range of businesses, including Pooled Investments marketing solar farms, hydro plants and pubs, restrictions, whereas bonds of offering a range from 5%-7% p.a. this type are. This means that fixed interest over 1-2 year terms. promotions to the retail market will, The bonds are transferable, but not in general, be restricted to high net listed – so investors should assume worth individuals, self-certified or they will hold the bond for the full certified sophisticated investors.

All three of the products discussed are using P2P lending to leverage existing business within their groups. This is a clever usage of the P2P lending concept as it means that the provider firms have ready-made investment options and/or client bases, with which they are already very familiar. This will save time and money in terms of sourcing and give a significant head start in relation to due diligence. And this type of front end adaptation of peer to peer lending demonstrates both the innovation of the sector and the flexibility of marketplace lending as a funding tool.

28 29 “In 2016 Deloitte research quantified an operating expense advantage of over 200 basis points INVESTMENT CASE when comparing the cost economics of illustrative bank and peer to peer loans.” WHY P2P LENDING?

There is a strong investment case borrowers and lenders fees for their very strong returns, but also the fairly means that some platforms have default DRIVERS BEHIND P2P LENDERS (RETAIL CONSUMERS) for P2P lending as a new method to services, their cut is substantially regular possibility of damaging losses. rates of less than 1%88. give retail investors exposure to an lower than that which a bank or Nevertheless, returns from P2P Various risk levels of borrowers can asset class that was previously only building society may take83. For lending BETTER RETURN ON INVESTMENT 77% lending vary widely. Loans to be found on P2P sites, from very reserved for banks and institutions. sites, the lower level of regulation is less individuals with good credit histories low to much higher and in order to costly to administrate, and lower capital TRYING OUT A NEW WAY OF LENDING/INVESTMENT 71% might yield 4% or 5% a year. Loans to assist the lender with gauging the ○YIELD adequacy ratios require less cash to property developers might yield 6% to risk profiles of the loans on offer be held to offset possible losses. In EASY/SIMPLE TO USE 68% On 6 April 2016, HMRC stated in its 9%-plus, and loans to small businesses (and to allow automatic allocation addition, online services mean that P2P guidance for individuals investing 9% to 15%-plus. Although it is generally of loans that fit investor’s criteria, CONVENIENT 62% lenders don’t have to have high street in peer to peer loans79, that, “The safe to assume that if a P2P loan including risk tolerances), the branches in costly properties, with advantage of peer to peer loans for carries a higher interest rate, it is likely platforms obtain a credit report ABILITY TO SPECIFY RISK AVERSION/RETURN 56% additional staff. Nor do they incur the lenders is that they can generate also to involve a higher level of risk. on the applicant. This information costs of overcoming issues with legacy ABILITY TO CHOOSE WHO TO LEND TO 36% higher interest rates that exceed the is used, along with other data (e.g. IT systems, making their systems more Depending on risk tolerance, investors interest that could be earned from loan characteristics), in programmed streamlined and efficient, giving quicker can find very high yields on offer and MORE SECURE 35% banks and other financial institutions.” proprietary models to assign a risk service. All of this adds up to P2P certainly, this is one of the reasons In 2016 Deloitte research quantified grade to the proposed loan and set platforms often offering competitive that retail consumers lend through PROVISION FUND 35% an operating expense advantage of an interest rate corresponding to the rates to both borrowers and lenders84. peer to peer lending sites. And the P2P over 200 basis points when comparing assigned risk grade. This produces risk QUICK RETURN ON INVESTMENT offering is even more compelling; at 30% the cost economics of illustrative bank Indeed, according to Deloitte rated returns, so that each loan on a the lower end of the risk range as bond and peer to peer loans80. And the research, marketplace lending can platform has a comparative risk rating RECOMMENDATION FROM FRIEND/COLLEAGUE 24% yields have been and declining for a lower overheads mean better rates for “provide higher yields than many against other loans on that platform. number of years, with 2016 seeing over investors in particular: as the banking other fixed-income assets (adjusted TAX BENEFITS 12% $13.4 trillion of bonds yielding negative As with banks and building societies, middle-man is cut out, investors can for duration and risk), data suggests rates86; heading up the risk scale, different lending sites will have RECOMMENDATION FROM BANKER/FINANCIAL ADVISER 11% get far improved headline rates than that marketplace lendings’ annual global equity markets at the beginning different lending criteria. Potential those charged by traditional banks for risk-adjusted returns are competitive of 2016 were extremely volatile. borrowers need to be a UK resident SOURCE: YOUGOV PLC 2016 instalment loans81, while borrowers with equities. Specifically, while direct and at least 18 years of age, hold a can benefit from lower rates, with the lending has underperformed the S&P LOWER RISK / HIGHER RISK current account and have a minimum sites themselves profiting via a fee82. 500 index over the past 20 years, it ADJUSTED RETURNS number of years’ credit history. has not had any negative return years SAMPLE RISK / RETURN TABLE This disintermediation of banks Previous credit defaults, CCJs or a and has been much less volatile.”85 As a result of the lower rates available removes the bank’s fee, which can tight budget for repaying the loan to borrowers, but also because of the be substantial, from the return The graphic shows the annual will increase the risk rating and the speed and efficiency of the automated LOWER INTEREST PAYMENTS HIGHER INTEREST PAYMENTS calculation equation; and while peer- percentage change of the S&P 500 interest payable. Depending on the online services, P2P sites are not LOWER EXPECTED LOAN LOSSES HIGHER EXPECTED LOAN LOSSES to-peer lending sites may charge both back to 1960 and highlights periods of site, it might mean that the platform just swamped with borrowers who will refuse to arrange lending at all89. LOWER EXPECTED RETURNS HIGHER EXPECTED RETURNS can’t get borrowing elsewhere; of S&P 500 PERFORMANCE VOLATILITY those borrowers surveyed by Nesta Since the investor has the ability to LOWER EXPECTED VOLATILITY HIGHER EXPECTED VOLATILITY 40% and the University of Cambridge, choose the level of risk they take on more than half reported that they and the return they can receive, they 30% had been offered funding elsewhere. have the opportunity to risk adjust The flexibility of peer to peer lending their portfolio to minimise volatility by 20% 1 2 3 4 5 6 7 which can allow borrowers to pay selecting lower risk rated loans which 10% back early without penalty, and the are likely to be very robust. By adding speed at which loans are approved – some carefully chosen higher risk REWARD / RISK 0% generally much faster than banks, are ratings to a well-diversified portfolio, it Each grading will refer to a small range of interest rates that are applicable to that risk grade. The obviously attractive features. is possible to increase the yield whilst -10% higher the risk grade, the higher the applicable interest rate range. retaining a good measure of stability Neither does it mean that all of those -20% SOURCE: INTELLIGENT PARTNERSHIP who apply to the platform are accepted LOW DURATION -30% as borrowers who can source loans from the site: The average rejection rate The typical three to five year duration NOTE: This infographic is intended to provide a basic understanding of the type of -40% for borrowers across these platforms of a peer to peer loan means that, risk frameworks used by P2P platforms. It is not intended to be representative of 1960 1970 1980 1990 2000 2010 is almost 80%87 and the strength of in comparison to other fixed income the risk spectrum used by any specific platform as each has designed its own risk SOURCE:MACROTRENDS, 14 SEPTEMBER 2016 the credit profiles which are accepted assets, such as bonds, it has a relatively framework.

30 31 “The return available to P2P loan investors is almost exclusively yield, with minimal capital appreciation element and because there is currently little market speculation about how the OTHER ASSET CLASSES price of P2P loans will move, volatility is very limited.” – Oxera COMPARISON WITH P2P LENDING

low duration. Both bonds and P2P loans in order to ensure preservation of correlation of between 0.13 and 0.19 is Relative to other asset classes, peer to peer lending certainly has some favourable features. are debt instruments, but bonds last, on that capital, loans from lower risk a minimal overall correlation!90 average, around 10 years. A longer term categories can provide useful near In terms of volatility, historically, PEER TO PEER LENDING COMPARISON WITH OTHER ASSET CLASSES allows for a greater amount of time for cash solutions with low volatility. stocks and shares have exhibited inflation or interest rate events to erode It is also worth remembering that an substantial price movement due to the real return available to the investor. LIQUIDITY VOLATILITY SECURITY YIELD adviser can charge for advising on P2P the nature of listing which follows the Additionally, short term loans, which lending with much more justification whims of market sentiment. Although Dependent on loan term Lower risk rated Tangible security includes 3% to 10% income. No don’t provide a longer income stream, than for charging on advice concerning there are secondary P2P markets, and secondary market real estate (1st and 2nd capital gains depth charge) and non-tangible can generally generate higher returns cash holdings. This achieves a win-win Oxera’s 2016 report finding that there PEER TO PEER security includes personal because lenders need to spend the scenario, with investors maximising is low use of secondary markets, LENDING guarantors, insurance time and money to source new loans returns on cash and advisers able indicates that investors understand coverage and provision of a for additional income. to charge for these assets under the long term nature of P2P investing. contingency fund management. Even greater benefits are Oxera states that, “This level of The most secure bonds – gilts – Completely liquid - Not volatile although Not subject to loss other than 0% unless deposited available when the adviser can ensure transactions is arguably lower than which are issued by governments although some liquidity inflation can erode the effects of inflation on with bank. (July 2016 tax efficiencies by recommending (and at least broadly comparable to) has to be sacrificed to its purchasing power purchasing power. Cash is the average easy access borrowing money, have certainly the building of a P2P portfolio via an the average rate of transactions in retail CASH earn higher returns over time protected by FSCS if deposited savings account rate was been struggling in terms of yields 92 aggregator which has FCA permission equity investment funds91. In fact, the within an institution with was 0.34%) in the last several years and in fact, a banking licence – up to to provide an Innovative Finance ISA. return available to P2P loan investors is their rates have recently hit record £85,000 per banking group almost exclusively yield, with minimal lows – even negative rates. This has DIVERSIFICATION AND LOW CORRELATION capital appreciation element and If listed, liquid, highly Subject to market None if the business fails. 3%-4% for UK equity pushed investors looking for stable liquid for large caps sentiment so very The FSCS applies to financial income (with the WITH OTHER ASSET CLASSES because there is currently little market income streams to look elsewhere and EQUITY prone to volatility of advice and investment possibility of capital speculation about how the price of P2P the lower risk, asset backed nature of Within the P2P asset class there are market movements firms, not shares gains) loans will move, volatility is very limited.” some P2P loans could well fit the bill. several sectors; consumer, business Dependent on the quality Bonds traded through Government bonds and Can be negative or and property lending, and within LendingRobot’s 2015 report, “How of underlying assets agents, brokers or those with a higher credit strongly positive NEAR CASH these are the multiple sub-sectors in much should you invest in Marketplace - fixed interest securities investment banks rating are generally more depending on interest which the borrowers are deploying Lending?” analysed a classic 60% equity such as bonds, and debt matching buyers secure. FSCS applies to rate movements One thing that may interest advisers the funds – for example leisure, hotels, / 40% debentures real portfolio, adding FIXED securities and sellers are less the fund managers and is the prospect of substituting P2P easy to buy and sell unsuitable advice health facilities and many others. P2P loan investments issued by US lending for a proportion of cash. In the INCOME than investments Diversification across these can lead platform Lending Club (up to 14% of low base rate environment, inflation is FUNDS that are traded on an investors to avoid difficulties across the portfolio), between 2005 and 2014 likely to devalue cash. Even if it’s sitting exchange and on any their entire portfolio if only one or two when major periods of volatility took particular day there on an adviser wrap platform such of the loans they have invested in are place. The analysis found that adding may not be a buyer or as Transact or Novia, it might attract a seller for the bonds subject to particular negative factors P2P lending makes a striking impact annual management charges or other effecting individual sub-sectors. in reducing volatility which decreases Dependent on secondary Very sensitive Government bonds Can be negative as fees that exceed the yield it is earning. faster than the returns. market depth for that to interest rate generally very secure, many bonds on the In addition, the majority of investors P2P loans can also be very liquid, bond type. Corporate movements corporate bonds depend secondary market have are unlikely to already be exposed to depending on the term of the loan and BONDS bonds may be essentially especially longer on the financial condition of been in 2016, to double debt of this sort, particularly retail illiquid dated bonds the bond issuer digit returns in higher the depth of any secondary market for investors, as this is a relatively new EFFECT OF P2P LENDING ON INITIAL PORTFOLIO risk corporate bonds in it. For example, loans can be available alternative investments asset class. This means that it can be with terms from 30 days, so that even RETURN VOLATILITY a diversifier to a balanced portfolio of Liquid as they trade Passive investment If the index tracked goes Depends on the market if liquidity was required a few days standard stocks and shares which does 7% 50% like a share on a stock tracking an index. If down, the investor loses being tracked. Fees after the deal was made, the cash exchange the index shifts, so money. But If an authorised (although low) are likely not yet include peer to peer lending. 6% should be accessible again in around will the ETF price. investment firm goes into to lead to tracking at three weeks. If there was a secondary There is a distinct lack of correlation 5% Vulnerable to market default, investors assets are just below the index VOLAILITY market or the platform would buy between the two asset classes. 4% EXCHANGE volatility protected and unsuitable benchmark 25% advice from an IFA is back the loan, the cash may be Research in the US concluded in 2015 3% TRADED FUNDS covered by the FSCS. But available even sooner, in some cases, that there was a very low correlation RETURNYEARLY 2% FSCS applies to financial on the same day and without a fee. between stocks and P2P lending; advice and investment A correlation value of 1 would be a 1% firms, not shares and ETFs Longer term loans will rely more perfect correlation while a value of 0 is 0% 0% are considered to be shares heavily on secondary markets for 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% in a company93 no correlation at all. So P2P’s average fast access to the original capital and % OF MARKETPLACE LENDING SOURCE: INTELLIGENT PARTNERSHIP SOURCE: “HOW MUCH SHOULD YOU INVEST IN MARKETPLACE LENDING?”LENDINGROBOT, 2015 32 33 “Almost 70% of those questioned in 2016 for a national survey agreed or strongly agreed that they like to know what their money is being invested in to get a return. This makes the access to credit “The British Business Bank estimates 500,000 SMEs are deterred or declined for finance every year.” risk scores and due diligence that marketplace lending allows, a strong driver: Knowledge is, after all, power.”

TRANSPARENCY many of the established P2P players A, B, C, D or E ). RateSetter also differs the choice in this sphere opens up In addition, lending to small firms is succinctly, “Funding for Lending isn’t take their fees over the life of loans from other P2P lending companies in paths to increased socially favourable harder work as large firms take more working”105. Among other statistics Many platforms make data on their and a significant amount are accrued that it does not categorise borrowers investments. money for longer and have more outlining the shortfalls of SME access loans available to the general public towards the end of the loan. This by credit rating, instead it only accepts assets to secure loans against102. As to lending, the Albion Growth Report as it is published on their websites. Importantly, there is growing evidence aligns platform and investor interests what it calls “prime” borrowers. a result, the British Business Bank 2015 noted some of the current This is the case for platforms which that these investments do work to a greater degree. Lending rates are then set based on estimates 500,000 SMEs are deterred challenges, with cashflow still an issue are members of the UK’s major trade to provide beneficial outcomes to the term of the loan rather than the or declined for finance every year. and access to finance presenting a association for P2P lending, the Many non P2PFA member platforms society: a recent report by the Centre credit rating of the borrower. barrier to growth for almost one in Peer-to-Peer Finance Association. provide similar disclosure information, of Economics and Business Research Nevertheless, some individuals and five SMEs (18%)106. The 2016 update of The application process is lengthy although some provide less detail Additionally, aggregators aim to (CEBR) states business loans obtained small businesses who do not satisfy the report found that manufacturing, to ensure the platform meets the or none at all. But those who place provide collated and consistent through P2P lending platform Funding the more stringent criteria that construction and retail identify access requirements of the P2PFA Operating their money into a bank will never independent information on the Circle have boosted the UK economy banks now place on granting loans, to finance as a major limiting factor107. Principles which include publishing be provided with this type of data, platforms and products they host, in by £2.7 billion since 2010. This has have been able, through P2P lending on publicly available pages, their bad although the first £85,000 of their order to make comparisons easier to created 40,000 new jobs and led to the services, to find alternative lenders debt rates, returns performance and deposited cash benefits from the undertake. building of 2,200 new homes by small who are willing to take on the risk full loanbook disclosure. However, protection of the FSCS. housebuilders98. of providing such loans or to offer 94 AUTHENTIC AND POSITIVE them at lower rates of interest103. only 8 of the current 50+ P2P Bank deposits also afford little or no The FCA recently stated that a With the lower overheads and better SMEs SUCCESS IN RAISING FINANCE platforms are members, although the control to the depositor over the use There are very positive factors related number of P2P consumer platforms technology and systems boasted by membership does include the four of their money. Almost 70% of those to P2P lending connected to ethical are now offering substantial volumes many platforms, this is an easier, more largest UK platforms who make up questioned in 2016 for a national standards and the democratisation of business lending to both sole cost and time efficient task for P2P 73% UK market share. AltFi Data, does survey agreed or strongly agreed that of finance. These provide a feel-good traders and SMEs99, in fact, close to lending platforms. And the speed the also provide several indices that allow they like to know what their money is factor to lenders and have also driven £900 million of SME loans were made technology brings to the transaction for tracking of the P2P universe. being invested in to get a return. This the supply of an alternative to the through marketplace platforms in 100 should not be under estimated as 9% This type of disclosure allows makes the access to credit risk scores finance which borrowers may get from 2015 and P2P business lending small businesses can be heavily time- potential investors and their advisers and due diligence95 that marketplace traditional financial intermediaries; increased by 75% in the same year. constrained. to fully examine items such as lending allows, a strong driver: there is a perception that – by directly Whether this is connected to a defaults, arrears, recovery rates Knowledge is, after all, power. linking individual borrowers and sentiment of helping the ‘little man’ Given the huge importance of SMEs lenders – it offers a more socially by giving greater access to credit, or to the UK economy, with 85% of new and to get a very good feel for how Transparency also extends to the CONSTRUCTION beneficial form of finance, without the the potential for higher returns, albeit jobs in the UK between 2008 and successful the underlying risk rating risk ratings used by the platforms: concerns sometimes levelled at banks at potentially higher risk, investors 2013 created by firms with fewer is. Since the information is regularly different platforms use different and other conventional financial clearly view it as an attractive market. than 50 employees and 2015 figures updated, it can be monitored models to score the risk within each intermediaries that, on occasion, they And it has been needed: showing that the annual turnover against other platforms so that of the loans they offer to investors. exploit their market power and pursue of SMEs was £1.8 trillion, 47% of all the relative performances can be Zopa, for example, uses credit scores Since the onset of the global financial profit without adequate regard for the private sector turnover in the UK, measured, allowing investment into provided by the credit bureau Equifax crisis, banks and traditional lenders 11% interests of their own customers96. the development of SME access to the platforms which most closely (and also sometimes additionally have been more reluctant to provide new sources of funding through peer match the investor’s requirements, information from CallCredit) to Marketplace lending has undeniably credit to borrowers - the results of to peer lending is timely: The 2012 for example returns stability, and net allocate borrowers into one of several opened up new asset classes to mass deleveraging of European banks Breedon Report, which examined the return over a certain period. ‘market places’ (A*, A, B, C, D or E). On retail investors. The information age and higher capital requirements financing of UK SMEs, concluded that RETAIL This kind of accountability gives the average borrowers in the A* and A has created access to a previously imposed by global regulators. This in the following five years there would P2P platform the incentive to list categories have incomes well above inaccessible asset class and this is also linked to the Basel Accord be a funding gap of between £84 sensible risks at sensible prices as national average and strong credit has given small investors a choice regulations introduced in 2008, which billion and £191 billion. In late 2015, their track record is easily available ratings. B and C borrowers have as to who they allow to use their required banks to hold significant the World Economic Forum estimated in great detail and disclosure allows incomes closer to the national average funds, a very important change as, amounts of capital against risky assets, the SME funding gap worldwide to informed choice. Without it there may and clean credit histories. D and E with banks, retail investors have no resulting in lending to small ticket be $2 trillion and named the UK as be a question mark over this because borrowers have incomes close to the choice about who their deposited loans of £250,000 or less becoming 31% one of the countries affected104. And some platforms take the majority national average and chequered credit funds are loaned out to: Since about unprofitable for banks. Basel III, due some of the initiatives put in place by of their revenue in the form of an histories. Returns increase when 70% of those surveyed in the Great for implementation in 2017, gives even the Government, such as the Funding arrangement fee, giving no exposure moving across the categories. British Money Survey of April 2016 higher capital requirements to banks for Lending scheme, introduced to to the viability of the actual loan. i.e. if agreed or strongly agreed that they as security against potential financial Funding Circle checks borrowers increase bank lending to SMEs have MANUFACTURING would be unhappy if they found out shocks and to cushion any failures of a loan defaults, the platform doesn’t through Experian and again there is a 101 simply failed. The Policy Exchange said their money was being used to fund higher risk assets . SOURCE: 2016 GROWTH REPORT, ALBION VENTURES share directly in the loss. That said, categorisation into six risk bands (A+, unethical activities97, giving them

34 35 “The asset class benefits from some disillusionment with the traditional banking sector, but it’s “Consumers purchasing financial products online is increasing – a reflection of both the growing advantages are not just sentimental - cutting out the incumbent intermediaries and beating them use of the internet in general, as well as confidence in its use for financial services.” on costs can have benefits for both borrowers and lenders.”

Although the Breedon Report did not identify a single solution to this problem, it % OF INDIVIDUALS WHO PURCHASED SHARES / INSURANCE / OTHER FINANCIAL SERVICES IN THE UK established that raising awareness about alternative finance methods would be key. Over half of UK smaller businesses CONCLUSIONS still go only to their main bank 25% Recent findings are that awareness of marketplace lending is fairly good, and and do not shop around for There is a strong investment case among retail consumers and SMEs in Britain, just over half of consumers (53%) 109 finance . Taking this into account, 20% for P2P lending, based around and three-quarters of SMEs are aware of marketplace lenders, but there is more the high rejection rates by banks, achieving better risk adjusted to do to turn that into engagement108. the economic significance of SMEs 15% returns than are available and the importance of sentiment elsewhere by accessing an AWARENESS AND USAGE OF P2P LENDING to P2P lenders, it would seem that 10% asset class that was previously there is definite scope for continued unavailable to retail investors. RETAIL CONSUMERS broadening of the P2P lending 5% These returns can be very market in this sector. predictable, particularly in AWARE? AWARE OF SPECIFIC USED? 0% the lower risk categories and P2P LENDERS? 2009 2010 2011 2012 2013 2014 2015 the diversification feature of 80% combined market share for spreading loans across numerous SOURCE: EUROSTAT, JULY 2016 business loans, excluding P2P lending, different borrowers is a powerful 4% was held by the four largest banks - 53% BORROWED In fact, low confidence in traditional conduct remediation costs in the next default mitigator. Asset backing Lloyds, HSBC, Barclays, RBS in 2014 mainstream banks has been a feature two years112, it is entirely predictable can also provide robust security (Competition & Markets Authority, of the landscape for some time – that there are confidence issues. and where data is available on Retail Banking Market Investigation not surprisingly, a substantial loss Not to mention the Royal Bank of default rates, period returns and 2015)110. Interestingly, in reputation 5% in consumer confidence across the Scotland (RBS), which is 73% owned loanbooks, transparency allows 53% LENT rankings in April 2016, all four of these banking sector was caused by the by taxpayers, posted a £1 billion for very detailed platform analysis P2P banks ranked below the 62.4 average 2007/08 crisis. Yet, nearly a decade loss for the first quarter of 2016. The and due diligence. LENDERS rating for UK banks. on, banks are still struggling to regain net loss of £968 million was higher The asset class benefits from 91% customer trust and rebuild their than the £957 million expectation by some disillusionment with the 47% NOT USED reputations as, once lost, customer analysts, and double the £459 million traditional banking sector, but 113 trust can be hard to regain and often loss in the same period last year . it’s advantages are not just costs a huge amount of time and No wonder PWC research has found sentimental - cutting out the money. This task has not been aided that fewer than 1 in 3 customers trust incumbent intermediaries and The full rankings: by the banks’ struggles with further their bank. beating them on costs can have 47% YES NO scandals including Libor rigging, All of this is whilst consumers benefits for both borrowers and mis-selling of payment protection 1. NATIONWIDE BUILDING SOCIETY 72.4 purchasing financial products online lenders. Automation allows a SMEs insurance and inappropriate interest is increasing – a reflection of both the measure of efficiency and speed AWARE? AWARE OF SPECIFIC USED? 2. VIRGIN MONEY 69.8 rate swaps further undermining growing use of the internet in general, and credit assessments provide P2P LENDERS? public confidence: Considering that as well as confidence in its use for an indication of risk for those who 3. SANTANDER 67.4 conduct litigation charges for the UK’s financial services. are confident in the evaluation five largest banks increased by 40% methods of their chosen 4% 4. HALIFAX 67.3 Overall, this suggests a continuing 76% BORROWED in 2015 to £15 billion and Moody’s platforms. expectation is that banks will make availability of both lenders and 5. METRO BANK 66.6 even more provisions for litigation and borrowers in the P2P lending arena. 3% 6. NATWEST 65.1 61% LENT P2P 7. THE CO-OP BANK 62.4 LENDERS 8. HSB 62.1 94% 39% NOT USED 9. BARCLAYS 59.8 “As someone who has personally been using peer to peer sites for a good few years it has always been strong and consistent in terms of returns, but there is no guarantee that will happen. Peer 10. TSB BANKING GROUP 59.7 114 to peer lending is not saving – it’s somewhere in between saving and investing. ” – Martin Lewis, 11. LLOYDS BANKING GROUP 57.3 24% YES NO MoneySavingExpert

SOURCE: GOV.UK 12. RBS111 49.3

36 37 RISKS AND CONTROLS POTENTIAL HAZARDS AND MITIGATORS

While the sector might not be as target. And the platform’s creators operating in the UK market, where risky as some advisers may have are taking action to ensure that they regulation is bespoke and overview RISKS AND CONTROLS thought at first glance, of course there have enough technical expertise to more focused: are risks and it is vitally important prevent such cyber-security issues. In October 2015, the Swedish to understand what they are and Zopa, for example, uses technology marketplace lender TrustBuddy how various platforms attempt to to verify borrowers’ id online and declared bankruptcy after the platform mitigate them. As P2P lending is still has reported that this has caught at uncovered alleged misconduct within seen as alternative and therefore least one fraudulent borrower trying the organisation, including misuse unconventional, if something goes to withdraw a sizeable amount. And of lender capital. This was the first wrong, it may well attract more Funding Circle ensures that its website significant European example of a attention and more complaints, so is subjected to an independent and platform not playing by the rules and making the risks clear to investors is professional security review several risking tarnishing the reputations essential. times a year. It also says that it of others in the market. Issues were “employs some of the strongest forms uncovered when new management FRAUD of encryption commercially available discovered allocation of new lender for use on the Web today. During any ONLINE capital to existing bad debt and that £3 transaction, our encryption turns your million loaned to borrowers was not As online P2P lending platforms are information into a coded sequence assigned to any lender119. Nevertheless, internet-based, there is risk related with billions of possible variations, commentators have highlighted that to cyber-security. This could come in making it nearly impossible for Sweden does not have the same many forms, from overloading the unwanted intruders to decipher.” regulation as the UK and continues platform’s infrastructure to confusing These issues don’t just encompass using existing rules on consumer and accounts or identity theft: To quote hacking - in May 2015, the FCA, issued business lending which were never the FCA, “The market has grown and a warning against Zopa Loans Review, designed to ensure the efficient and evolved rapidly and there is a risk stating that they are unauthorized correct running of peer to peer lending. that firms’ infrastructure, systems to provide loans in the UK, as well as and controls may not be able to There have also been high-profile being unaffiliated with the popular P2P keep pace.”115 Ultimately, Alternative collapses of well-known internet lender Zopa Limited. Copying Zopa, Finance offers a combination of high finance platforms in other much less the clone site was leveraging the Zopa growth, confidential data and money regulated markets120. Most notably, P2P lending brand118. Thankfully both that appeals to all the wrong people China, where, by November 2015, platforms and the regulator are alert to for some very obvious reasons116. But there were over 3,600 P2P platforms this type of cyber activity. The advent platforms don’t have their heads stuck as the industry raised more than of the regulated activity of running in the sand on this issue - the Nesta 400 billion yuan (over £46 billion), a P2P lending platform means that 2015 UK Alternative Finance Industry according to the China Banking internet users now need only check the Report noted that 51% of surveyed Regulatory Commission (CBRC). The Financial Services Register or the Credit platforms regarded cyber security CBRC also stated that more than Interim Permissions Register to verify as a factor that could have a very 1,000 of those were problematic121. that those running the site are the detrimental effect on the sector117. Again, Chinese regulation of the correctly registered entities. P2P marketplace is very loose By February 2016, PWC had OFFLINE in comparison to that of the UK. performed ethical hacking duties Chinese platforms operated in a for as many as 20 different P2P The Nesta 2015 UK Alternative Finance regulatory vacuum until 2016 and lending platforms, the findings of Industry Report found that 57% of China’s regulatory approach can be which are intended to assist with platforms saw a collapse of one or best described as hands-off except toughening up security measures. more of the well-known platforms due in the cases of major risk events and Fergus Lemon of PwC stated in 2015 to malpractice as a high risk to growth. outright criminal violations. Industry that he was encouraged by the level Such failures - either as a result of self-regulation is touted in the latest of engagement with ethical hacking breakdowns in corporate governance P2P Lending draft rules document as service providers by the alternative or outright fraud have in fact occurred the ideal approach, and regulators investment industry whose members in late 2015 and early 2016, although are more interested in controlling clearly understand that they are a importantly, neither platform was

38 39 “If firms are abiding by the FCA rules and guidance, what happened at Lending Club shouldn’t “New risks have to be weighed against the desperate need for credit in Europe. The industry, happen here. Lenders should be made aware of the specific nature and risks of entering into a like securitisation, will be hoping to receive further support from European policymakers keen to P2P agreement. Apart from specific rules for P2P lending, the FCA also has overarching conduct stimulate lending.” – Financial Times of business and client best interest rules.” – Linklaters Law Firm undesired activities rather than platforms simply match borrowers However, Lord Turner later clarified Rothschild, believes Lord Turner’s DROP IN LENDING CLUB SHARE PRICE (2016) setting legal barriers to entry (e.g., a and lenders and do not take any that his comments were taken out initial remarks “are at odds with the license and permit system)122. responsibility for the funds of the of context and that he was speaking evidence”: “Zopa’s performance both $10 lender. This is unlike bank deposit about individual investors, rather at the time of the 2008 crisis — where In comparison, the US market is more accounts, where banks lend out the than platforms, making a credit lenders received positive returns — regulated, but it has not been immune funds but they are taken onto the assessment about who they lend and since, has been superior to most to concerns: In May 2016, US platform $8 bank’s balance sheet. Therefore, if to. He said, “But in fact, individual UK banks.” During its first full year Lending Club, sold a large portfolio of there is a default, they are negatively investor credit assessment now plays of operation in 2006, 0.13% of Zopa’s $22 million to a big investor, however, affected and they have a responsibility only a very minor role in the growing loans defaulted, increasing to 4.47% in $6 some of the loans did not meet the to their depositors. In addition, the FSCS direct lending market... only a small 2008. Interest payments to investors buyer’s criteria but were doctored guarantees the first £85,000 of funds percentage of investors now directly dipped only slightly during the financial to look as if they did. Lending Club $4 held for depositors per banking group. select specific portfolios of loans, and crisis, from about 6% to 4%.”127 bought back the loans and launched even those investors rely crucially an investigation, concluding that P2P platforms generally have no It seems inevitable that commentators on the platform’s centralised credit $2 “the company’s internal control over such ‘skin in the game’ and only would link a notable increase in default assessment of the relative riskiness financial reporting was ineffective”, stand to lose their outstanding fees rate to the broader issues around of different loans.” As long as the P2P MARCH APRIL MAY JUNE JULY AUGUST firing the boss and two other should a borrower stop repayments. platforms’ credit scoring, underwriting industry avoids developing complex and executives, not to mention triggering Consequently, they are not as and due diligence capabilities. And the SOURCE: MARKETWATCH, AUGUST 15 2016 opaque products, Lord Turner felt that a huge loss in the company’s share incentivised as they could be to ensure lack of a standardised methodology direct online lending is “likely to become value. The US Treasury Department the quality of checks on borrowers: In amongst platforms, which makes like Britain’s P2P firms have a good record generated by fees at the outset, if deal a stable, significant and useful part of said that online lenders should June 2014, Andrew Tyrie, the chairman for like comparison across various of publishing details of their loans flow were to slow, perhaps because our total credit supply system.”126 support more transparency, but of parliament’s Treasury Committee, platforms difficult, if not impossible, for investors to examine, but the of economic uncertainties, the effects stopped short of calling for new rules. wrote to the FCA to warn that “poorly This is because, P2P lenders carry does not help. Certainly, the P2P trustworthiness of published details on the operation of the platform could informed investors may be left with out credit checks on borrowers in the Finance Association implements can still be brought into question, as be catastrophic; the temptation to UK platforms point to the UK’s a false sense of security about the same way as a bank to try to ensure standardisation of some operational with the Lending Club incident in May accept more risky borrowers, could regulatory regime for marketplace balance of risks versus returns”124. And that only borrowers with a good record metrics amongst its members, but 2016, for example; while a big investing become irresistible, leading to higher lending platforms being the only one in February 2016 Lord Adair Turner, of repaying credit are considered. credit scoring/risk rating methods are institution in the US was able to uncover default rates, leading to even fewer in the world which has been designed former chairman of the UK’s financial This selectiveness is borne out by the currently not included. That said, the the mis-selling by Lending Club, it is originations, leading to lack of funds specifically for the P2P lending regulator, the Financial Services number of borrowing applications industry is working on delivering more much harder for small retail customers to run the platform and eventually, business model: The United States Authority, was quoted as saying that which are rejected by P2P platforms practical tools with which to analyse to examine loans so thoroughly and the platform going out of business; if and other countries regulate P2P insufficient credit checks by P2P sites (around 4 in every 5 in 2015). And, the lending performance of the sector. hold the platform to account if any inflows dry up, it could be very difficult under existing consumer and business could lead to big losses over the so far, these models have been very wrongdoing is suspected128. for smaller platforms which do not lending rules fashioned for banks and Yet, businesses do fail, particularly if next decade that would “make even largely successful, possibly because P2P have reserves of cash. other lenders. they are early-stage companies; and Nevertheless, the damage that can be the worst bankers look like absolute lenders have automated their lending inevitably some proportion of peer to done by reputational and track record In a market crowded with P2P Linklaters law firm has stated that, “If geniuses”. decisions and some have leveraged peer loans will default on platforms. contamination is clear - Lending Club’s platform competitors, this could lead firms are abiding by the FCA rules and alternative data such as social media to The suggestion was that Lord The key issue is whether platforms are share value dropped by over 60% in to failures and/or the consolidation of guidance, what happened at Lending inform lending decisions. Turner was calling into question doing the utmost to lower the chances less than a week129, a sharp reminder smaller players, who are absorbed by Club shouldn’t happen here. Lenders the business model of evaluating Christine Farnish, chair of the Peer of arranging loans to these parties and to platforms that their disclosure those which have managed to scale up should be made aware of the specific borrowers based on a series of to Peer Finance Association and a good underwriting criteria (to provide needs to be correct. Ultimately, it may or who have specialised in areas such nature and risks of entering into a algorithms. In part, this relates to former member of the Financial realistic credit rating) are crucial here. be this type of potential consequence as student lending. Deloitte’s view P2P agreement. Apart from specific the rise of automatic-bidding, which Services Authority, said Lord Turner’s which keeps platforms keen to provide is that the marketplace lenders that rules for P2P lending, the FCA also has Whilst platforms are very transparent can enhance market efficiency, by original comments were “unfair” and the best commercial outcome for their ‘win’ will be those that are right now overarching conduct of business and with making their default rates available arranging loans quickly and providing “ill-informed”: “The suggestion that clients. building either scale or niche expertise client best interest rules.”123 to investors, one thing to take account significant diversification according to platforms serve unbanked customers through strategic partnerships130. This of, is that currently, the data provided an investor’s set criteria. But, at the and small businesses who can’t ORIGINATION suggests a maturing of the sector, DEFAULTS by platforms is not independently same time, auto-bidding challenges borrow is incorrect. Virtually all can rather than any collapse. verified - even if it is published on the Some have asked, if you’re not a Unlike money deposited in a savings P2P business lending platforms to get loans from banks, but prefer P2PFA website. This opens the door to bank, where does your borrower/ Moreover, the UK market currently account, money invested in P2P ensure their underwriting and credit keener prices and better customer the prospect of issues with unaudited lender origination come from? Since benefits from substantial government lending is, in the main, unsecured, risk management capabilities are always service from P2P platforms.” And, information - whether they be genuine the income of platforms is very much support which actively promotes peer which means the debt is not rigorous and reasonable, as, in this Tim Levene, founder of Augmentum mistakes, fraud or failure of corporate linked to the origination of lending to peer lending to both individual guaranteed against property or other scenario, the platform is making loan Capital, which invested in the first P2P governance. deals, with much of the revenue consumers and companies. The assets. In addition, most P2P lending selections on behalf of the lender125. platform Zopa and is backed by Lord

40 41 “Non-traditional data metrics will increase the ability of marketplace lenders to serve customers “The market has grown and evolved rapidly and there is a risk that firms’ infrastructure, systems with varying credit histories, or none at all, but excellent credit potential.” – Deloitte and controls may not be able to keep pace.” – FCA

Innovative Finance ISA is expected MAIN PROTECTION METHODS FOR P2P LENDING INVESTORS PLATFORM MELTDOWN of FundingKnight.”134 FundingKnight The FCA also requires platforms to drive several hundred thousand had previously alluded to a strong to ensure loans continue to be A small number of UK P2P sites additional people to the sector and the pipeline demand on the borrower administered if a platform fails. To launched and failed in the earlier involvement of the British Business side, but this still demonstrates the do this, a platform may have an development phase of the sector, Bank, targeting credit at SMEs through DIVERSIFICATION A well-established CONTINGENCY FUNDS Some strong interest of institutional money agreement with a third party back- when new, young, dynamic players platforms, looks set to continue whilst way of spreading risk so that platforms run contingency funds, and the potential it sees in P2P up service provider - the most usual entered the industry, some of whom the lending gap stubbornly persists. individual defaults do not unduly also known as provision funds platforms. Potential is an important option. This service provider will take were underprepared for the realities affect the returns lenders can or safeguard funds. They are set factor and investors can clearly see it - over the running of the outstanding The advent of the bank referral of P2P lending. Quakle, BigCarrots, receive from their basket of loans. up specifically to provide a safety suggesting that, at this stage of the life loan book and gradually wind it down scheme and the partnerships of P2P yes-secure, and Wonga all launched It is always sensible to spread net in the event of defaults on cycle of the P2P market, consolidation as each loan is repaid. Alternatively, platforms with mainstream banks P2P sites which rapidly disappeared P2P lending across a number of investors’ loans. These are usually rather than obliteration of smaller P2P platforms can arrange for a guarantor is also likely to be a major factor in and GraduRates was absorbed by sites, so that the investor is not built up over a period by taking lenders may be more likely. for all outstanding loans and hold raising awareness of and confidence Ratesetter in 2014. depending 100% on the quality of a small amounts from borrowers’ sufficient collateral in a segregated in marketplace lending with a wider The platforms which have disappeared single site’s credit checks. fees and whilst they will never be FundingKnight provides a more recent account to ensure funds are available range of potential customers. This or changed hands were all very small in able to guarantee full repayments example of the potential for platform to cover the costs of winding down the in turn will create P2P lending deal comparison to the market size and these to all lenders on any platform, failure. Founded in 2011, it fell into loan book. These types of arrangement flow as will the increasing comfort types of failures by new entrants are they do have a chance of providing administration in mid 2016 after its should mean that lenders are not and familiarity of the UK population probably less likely moving forward, as ASSET SECURITY Security such as useful reassurance whilst default origination volume faltered with only affected if a platform fails. with online financial services. New the sector is now in a phase where new property can be very effective in rates remain in the very low single £2.02 million originated in the first six advancements in the manipulation of players could well be backed by very large There is limited information of this guarding against loss of capital. figures. Any contingency fund may months of 2016, compared to £9.18 ‘big data’ will also mean that boutique businesses. The tightening of regulation having already happened though Security over assets could be a first also be used if there is platform million in the same period in 2015132. data providers may help P2P platforms of P2P lending activities is certainly an and of the 18135 platforms which have floating charge over a borrowers’ meltdown as often, the funds are However, the issues were not caused to mine new client categories - “non- indication of the maturing of the market closed their UK operations since 2011, accounts receivables (ArchOver), held in trust for all lenders and by bad underwriting - but a dispute traditional data metrics will increase and it also raises the bar to new entries there were only two cases where or first ranking mortgages over therefore they may be able to ask with GLI Finance, previously one the ability of marketplace lenders to which don’t have sufficient capital and investors may have made a loss; one, tenanted residential properties for losses to be reimbursed from of FundingKnight’s main investors, serve customers with varying credit expertise to work successfully within Quakle, only lent £16,000 in total in (Landbay), a first legal charge over the fund by the trustees, depending funding 75% of its loans (not a very histories, or none at all, but excellent the regulatory framework. the UK, whilst the other, Big Carrots, commercial property (Proplend) or on the terms of the trust and the diversified source!). A change of credit potential.” 131 accounted for less than 1% of the 2012 the right to deduct payment from amount held in the fund. But not management in FundingKnight led Ultimately, that regulatory framework market136. This very much plays into the niche the borrower’s wages (Neyber). all platforms have contingency to personal animosities with GLI who includes provisions to protect against business models that are employed In the event of default, such funds, including some of the then withdrew their loan funding in the prospect of platforms going out of Alternatively, the investors may also by platforms which develop the skills security could be accessed/sold larger ones such as Thin Cats and February 2016. Since it takes origination business and borrowers and investors have taken advantage of some or all and technology to service clients and with the proceeds going to the Funding Circle. They feel that proper and servicing fees, rather than any being left without their input and of the Investor Protections discussed sectors that other traditional credit investors. The coverage of losses diversification and asset backing is interest on the loans it originates, therefore unable to make or receive on page 42 which may also apply in providers just cannot. This type of will depend on the valuation of the sufficient. FundingKnight’s revenues are reliant outstanding payments: If the P2P the event of platform meltdown. But, innovation has also infiltrated the secured asset, whether it covers on a constant stream of new loans and platform is no longer operational, the whatever happens in the event of business processes of platforms, the full amount of the loan at the therefore investors willing to buy those lender still has its legal rights (through platform failure, the investors funds INSURANCE Some platforms also making loan applications and decisions outset, whether the value of it has loans. No investors means no new the contract it signed originally with are likely to be held for longer than use insurance. Lending Works, for faster, customer service more dynamic increased or decreased whilst the loans, which means no revenue133. the borrower), against the borrower to intended at the very least. example, offers insurance which and administration more efficient. loan period has been running, or continue to receive loan interest and safeguards lenders’ money against Yet, at the end of June, the firm was whether the borrower still works repayments. Any funds held by the LIQUIDITY all the major reasons for borrower rescued by GLI Finance, which also for the same employer. platform on behalf of the lender, e.g, invested a further £1 million in the Investors on P2P lending platforms defaults such as accidents, illness, funds ready to be loaned or to be paid business. GLI CEO Andy Whelan may not realise that they are usually death and redundancy. as interest or loan repayment, at the said: “We believe FundingKnight is a ‘locked in’ to their investments until insolvency of the platform, are subject fundamentally good business with they mature. As an investment is to the FCA Client Money rules which strategic value. By acquiring the lent, it can be difficult and expensive stipulate that they must be held in a business at a low entry price, we will for investors who need to access ring-fenced account, separate to the help ...provide reassurance to the their money sooner than expected assets of the platform. As a result, they investors in FundingKnight loans and to withdraw it before the end of the should still be considered as belonging FundingKnight’s SME client base that term. To enable them to do this, there to the lender by any party brought in to have existing loans or are seeking to must be another lender to take on the distribute the assets to creditors of the borrow. In the medium term, we will loan. The platform may charge an extra platform. be seeking to maximise the potential fee for this, although some products

42 43 “Any rise in base rates will benefit both our lenders and borrowers as bank spreads will increase as they always do as interest rates rise. Commentators have been talking about the prospective “The Basel III Accord... amounts to higher costs for lending, particularly for higher risk transactions... increase in bank profitability as interest rates rise and that will have to be paid for by consumers, This may further discourage higher risk assets, such as SME loans, being held by banks.” making our alternative proposition even more compelling.” – Giles Andrews, Zopa such as Zopa Access, do not. And if The use of bigger platforms with higher Nevertheless, rising borrowing SOURCES OF UK SME FINANCING engage with it, as the two sectors there is a shortfall in interest because volume suggests greater liquidity rates might also lead to a spike in can provide complimentary services the new lender is demanding a higher capabilities and less investor risk in the borrower defaults, a risk that the P2P BANK LENDING ASSET FINANCE PRIVATE EQUITY P2P BUSINESS LENDING to each other which are mutually rate of interest or market rates have event of a run on a platform’s loans. platforms will be acutely aware of. beneficial; banks have many existing risen, this money must be made up by But the high degree of diversification £80bn customers with high levels of brand INTEREST RATE RISES the lender transferring the loan. across different risk categories that is loyalty, from whom to generate loan available within the P2P marketplace This issue will also affect the In the event that bank base rates rise, £60bn originations, and taking deposits is likely to be very useful in limiting Innovative Finance ISA, as the pushing up rates offered by banks on gives inexpensive access to funding. these risks. Government will not extend the deposit accounts, P2P platform rates £40bn Platforms can provide routes to could look relatively less attractive, business that banks would otherwise maximum 30-day access period to BANKS RE-ENTER THE MARKET money which has been lent and is yet for more risk, triggering a move £20bn not have been able to access and to be repaid. This means investors of investors to the safe haven of There has been speculation that can shine a light on new and efficient may only be able to access within 30 traditional savings accounts. This might banks which heavily retreated from £0 customer service and administration days money and returns which have be more pronounced if inflation rates the lending market in the aftermath 2012 2013 2014 2015 methods. been repaid. This differs from the stayed low, reducing the erosion of of the 2007/08 crash, are now re- SOURCE:BRITISH BUSINESS BANK withdrawal and transfer rules that cash value that inflation produces. entering the market across many of LACK OF TRACK RECORD in those areas they shrunk from after changes are being phased in up to are in place for other ISA investments the sectors in which P2P platforms Although there are now over 50 P2P Of course, such a risk has been 2008/2009 takes a couple of fairly 2019 and are causing uncertainty where there is a guarantee that it will have had success, to such an extent platforms in the UK, Zopa, the first pushed further into the future by substantial hits: among banks about how to recoup be possible to withdraw or transfer that the platforms will not be able to company in the world to offer P2P loans, the Brexit vote and the subsequent the additional lending costs from their the investment in all cases. compete. The result would then be was only launched in February 2005 and economic uncertainty which led the The EU Basel regulatory existing loans in order to retain their the slow decline of the platforms until it was not joined by other UK platforms P2P platforms though are at a bank of England to drop the base rate frameworks for banks aim to maintain profit margins and therefore available all of their business was re-absorbed until 2008 when LendInvest was competitive disadvantage relative in August 2016 to 0.25% with the banks’ solvency by strengthening capital. This may further discourage by banks and the disappearance of established and 2009 when Funding to banks in providing such liquidity strong possibility of more downward the regulation, supervision and risk higher risk assets, such as SME loans, P2P lending as an asset class. Circle launched. This means that there services, not having access to money movement to follow. And currently, management of the sector. This was being held by banks142. market funding or to central bank P2P lenders continue to benefit Statistics do reveal that the availability initially undertaken through Basel 1 in is very little data on the performance The Brexit vote has created liquidity provision. The bank of from what has been a long term low of bank debt to small and medium 1992 by introducing capital adequacy of the industry that goes back even economic and political uncertainty England has, however, found that interest rate environment in which sized businesses in the UK increased requirements that meant a certain as far as ten years. It also means that leading to the prospect of slowed “loan agreements often can be sold interest on a typical 90 day deposit for four consecutive quarters in the amount of the bank’s regulatory there is no consolidated material growth or possibly even a recession. before maturity in secondary markets account has dropped by 82% over the year to October 2015 for the first capital must be allocated (at least collated from a full economic cycle. 137 138 139 notionally) to every loan advanced, This may cause some banks to draw operated by platforms.” And whilst last 10 years . time since 2007-8 . What’s more, Detractors say that, “Thus far, back again as deteriorating economic the mere existence of a secondary some experts such as Deloitte “do or commitment made, by that bank. In any event, P2P platforms have a most marketplace lenders have Therefore, the capital adequacy conditions pull more potential market does not mean that it will be not believe that the banking model only operated in an environment different view of rising rates, with borrowers into higher risk categories. deep enough to guarantee an exit when will be fully disrupted by marketplace requirements of any loan carry an Giles Andrews, Executive Chairman of historically low interest rates, investors want it at what they judge to be lenders.” On the other hand, they also implicit cost to the bank advancing of Zopa, stating that, “Any rise in base So, P2P lenders perform several declining unemployment, and a fair price, a substantial proportion of do not believe that P2P platforms it. The original Basel Accord was rates will benefit both our lenders valuable functions: investment friendly capital markets platforms do have a secondary market. are a temporary phenomenon. This is relatively rudimentary in the way it and borrowers as bank spreads will they may provide supply into areas - a perfect storm for these non-bank probably the attitude of Keith Morgan, allocated capital to risk, whereas Basel This indicates that most P2P platforms increase as they always do as interest of the lending market where banks do lenders to thrive as they satisfy chief executive of the British Business II adopted a different approach and do offer some liquidity services, for rates rise. Commentators have been not have the risk appetite to participate, borrowers’ needs for credit along with Bank, who stated in February 2016 that, sought to match the amount of capital 144 example Funding Circle in the UK talking about the prospective increase such as high-risk retail borrowers investor appetite for high yield” . “While there are encouraging signs that required to be held by an institution allows its business customers to repay in bank profitability as interest rates volumes are up and alternative finance more closely to the exposures that it while the likelihood of a significant Whilst default levels are low in the loans early, with their automated rise and that will have to be paid for markets are thriving, there remain faces141. The Basel III Accord brings in outflow of deposits from the banking current environment, unfavourable bidding re-investing funds in new loan by consumers, making our alternative areas that still require attention.” In the stricter rules on calculating the capital system does not seem strong, conditions, which restrict cash in the applications. Most platforms also allow proposition even more compelling.” SME sector, he said not enough small to be held for each type of asset, adds marketplace lenders offer a low-cost economy could increase defaults, investors to sell loans they hold, for a He is making a reasonable point businesses were scaling up, a move a requirement for capital buffers to option for certain investors to gain particularly at the higher risk end of fee, for example Zopa Classic. These that, broadly speaking, a rise in that would increase UK productivity: be held and imposes liquidity ratios direct exposure to new asset classes143 the of the scale. However, assessing services are encouraging to those who the base rate equates to a greater only 3% of start-ups become midsized, to ensure that banks have sufficient the underwriting and its overall are interested in longer term loans but cost of finance for borrowers, and they provide a faster, more efficient compared with 6% in the US140. liquidity to deal with severe market effectiveness in selecting the best better returns for savers. And in this customer experience than banks. have liquidity concerns. The longer shocks and can continue to run in the borrowers and allocating the correct investors are willing to tie up their situation, the low cost model of P2P More recent developments could medium and long term. This amounts The traditional banking sector may in level of risk and therefore return is money, the more they will earn, so lenders is still likely to undercut bank mean that the willingness of to higher costs for lending, particularly fact, be more of an opportunity than very difficult until the industry has there is a risk premium at work. rates and provide more to investors. mainstream banks to re-enter lending for higher risk transactions. These a threat to the P2P platforms which experienced these conditions.

44 45 “The peer to peer lending sector has embraced a level of transparency which is unrivalled in financial “P2P lending is likely to prove relatively defensive in a recession based on the performance of services, and it is possible to make judgements about the calibre of credit decisions made by each the more mature platforms such as ZOPA during the 2008 financial crisis and the performance individual [P2PFA member] platform in respect of their entire loan book through material which is of similar lending conducted by banks over a longer historical time period.” – Cormac Leech, Victory already published.” – Christine Farnish, Peer to Peer Finance Association Park Capital

However, in February 2015, AltFi Data and outperforming the Bank of looking very well, provided you spread P2P LENDING IN A RECESSION CONTRIBUTION BY CORMAC LEECH, VICTORY PARK launched its P2P returns and volume England base rate by some margin. The your money around.”148 indices as benchmarks for tracking these predictable income return delivered by Landbay, Funding Circle and Zopa have key indicators on a standardised basis. the Zopa platform during the decade ZOPA LENDER RETURNS (2005-2012) also all commissioned their own stress Cormac Leech at Victory Park from 2005 - 2015), averaged at 5.6%145 Although more time needs to pass for testing. Landbay, a P2P platform for buy- Capital takes a look at the prospects whilst the somewhat more alarmingly NET YIELD SERVICING COST LOAN LOSSES these indices to provide more valuable to-let mortgages, commissioned The for P2P lending in a downturn. volatile FTSE 100 averaged just under data over a material period, they are Wriglesworth Consultancy. The report 14% 6%146 from 2006 to 2015. P2P lending is likely to prove already allowing investors to monitor found that platforms such as Landbay 12% relatively defensive in a recession underwriting standards as meaningful Zopa maintains that the financial are capable of weathering even the most based on the performance of the 10% drops in net returns (and possibly crisis marked a turning point in its severe of economic shocks. The results more mature platforms such as thereafter, volume) will reflect increased development. On the credit supply showed expected/projected losses on 8% ZOPA during the 2008 financial crisis defaults. This is likely to discourage side, new lenders entered the market, the current/projected loan book of just and the performance of similar 6% investors from deploying further capital. attracted by the higher rates (and 0.03% under current economic conditions lending conducted by banks over a In other words, benchmark indices hold risk) available from exposure to P2P – increasing to just 0.30% in the Bank of 4% longer historical time period. platforms credit analysis to account. assets, relative to those offered on England’s adverse scenario149. 2% conventional banking products. Looking at Zopa’s performance Platforms also do much to offset this Funding Circle hired Hymans Robertson 0% And, on the credit demand side, a first: loans made during 2008 (the issue by being very transparent with who used a scenario in which UK GDP 2005 2006 2007 2008 2009 2010 2011 2012 wider and more creditworthy pool peak of the global financial crisis) their data including putting loan books drops by 4%, interest rates increase of potential borrowers appeared as had annualized losses of only 2.3% SOURCE: ZOPA online for analysis, and members of from 0.5% to 4.2% and inflation banks deleveraged. resulting in an IRR for Zopa investors Similarly we can use central bank data on bank lending to consumers and industry trade bodies such as the increases from 1.8% to 6.6%. The deploying capital in 2008 net of businesses to get a longer historical perspective. This approach is likely to be on Peer to Peer Finance Association are Further information is available as test found that average annualised loan losses and servicing fees of the conservative side since P2P lending to date has outperformed the underwriting obliged to do this in order to give a result of stress testing by some of returns for the Funding Circle loan 5.9%. ZOPA’s gross yields re-priced and return performance in consumer lending to date. The following chart shows investors their own opportunity to the platforms which mirrors the Bank book would drop from 6.7% to 5.6% in up by 1.9% upwards in 2008 as the returns from investing in US credit card receivables from 1995 to 2015. As make judgements. Additionally, though of England stress testing on banks. these conditions. Bad debt rates were lenders demanded better returns the data shows, returns remained positive in every year. Peak loan losses were not a significant data set, performance The tests modelled the impact of a projected to rise from 2.2% to 3.4% at to compensate for risk. By contrast approximately double the average (1.9x). information is available for Zopa for recession on the P2P platform loan peak on a yearly basis. To put this into bank lending rates were largely 2008, when loans written exhibited book of the larger platforms and context, the expected increase in loss static in 2008 vs. 2007 (likely due to a 10x jump in the default rate, giving showed that they exhibit suitable rates represents a c.50% increase150. negative PR risk for banks increasing RETURNS FROM US CREDIT CARD RECEIVABLES (1995-2015) a general indication of what could resilience in times of economic Gareth Rumsey (Director at Experian) consumer loan rates in a recession). happen, although it does not provide downturn. The results indicated that NET YIELD LOAN LOSSES AVERAGE NET YIELD has examined UK business insolvency At the other end of the spectrum, specifics on the various risk categories. investors who lend over a five-year rates from 1965 to 2014 and found in 2008, the FTSE100 equity index 18% period, should not lose capital during This data suggests that Zopa’s that insolvency rates in recessions returned minus 28% and UK a crisis147. The test assumes a severe performance during the 2008/09 also typically peak at around 1.5 times property returned minus 22%. scenario: a one in 100-year recession, financial crisis was impressively the average. He presented this data 13% roughly as extreme as the 2008 credit stable, largely resisting the volatility at the AltFi Europe Summit 2015 and crisis and 4thWay stated that, “the top that featured in the traditional markets found that the Funding Circle stress P2P lending companies still come out test figures were entirely reasonable. 8% He did point out though, that ongoing ZOPA PERFORMANCE monitoring of the risk profile of the FTSE 100 BOE BASE RATE ZOPA platform portfolio is essential because, 3% if it shifts towards higher risk, the 30% potential default rates will also rise151. 20% Whilst the Funding Circle results are 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

10% only averages and will not match SOURCE: FEDERAL RESERVE specific individual portfolios which may 0% be made up of higher or lower risk, US credit card receivables, a good proxy for US unsecured consumer loan returns -10% according to credit score, to different and risk, achieved an average net return of 8.7% over the past 20 years. Peak geographical spreads etc, the amount loan losses were 9.5% and returns were positive for all of the past 20 years. In -20% of data now available can be useful and conclusion: P2P is surprisingly resilient in an economic downturn. -30% it is growing as time passes. 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

SOURCE: BANK OF ENGLAND STATISTICAL INTERACTIVE DATABASE RUSSEL FTSE 100 INDEX (31 MAY 2016) 46 47 “Investors are broadly aware of the risk and liquidity profile of P2P lending, and their behaviour “Cormac Leech at Victory Park Capital takes a look at the prospects for P2P lending in a downturn.” does not suggest that they are confusing it with deposit accounts provided by banks.” – Oxera

REGULATION increasingly similar in substance to Statement. found in the Regulation sub-section of loan-based crowdfunding.” OTHER MACRO-ECONOMIC RISKS other, existing regulated activities, the Milestones section of this report. In its 2016 review of the UK P2P Platforms are working to ensure However, evidence from FCA There are other macro-economic risks but without being subject to the same lending industry, the FCA highlighted that investors are educated on this Interim Statement: Following supervisory work with firms has also that would normally be associated regulatory requirements or offering a number of areas where it sees topic and to ensure that information feedback from platforms, lawyers, revealed the risks of: with downturns and which can affect the same consumer protections. provided is fair, clear and not compliance consultants, trade bodies potential regulatory risk, so that it can Firms’ desire to maintain the returns profile of this asset Conduct Risk: This relates to the misleading. and consumers, the FCA intends to decide if new legislation needs to be confidence in platforms has class. These include unemployment, behaviour of platforms leading to undertake further research, possibly introduced to mitigate it. These areas Non-compliance with new occasionally led to firms acting in a confidence levels of consumers poor outcomes for customers, such as leading to strengthening of legislation, are summarised in the Regulation regulations: Some platforms may not nontransparent manner, masking and businesses in the economy, the treatment of borrowers, including on various issues referred to in it’s section in the Milestones section be able to keep up with the pace of true loan performance and exposing uncertainties in the wider housing affordability, treatment of customers Call for Input. As well as those already of this report. In this section, some regulatory change and comply with investors to risks. market and inflationary pressures. All in financial difficulty and clarity of mentioned in this report, they include: of those areas are picked out for a new legal requirements. In such a fast of these have the potential to erode information before, during and after Firms that allow investment in closer look and an outline of items developing sector, this is not really The treatment of retail and the ability of borrowers to meet the point of sale. The FCA expects loans originated on other platforms particularly emphasised in December surprising and the regulator seems institutional investors and how contractual repayment obligations. 2016’s Interim Statement is provided. marketplace lenders to manage (not aggregators) so that the failure keen to work with platforms to iron platforms deal with conflicts of interest If we take unemployment, ONS figures conduct risk by looking at their of one platform may have a direct Possibility of regulatory arbitrage: out issues, suggesting that any issues show that it has been falling steadily, business models and strategic plans Standards of disclosure and impact on the viability of others. This is a practice whereby firms to date have not been deliberate reaching an eleven year low of 4.9% to ensure that they are identifying, financial promotion of loan-based capitalize on loopholes in regulatory or malicious. The FCA specifically Overall, it is no real surprise that the in July 2016. And the employment mitigating and monitoring all the risks crowd-funding to investors. systems in order to circumvent referred to this issue in it’s Interim FCA wants to see more consistent rate was 74.5%, the joint highest since to consumers arising from them. unfavourable regulation. In P2P Statement, but for the future, the The adequacy (or not) of wind-down standards around disclosure to comparable records began in 1971153. lending, this may come about by The FCA is clear that all firms, FCA appears to be very attuned to plans and how they work in practice. investors, management of conflicts of The Bank of England has forecast that including P2P lenders, need to accord the P2P lending market and the Peer interest, and financial promotions. the structuring of products to take The Statement was quite positive in UK unemployment will rise to 5.4% equal significance to customer to Peer Finance Association has been advantage of the lighter regulatory relation to investors’ understanding The fact that a number of existing in 2017, 5.6% in 2018 and dropping outcomes as to commercial objectives, keen to encourage the industry to 154 touch within the P2P lending market. of the P2P market. In relation to the platforms such as Folk2Folk, back to 3.3% in 2019 . But this is so that disclosure standards are embrace regulation. Consequently, The FCA is concerned about schemes suggestion in the Call to Action that LandlordInvest and UK Bond still relatively low if we consider that kept high, financial promotions meet most platforms are likely to welcome which are, in reality, collective P2P platforms may have to check Network have now received their the lowest rate on record is 3.4% in the FCA regulatory requirements assistance with resolving any investment schemes (CIS) which have whether investors meet certain full authorisation from the FCA is 1973/74 and the rate hit 11.9% in 1984 and information is fair, clear and compliance problems. restrictive regulations relating to criteria before being able to invest very positive. It demonstrates that - the highest since ONS records began. promotion to retail investors, taking not misleading. Again, the FCA is Should regulatory issues lead money, in the way that crowd funders their businesses meet the regulator’s The International Monetary Fund advantage of P2P lending rules, which monitoring these three items in to investor detriment, investors must do, it stated, “The research for expectations suggesting that, whilst has stated that the UK is likely to exempt P2P platforms from being particular and has, in the past, currently have access to the the review may corroborate feedback there is a need for some to raise experience uncertainty weighing on defined as a CIS. It also has concerns expressed concern about a lack of Financial Ombudsman Service in from those respondents who said standards to match current good private firms’ investment and hiring that asset management activity may clarity on platform sites regarding the cases where the platform does not that retail investors have sufficient practice, high standards do already in 2017 and 2018 and that consumer take place in the guise of P2P lending differences between bank deposits resolve a complaint to the investor’s knowledge of the risks involved in exist within the industry. confidence is also likely to be and therefore operate under a set and P2P lending and how this affects satisfaction. But investments in P2P negatively affected155. Additionally, the of rules that were not designed for their risk profiles. lending are not protected under the UK UNEMPLOYMENT RATE Bank of England has projected that it. Alternatively, banks might claim Provision Fund Confusion: Financial Services Compensation CPI inflation will rise to 1.9% in 2017 that P2P platforms are currently 14% Some platforms have established Scheme (FSCS), which guarantees and 2.4% in 2018 and 2019. Whilst taking advantage of the regulatory these to help investors recover lost eligible deposits in building society 12% this is a relatively large increase, it is arbitrage that occurs because they monies in the event of borrower and bank savings accounts, including much closer to the 2% targeted by the are carrying out similar functions to default. However, no P2P platform cash ISAs, of up to £85,000 per 10% BoE for a healthy economy, than the banks without being subject to the guarantees that a provision fund institution. Whilst this is currently negative and just above zero rates of same capital adequacy requirements. 8% will make investors ‘whole’ (enable under review, with the possibility of late 2015 and early 2016. The clear risk here is that consumers them to receive all their money) after introduction by the FCA as a result 6% Inflation seems to be a growing invest under rules which perhaps do borrowers have defaulted. The FCA of the 2016 review of the sector, threat to real returns and the true not protect them in the same way as feels there is a risk that investors there are already situations where 4% value of earnings versus the cost of the rules that really should have been will misunderstand such funds as it does apply such as in the event of 2% living, particularly at a time when applied. a guarantee that their investment unsuitable regulated advice if the 1980 1989 1998 2007 2016 bank interest rates are so low and In the Interim Statement, the FCA is safe, when their role is simply to advice was given after 6 April 2016 and 152 SOURCE: OFFICE FOR NATIONAL STATISTICS generating minimal additional income. noted that, “business models are mitigate possible losses . The FCA they entered into a ‘P2P Agreement’. becoming more complicated and look reiterated its misgivings in its Interim Examples of other instances can be

48 49 “The industry acknowledges the risks and different platforms have developed different business models to address them.”

The Brexit vote and subsequent it’s “not surprising” that P2P lending is smaller platforms, with less developed devaluation of sterling have gaining in popularity, “as investors look infrastructure and therefore less contributed to a jump in inflation and for better returns in exchange for taking advantage in overhead costs and with WAYS TO INVEST & ADVISE in August/September 2016 the CPI hit a on some risk”. In fact, RateSetter had one less capital reserves which allow for twenty month high of 0.6%156. The Bank hundred thousand new site visits in July a period of fewer originations and of England has revised its projections 2016 alone159. therefore less income. Such reserves upwards and now foresees the 2017 might be required while borrowers In terms of the interest rates that annual rate more than doubling the come to terms with how bank lenders investors can now expect from P2P 2016 figure (expected to be 1.3%) at react to base rate cuts, and any effects platforms, P2P rates are not directly 2.7%157. on P2P borrowing rates. Nevertheless, related to market fluctuations and do small niche platforms which experience The Bank of England also reported not track the base rate in the same way little competition with banks because in November 2016, that the housing that some bank rates do. Platforms can banks simply are not interested in their market has been more resilient than find their own equilibrium, dependent specialist market, may not experience expected, although the commercial on the demand within their own lending any damaging repercussions. property market has been subdued. market. If more investors start to lend, Confidence in the economy is a strong the supply of money increases, and – all Also, it is worth remembering that falls factor in the housing market, so this is other things being equal – the rate that in base rates do not force banks to lend; good news for myriad industries and borrowers pay should drop as a result. Kevin Caley, founder and chairman the businesses and individuals who That means that the platform becomes of ThinCats has welcomed genuine are dependent on it. Nevertheless, more attractive for borrowers, whose fiscal stimulus, but points out that, annualised growth in the average of demand pushes the rates back up160. “Given the fears about the economy, the Halifax and Nationwide house price banks will also become more fearful Bearing in mind the low interest indices slowed to 2.5% in the three that companies and individuals will savings rates available through banks, months to September 2016 from 4.6% default, which could tip the scales in the with the distinct possibility of further in the three months to June158. other direction.” In fact, the reaction cuts to these, more lenders could of RBS and Natwest to the threat of well be attracted to P2P lending by the PEER TO PEER LENDING AND base rate cuts, in late July 2016, was to higher returns available. Whilst the FALLING INTEREST RATES write to nearly 1.3 million business and BoE base rate cut may have cut banks’ commercial customers, advising them In August 2016 the Bank of England’s overheads, assuming they pass this that negative interest rates, (depositors (BoE) monetary policy committee saving on to borrowers, the 200 basis must pay regularly to keep their money (MPC) cut base rates to a record low of points operating expense advantage161 with the bank rather than receive a 0.25% in an effort to stimulate growth of P2P lending platforms in comparison return on it) are a real possibility162. in the wake of the EU referendum. to banks, will only be eroded by a small The fundamental reasoning being to proportion of that advantage. And even encourage banks to lend as their net a drop to 0% bank base rates will leave interest margins increase. However, the platforms with three quarters of many platform operators are positive their overhead costs advantage intact. about the opportunities that this could Although this may push platforms create for the P2P lending industry, to tighten their margins and give without significant concern that banks borrowers lower rates in order to CONCLUSIONS could attract a chunk of borrowers who maintain the spread between banks would previously have been potential As with any asset class there are and P2P lenders, it still leaves the P2P lending customers. risks, and with a short track record platform lenders with a competitive in comparison to other assets it Banks have reduced their rates to edge. It also suggests that any drop in remains to be seen just how these savers following the BoE cut, and P2P returns available to lenders will risks will play out in a downturn or Stuart Law, CEO of Assetz Capital, only be in line with drops in deposit after a major scandal. Nevertheless, thinks that this will lead “savvy savers rates passed on to savers by the banks, the industry acknowledges the to continue to turn to the alternative leaving the platforms’ USP of higher risks and different platforms have finance market… and get decent returns than bank returns largely unscathed. developed different business on their capital”. Meanwhile, Ratesetter Perhaps the greatest risk lies with models to address them. CEO and co-founder, Rhydian Lewis says

50 51 “Most platforms have moved away from the fee model that targeted both lenders and borrowers WAYS TO INVEST and five of the top six P2P platforms and a number of others charge no fees to lenders.” P2P EXPOSURE AND WHAT TO LOOK OUT FOR

For advisers who buy into the investment case, there are a number of ways to get exposure to the sector, each with their The oldest platform on the list, Zopa, comparison table. This type of P2P also have to pay a fee equal to 10% of own unique pros and cons and issues to take into account. was the first P2P lending platform in lending investment will be discussed interest received. The fee is due when the world and offers only unsecured in more detail in the Active vs Passive actual interest is received. FOCUS ON PLATFORMS consumer lending (including small Investment Strategy section later in Which fees are charged and when sole proprietor businesses). The this report. When it comes to platforms, the variances in the business models that operate in the current P2P market have already been depends on the particular platform newest platform in the table, Neyber, noted. To give an idea of the models that exist, a sample of 8 of the platforms in the lending market follows. These are just a few of the used so advisers should be looking for uses an innovative model of lending differentiators in the P2P lending the fees chargeable to lenders, if any, to employed consumers and then marketplace. Others to consider are as well as checking how returns are taking payment through a salary EXAMPLE PEER TO PEER LENDING PLATFORMS auto bidding availability, the range quoted on each platform - i.e with or sacrifice system in conjunction with of loan terms, whether early loan without fees deducted (and projected the employer. The largest UK P2P repayment is allowed and if the defaults). However, as the platforms platform, by a small margin, Funding platform offers fixed rates, variable use various return methodologies, it is Circle, is not involved in consumer rates or both. not currently possible to draw like for lending at all, supporting instead only like comparisons between different lending to small business. LendInvest LAUNCH 2013 2010 2014 2014 2013 2011 2010 2005 HOW PLATFORMS CHARGE FEES platforms. But market participants and Landbay support only lending such as LendingWell hope to introduce secured on property, whilst RateSetter How the platforms charge their fees standardisation for investors across INTERIM INTERIM INTERIM FULLY INTERIM INTERIM INTERIM INTERIM is the only platform supporting FCA is probably going to be of particular products making much more informed STATUS* PERMISSION PERMISSION PERMISSION AUTHORISED PERMISSION PERMISSION PERMISSION PERMISSION lending to unsecured consumer, interest and since the fee models judgements about the relative levels unsecured small business and real tend to be much more transparent of charges possible. estate lending (although it does also LENDING than those built by traditional banking P2B P2B P2B P2C P2B P2B P2B & P2C P2C As a result of the limited fees charged TYPE deal with secured lending). LendInvest institutions, quite revealing. The main to lenders, they can expect typical also does bridging finance and is the P2P platform methods are: largest player in this property lending fees to be very low, if anything. SOURCING PROPERTY CONSUMER FEES TAKEN FROM BORROWERS However, advisers should look out for BORROWERS: PROPERTY SMEs CONSUMER PROPERTY SMEs CONSUMER segment. The other platform in the (MORTGAGE) & BUSINESS SPECIALISM table, Assetz, has a number of options Most platforms have moved away less obvious fees such as service fees available to borrowers, all connected from the fee model that targeted both built into the interest rate payable by SECONDARY to property as security which does lenders and borrowers and five of the the borrower and taken directly from N/A MARKET x not have to be real estate - it can be top six P2P platforms and a number loan repayments made by borrowers. equipment or presales of property of others charge no fees to lenders. The reality is that this is coming from PROVISION developments. money that would otherwise be going PROVISION Taking Landbay as an example, it PROVISION PROVISION FUND into the investor’s pocket. These FUND. UK Other models which do not apply to does not charge lenders, but has two NATURE OF FUND. PROVISION FUND. (CONSUMER might be called annual investment PROVISION BUY TO LET PROVISION borrower fees: firstly, it charges its PROTECTION LOANS FUND AND LOANS INSURANCE & BUSINESS the platforms in the table include FUND. PROPERTY FUND borrowers an upfront fee ranging or management fees or even lending (IF ANY) SECURED ON INSURANCE SECURED ON MAY BE lending in bridging loans for property USED AS success fees which is the Madiston ASSETS PROPERTY SECURED/ development (SavingsStream) from 2% to 2.5% to cover the costs of SECURITY Lend Loan Invest platform’s name for UNSECURED) and supporting P2P lines of credit screening borrower profiles and the its charge of 0.5% of the amount being (overdrafts), (Growth Street). establishment of a new loan. Landbay lent out per annum. This is deducted MIN / MAX £1 £20 £200 £10 £100 £50,000 £10 £10 also charges an annual a 0.5% to Assetz does not allow investors to from the investors account monthly164. INVESTMENT /NO LIMIT /NO LIMIT /NO LIMIT /NO LIMIT /NO LIMIT /NO LIMIT /NO LIMIT /NO LIMIT 1.00% margin on the loan principal pick individual loans or interest rates, Funding Circle has a similar fee of 1%. outstanding163. CAPITAL & CAPITAL & instead it provides several different So, it is essential to look at the overall VARIES FEES TAKEN FROM BORROWERS AND REPAYMENT CAPITAL & INTEREST/ CAPITAL & INTEREST/ CAPITAL & CAPITAL & CAPITAL & packaged ‘accounts’ with different picture to see how the fees affect the ACROSS METHOD INTEREST INTEREST INTEREST INTEREST INTEREST INTEREST INTEREST access times, investing in different INVESTORS gross yield and how competitive the PRODUCTS ONLY ONLY asset classes - such as green energy Some platforms do still charge platform’s net yields are when fees are and at a selection of different target fees from both borrowers and taken into account. INSTITUTIONAL interest rates. These are referred to investors. Proplend, for example, LENDERS ADVISER PORTALS as products and generally they offer a charge borrowers a Listing Fee and small range of loan terms and interest a Completion fee. Also, loans are Some platforms have already made SOURCE: INTELLIGENT PARTNERSHIP rates for investors to choose between. secured against property. So, any tentative efforts to engage advisers Many platforms offer products, *Firms with interim permission were previously licensed by the Office of Fair Trading, which regulated consumer credit before legal and valuation fee incurred in and this has led to the establishment including Landbay, LendingWorks, the FCA, and are able to continue carrying out consumer credit activities until the FCA fully authorises them (or refuses their arranging a loan is also borne by the of adviser portals provided by some Ratesetter and Zopa from the application for full authorisation). Any delays to full approval are due to the FCA’s processing time. The deadline for applications borrower. Proplend P2P investors of the platforms such as Ratesetter was 31 March 2016 and the FCA has stated that it could take up to 12 months for applications to be processed.

52 53 “The majority of P2P platforms in the UK are marketplace lenders, some of which have been “The fundification of the P2P industry is becoming more evident, firstly in the United States established for some years, with low default rates which suggest that their credit scoring is up to where it is big business and more recently in the UK where it is growing.” scratch.”

which allow advisers to register and it has agreed with the borrower and the for repayment of the funds it has of investing it does not mean that investment opportunities which have money than amateur “peers” ever transact business online for their lender for its services. borrowed. no scrutiny is required before other passed LendingWell’s stringent risk could, providing P2P with scale on the clients. This online model provides IFAs people’s money is invested based on management criteria and offer ease of deposits side and taking advantage Some commentators do not like For this reason, the bank has a strong with the means to set up and manage the platform’s investment decision. diversification across maturity, asset of nimble, technology-driven this dynamic as they point to the incentive to ensure that whatever it client accounts, set their own fees, get This would be like investing in a fund type (consumer, business, property) underwriting by P2P platforms167. marketplace lenders’ position outside does with the money it has borrowed, notified as client funds mature and without looking into the fund manager. and target return. of the risk of the deal, receiving some will provide secure returns. If this is not There are at least four P2P lending benchmark their own clients. kind of upfront fee and then having no the case, the bank is still responsible All of this platform diversity means In the process of investing, individuals focused investment trusts listed on This type of functionality can only real interest in the loan repayments for repaying the loan to its depositors retail investors get a wide choice of can retain control over comprehensive the London Stock Exchange, one of the be positive for a sector which has thereafter. The argument is that this and it will lose money. In short, the investment, not just a take it or leave it investment criteria selection such most recent of which was the Funding historically suffered from low levels could lead to the credit scoring of bank takes on some of the risk. The bank mentality. This obviously means as maturity, asset type (consumer, Circle SME Income Fund Limited, of adviser engagement with research the platform being less robust than investors risk lies with the bank not more work for advisers to look at the business, property), target return and which raised £150m before its initial published by Intelligent Partnership in it should be, with the aim just to repaying them. Therefore, what an options and decide the most suitable platform. close. The fund focuses on loans to its Alternative Finance Report 2015/16 make deals from which it receives a investor/depositor should be interested ones. small businesses in the UK, US and STRUCTURED PRODUCTS: FUNDS AND revealing that just 9% of advisers fee, whether or not those are good, in is the financial stability of the bank Europe buying up to 35% of loans BONDS expect the P2P lending sector will correctly risk rated deals for the and how deep its reserves are. It METHODS OF ACCESS TO DIRECT originated through the Funding Circle form part of their advice process in investors. This is a very short term would also be useful to have access LENDING STRATEGIES Some platforms offer innovative marketplace and allows individual the next 12 months. Another 2015 outlook though as, poor borrower to information regarding its record in structured products. With low yields and institutional investors to buy and GOING DIRECT survey from Yorkshire Building Society selection will lead to defaults and high picking the parties to which it lends its as the potential “new normal” in the sell shares in the vehicle, which will found that less than one in five (18%) default levels will lead to investors investors funds, but this kind of data for Obviously, many investors want to market, the LendingWell bond offers manage a selection of loans on their financial advisers would invest, or simply not using the platform. underlying bank transactions is simply make their own investment decisions. a unitized P2P loan product to enter behalf. It targets a dividend yield of have invested, their own money into not made available to deposit account Investors can have varying levels of the market through a single point of about 7% a year and is eligible for Indeed, the majority of P2P platforms P2P lending schemes165. But, given that clients. But those who save into a bank control and input into their investment access, with a low cost, tax efficient, SIPPs and ISAs. Two thirds of the loans in the UK are marketplace lenders, there are so many potential benefits deposit account do benefit from the beyond choosing their preferred passive and transparent investment are UK originated, with 24% from the some of which have been established to so many potential clients and that it FSCS deposit protection scheme. return, risk profile and term. Some strategy. US. for some years, with low default rates is only a matter of time before whole platforms allow them to look at each which suggest that their credit scoring An example of a pure balance sheet The fundification of the P2P industry is Other investment trusts include of market advisers are obliged to give individual loan, whilst others will simply is up to scratch. But that doesn’t lender is Kabbage, but whether any becoming more evident, firstly in the Victory Park Capital Specialty advice on direct lending strategies, automatically match their inputted mean that thorough due diligence pure balance sheet lenders who are not United States where it is big business Lending Investments PLC, P2P those integrating the needs of preferences against one or more is not called for and where possible, banks can be considered as P2P lenders and more recently in the UK where it Global Investments PLC and GLI advisers into their P2P offerings are loans without the lender undertaking if the interests of the platform can is open to debate. Is it really asset is growing. Alternative Finance PLC. All are taking a sensible route. detailed analysis of each. Of course, be aligned with the investor, so that management and regulatory arbitrage? suitable for institutional investors those looking for specific sectors to Platforms are understandably positive the marketplace lender receives a and professionally-advised private PEER TO PEER LENDING PLATFORM HYBRID MODEL invest their money into, or who have about this development, and with meaningful portion of its fees during investors as well as non-advised BUSINESS MODELS particular knowledge that allows them good reason. For retail IFAs, these the course of the loan repayments, it There are some P2P lending platforms private investors who are capable of to make more informed judgements, funds are retail investments that are MARKETPLACE LENDERS (PEER TO PEER may be a worthwhile safeguard. which invest their own money, from evaluating the risks and merits. may be looking for much more control easier to understand and therefore PLATFORMS) their own balance sheet, alongside PURE BALANCE SHEET LENDERS than those who just want a return. to recommend to clients. They could At June 2016, P2P Global Investments their investors i.e, they make up part Marketplace Lenders are arrangers therefore play a big role in taking (P2P), was the largest in the sector While all online lending sites can be of the loan from their own capital, However, from the perspective of who generally underwrite, price P2P lending to the mass market. And at £868 million, with a yield of 6.9%. classified as ‘marketplaces’, some such as OnDeck. This means that, not portfolio diversification, an investor and service the loans that they since the UK is the second-largest It has a large portfolio of loans to marketplaces are also the lenders only does the platform originate the who goes direct does need to think originate from consumers and small wealth management centre in the consumers and businesses, and can themselves. These are balance sheet loan by sourcing the borrower, and about the best ways to do this and businesses, but they do not fund world, with $1.6 trillion of client assets take equity stakes in P2P platforms lenders. Banks are generally pure act as an intermediary by matching the time it will take to review all of them. Instead, they source individuals administered and managed at the end too. Two thirds of the fund is focussed balance sheet lenders, as they source the borrower with lenders (investors), the possibilities. Some aggregators and institutions to do this as an of 2014, according to Deloitte166, even on European and US consumer loans funds which they take onto their but it also becomes one of the lenders facilitate this by matching their investment, with the result being that attracting a small portion of those which account for 18.86% and 46.16% balance sheet and then lend them itself. This gives the platform a very requirements across a number of lenders and borrowers are connected. assets could be huge for P2P lending. respectively of the portfolio total, out to third parties. This means that good incentive to price the risk lending platforms and then providing The marketplace lender therefore with a target net annualised return of there have been two lending events accurately, because it stands to lose if the results for the investor to make For advisers, their existing tools mean does not have a stake in the loan insofar 5%-15%. – one where the bank has been lent the loan doesn’t perform well. his own selection. LendingWell, they can buy a fund today and it as the money that has been loaned funds from its depositors and one for example, will offer simple, gives them diversification and global does not belong to it and it has no claim But again, this does not mean that due where the bank then lends those innovative structured products exposure. In fact, some see funds as on the repayments and any interest diligence goes out of the window. Just funds to a third party. Consequently, which will allow retail investors to the new intermediators - providing due on the capital, aside from the fees because a platform has experience the bank is responsible to its lenders access a curated list of direct lending professional management of more

54 55 “Some see funds as the new intermediators - providing professional management of more money “There are at least four P2P lending focused investment trusts listed on the London Stock Exchange.” than amateur “peers” ever could, providing P2P with scale on the deposits side and taking advantage of nimble, technology-driven underwriting by P2P platforms.”

FUNDING CIRCLE SME INCOME FUND LIMITED PORTFOLIO STATISTICS VICTORY PARK CAPITAL SPECIALTY LENDING INVESTMENTS STATISTICS

NAV (CUM INCOME) ALLOCATION INVESTMENT EXPOSURE / BORROWER TYPE INVESTMENT EXPOSURE / GEOGRAPHY

100% 100%

80% 80%

60% 60% US UK CE 43% 37% 24% LOANS 66% LOANS 1% LOANS 40% 40%

16% 20% 20% 3% 1% UK 25% OTHER 4% 0% 0% US 71% EQUITY MARKET BALANCE CASH RESTRICTED CONSUMER SME LOANS SHEET CASH CALIFORNIA 19% EAST ANGLIA 4% GERMANY 41% SOURCE: VICTORY PARK CAPITAL SPECIALTY LENDING FACTS – MAY, 2016, VPC SPECIALTY LENDING NEWSLETTER FLORIDA 9% LONDON 17% SPAIN 11%

GEORGIA 6% MIDLANDS 10% THE NETHERLANDS 49% Victory Park Capital Specialty Lending Investments (VSL) takes a similar approach and yields 9.3%168, while 71% of the portfolio ILLINOIS 4% NORTH EAST 8% is allocated to US loans and 25% is allocated to the UK. Compared to P2P Global Investments, Victory Park has a much larger

NEW JERSERY 6% NORTH WEST 14% allocation to SMEs, making up 37% of their investment exposure.

NEW YORK 8% SOUTH EAST 27%

OHIO 3% SOUTH WEST 11% GLI ALTERNATIVE FINANCE PLC PORTFOLIO ANALYTICS OTHER 34% NORTHERN IRELAND 2%

TEXAS 8% SCOTLAND 4% PORTFOLIO BY MATURITY BAND FUND YIELD VS BENCHMARK INTEREST RATES PORTFOLIO BY GEOGRAPHY SOURCE: FUNDING CIRCLE SME INCOME FUND WASHINGTON 3% WALES 3% NEWSLETTER, JUNE 2016 35% 32.9% 10% 9.0% 28.8% 30% 8.0% 7.5% P2P GLOBAL INVESTMENTS PORTFOLIO COMPOSITION 8% 25% 23.1%

20% 6% 15.2% 15% BY ASSET CLASS BY INTERNAL CREDIT GRADE 4% 10% US CONSUMER 1.56% A 33.02% 2% 0.6% 5% 0.25% CASH & MONEY MARKET 20.37% B 25.07% UK 53% EUROPE 6% 0% 0% EUROPEAN CONSUMER 18.86% C 21.16% US 17% ROW 5% 0-6 6-18 18 MONTHS MORE BOE RANK 10Y UK TARGET FUND FUND MONTHS MONTHS - 3 YEARS THAN 3 OFFSHORE BRITAIN 17% EUROPEAN SME 4.01% D 19.68% RATE ILT YIELD YIELD YIELD YIELD YEARS EX TER EQUITY 3.35% E 1.07% SOURCE: THE SME LOAN FUND MONTHLY FACT SHEET, AUGUST 2016 EUROPEAN REAL ESTATE 3.30%

US SME 1.82% The SME Loan Fund, previously known as GLI Alternative Finance PLC, invests in loans originated principally through the 19 lending platforms in which parent GLI Ltd is the principal external equity investor. It aims for an 8% yield and closed in AUSTRALIA CONSUMER 1.56% September 2015 after an initial raise of almost £53 million. The fund has a focus on SME loan assets, over half of which are UK BONDS 0.57% opportunities, diversified by asset class, geography and duration.

SOURCE: P2P GLOBAL INVESTMENTS PORTFOLIO COMPOSITION – JUNE, 2016 P2P GLOBAL INVESTMENTS NEWSLETTER

56 57 VPC SPECIALITY LENDING INVESTMENTS P2P FUNDS YTD GLI ALTERNATIVE FINANCIE PL PERFORMANCE P2P GLOBAL INVESTMENTS PLC “The aggregator can provide an extra layer of due diligence on the platforms that it accommodates.” (9 SEPT 2016) FUNDING CIRCLE -20% -15% -10% -5% 0% -5% SOURCE: INVESTORS CHRONICLE

In terms of fees, Funding Circle SME In addition, P2P Global Investments by renowned fund manager Neil All of these funds are very new, with SHARE PRICE TRADING OF PEER TO PEER LENDING FUNDS AT 11 AUGUST 2016 Income Fund Limited charges no and Victory Park Capital Specialty Woodford, is the second-largest P2P Global Investments PLC the management charge or performance Lending Investments take a 15% holder of both the VPC and P2P oldest, having launched in May 2014. PEER TO PEER LENDING FUND 01 JAN 2016 30 DEC 2016 fees, only fees associated with Funding annual performance fee for any trusts170. Consequently, they have very little Circle’s 1% servicing costs. Victory Park increase in the share price that is over track record. VICTORY PARK CAPITAL SPECIALTY These managers do not seem 1012 792.5 -21.69% Capital Specialty Lending Investments and above the total (net) value of any LENDING INVESTMENTS PLC concerned by the youth of the sector In addition, listed funds are always PLC and P2P Global Investments PLC P2P loans, cash and other assets in the or the difficulty with judging value for at the whim of market sentiment originally charged a management fee fund. But there is a high water mark, money because there is no benchmark since some of the yield is in the rising of around 1%, which is reasonably so that, if the share price falls and then P2P GLOBAL INVESTMENTS PLC to measure the fund performance share price instead of paid out from 94.5 78.75 -16.67% normal for a managed fund, although rises again, the performance fee does against. Platforms recognise this loan interest received. Consequently, not cheap. However, in June 2016, P2P not apply until the fund gets over its issue and the Peer to Peer Finance a change in the share price is an Global Investments PLC reduced its previous high. Nonetheless, the effect Association and AltFi Data, which important factor for investors. This management fee to 1% of net assets, of fees of this level on the overall yield GLI ALTERNATIVE FINANCE PLC 101.5 93.69 -7.69% provides quantitative indices on the has been evident in the uncertain with leveraged assets charged at 0.5% could be significant. industry, are working on it: “The next times after the Brexit referendum reflecting that a significant portion of Nevertheless, for the most part, it is stage of communicating this sector’s with all four of the funds mentioned in the benefits of the funds’ targeted 100% through these trusts that mainstream return to an increasingly wide pool this report trading at discounts to net FUNDING CIRCLE SME INCOME FUND LTD 101.625 101 -0.62% leveraging will accrue to the manager. asset managers have looked to gain of investors will be the adoption of a asset value in August 2016. GLI Alternative Finance PLC fees are up their P2P exposure, rather than buying returns benchmark by the specialist to 0.75% annual management fee, but Analysts at Winterflood, have loans directly from the platforms. And asset managers in the sector. These SOURCE: CITYWIRE AND INVESTORS CHRONICLE/MORNINGSTAR there is no performance fee. identified the ability of the asset class AGGREGATORS there is some P2P fund investment asset managers need to advertise to to withstand more difficult economic However, some of these funds invest involvement from some impressive prospective investors the impressive In response to the number of platforms, there has been an emergence of environments as a key concern. But, in other funds and these independent fund entities: Invesco Perpetual, the returns that are available. As asset aggregator sites. These aggregate information for research and comparisons, as we have seen, the robustness of the funds charge their own management UK arm of the $790bn US manager, managers adopt an industry standard but also allow advisers and users to transact. They aim to simplify the selection underlying loans is evidenced by the and performance fees on top of the fees owns a third of VPC Speciality Lending benchmark it will further improve the process, which highlights an awareness of the help investors need to easily low default rates and by the stress- charged by the initial P2P fund. It is also and P2P Global Investments, plus visibility of the sector and, in so doing, compare marketplace finance providers, an important part of bringing non- testing of loan books. And the fear of worth verifying whether the initial fund half of Funding Circle SME Income attract further retail and institutional bank funding into the mainstream172. platforms resorting to poorer quality is passing on the P2P lending websites’ Fund Limited. Meanwhile, Woodford investors to the space.”171 loans as more deal competition grows, These sites give access to multiple origination platforms as a portal, which allow fees for lending through them169. Investment Management, run is offset by the relatively rapid loss of greater diversification across multiple platforms using a single account log-in.

reputation and future business caused The benefits are substantial: 1 YEAR PERFORMANCE (12 AUG 2016) by rising default rates because of the transparency of loan book data. REDUCED ADMINISTRATION AND all of the relevant information and It’s also worth noting that most of PROCESSING: this is exemplified therefore much more control of the VPC SPECIALITY LENDING INVESTMENTS P2P GLOBAL INVESTMENTS PLC these funds have now deployed their by the treatment of ISAs, where overall investment process. aggregators can have ISAs across 110 110 capital, which has been one of the EXTRA DUE DILIGENCE: the aggregator factors in the recent slow-down in net multiple platforms unlike platforms 100 100 can provide an extra layer of due themselves which can only wrap lending in the sector. diligence on the platforms that it 90 90 investments on their own platform accommodates. Structured products also include in an ISA. 80 80 packaged deals for loans and other INDEPENDENT RESEARCH that the EASY ACCESS to low cost 70 70 debt instruments which package up aggregator aims to provide on a like SEP 2015 NOV 2015 JAN 2016 MAR 2016 MAY 2016 JUL 2016 SEP 2015 NOV 2015 JAN 2016 MAR 2016 MAY 2016 JUL 2016 diversification across multiple debt in slightly different ways, such for like basis. as within bonds which are issued platforms: There’s no need to fill in GLI ALTERNATIVE FINANCE PLC FUNDING CIRCLE SME INCOME FUND LIMITED against P2P loans. Where the bonds multiple investment applications ONGOING MONITORING OF PORTFOLIO are listed, this gives a route to the in order to take that extra facilitated through the production 105 105 P2P lending asset class which allows diversification step that allows for of periodic reports showing the 100 100 easy access to funds as the bonds are three-way diversification across breakdown and performance of platforms, sectors and products. advisers’ clients’ portfolios. 95 95 listed and transferable and they are of institutional quality, giving advisers WHOLE OF MARKET IS AVAILABLE in one OPPORTUNITIES TO MAXIMISE CASH 90 90 some peace of mind that they have place: a potentially huge time saver RETURNS and legitimately charge for 85 85 been thoroughly reviewed with robust and also providing the user with that advice on an AUM basis. NOV 2015 JAN 2016 MAR 2016 MAY 2016 JUL 2016 JAN 2016 MAR 2016 MAY 2016 JUL 2016 due diligence analysis. much greater confidence in finding SOURCE: GOOGLE MONEY

58 59 “Aggregators can have ISAs across multiple platforms unlike platforms themselves which can only “This kind of efficiency and control may come at a cost, but the benefits suggest that the aggregator wrap investments on their own platform in an ISA.” model for accessing the investment world of P2P lending does indeed make most sense for advisers.”

AGGREGATORS ACTIVE VS PASSIVE INVESTMENT of the risk of borrower default entirely of his loans. Also, active investors, STRATEGY possible because of the sheer volume may be able to uncover better deals There are a number of sites providing a variety of aggregator services, including: of loans that funds can be spread by searching the market themselves, Both active and passive investment across. But it does mean that the whereas, the product option provides strategies are available to those choice of platform is critical as, without no real prospect of out-performance seeking investment through P2P LENDINGWELL a good selection of chosen, robust by superior loan selection as the lending. A passive investment loans in the first place, a high number platform is only looking to meet the approach may be a packaged LendingWell will provide a single platform designed specifically to serve retail investors by allowing them to access analyse may fail. Access portals, or aggregators product target returns. It is therefore investment product, or simply involve and invest into the broad P2P lending market. The platform will offer simple and innovative structured products secured by help to mitigate this problem by unlikely to look outside of the criteria use of an automatic bidding system. a diversified portfolio of loans suitable for a mass market retail investor base. Such bonds offer a streamlined access point adding another filter which applies relevant to those. An active investor, It relies on the platform or aggregator for investors to achieve diversification across sub-asset class verticals, platform loan originators, loan maturities and asset carefully selected eligibility criteria on the other hand, might identify to set a sensible mix of risk levels and security offered. and risk management. borrowers in a field in which he/ returns and to diversify effectively she has expertise, and therefore across platforms and sectors. This is a LendingWell offer this option which WWW.LENDINGWELL.COM Investor focused confidence to invest at a higher risk convenient option which relies entirely works like a discretionary fund rating and therefore higher return. on the expertise of the platform or manager model portfolio, wherein And an investor’s desire for control aggregator. the client and adviser benefit from may not be all about the targeted delegating the day-to-day investment The automatic bidding system of return. Instead they may be looking to management process, gaining ongoing the platform, matches each tranche support sectors with which they have INVESTUP BONDMASON access to an investment professional of investor money with borrowers an affinity or an ethical connection. and reducing the administrative as deals matching these criteria Allows direct retail investors to buy shares and lend It allocates investors funds into loans across various P2P burden. A model portfolio is one Still, there are issues with this as the become available. The benefit of money across multiple P2P platforms from one site with lending platforms, working on the basis of building a way to access the skills of a full-time most popular loans can fill up with the auto bidding system is that it one application. balanced portfolio of loans for each individual investor manager without paying a small investors very quickly, so timing of quickly allocates the investors funds fortune as all monies are managed the investors due diligence needs and reduces the risk of uninvested WWW.INVESTUP.CO.UK Investor focused WWW.BONDMASON.COM Investor focused under the same investment strategy. to be fast enough to actually take cash, which is not earning a return, an opportunity if the investors lowering the overall yield (cash Passive investors are likely to be decide they like it. Another negative drag). This is particularly useful for those who trust the platform to find is that the diversification possible reinvesting as returns come into borrowers, assess creditworthiness through passive investing can be so the investors platform account, as it and then choose suitable loans. This GOJI FINPOINT high – perhaps across hundreds or allows for compounding of growth. gives them a very straightforward thousands of loans, depending on It also means that the investor does lending experience. It leaves the Has announced an aggregator platform coming soon, which Offers businesses looking for finance out to their lenders as the amount invested, that risk to the not have to spend the time and effort platform in charge of the investment will facilitate diversification of an investor’s funds across identified by their criteria on a referral basis. Partners with overall return from one, several or looking at the due diligence and for the full term and leaves any active loans, platforms, loan classes and maturities. various finance options including banks and P2P lenders. even dozens of defaults is minimal: credit information of the borrower investment decisions required to meet even a skilled and experienced - he simply relies on the platform’s the target return, in the hands of the WWW.GOJIP2P.COM Investor focused WWW.FINPOINT.CO.UK Borrower focused investor would find it very difficult to research in this regard. platform. Many investors are happy reach these levels of multiplicity. with this as they consider that the The disadvantage of this system is platform has much more expertise Of course, there is always the option INTELLIGENT that, unless the investor manually LENDING than they do. to play the field by putting some selects his borrowers and conducts his INTELLIGENT ADVISERS FUNDING cash into a product and some into own due diligence, he may never know An active strategy, on the other hand, LENDING ADVISERS OPTIONS loans chosen by the investor as some how the party which is borrowing allows investors to effectively choose platforms offer both free choice of all from him met the criteria and why their maximum exposure to individual Provides unbiased information and execution for One of the neutral platforms with over 50 lending available loans and packaged products they need the loan. Such information loans and requires the opportunity investors in P2P loans. The company has a proprietary partners providing finance choices for small businesses. to investors. to review all the available information model to value and assess risk, and has developed an Chosen as a designated platform for the Bank Referral will depend on the levels of disclosure such as credit rating, location and execution platform to allow investors to obtain access Scheme. on underlying loans provided by the AGGREGATOR COSTS business sector on each business to the same high speed execution that institutional relevant platform as this varies across looking for a loan before actually By centralizing the mind-boggling platforms use. WWW.FUNDINGOPTIONS.COM Borrower focused all platforms. committing cash. The investor can array of options on offer – aggregators Nevertheless, auto-diversifying makes then select the companies to which aim to assist newcomers and those WWW.ILADVISERS.COM Investor focused alleviation of a very significant portion he wants to allocate his cash as part looking for ease of use, with making

60 61 “The additional due diligence layer provided by the aggregators is a useful resource as advisers navigate a new asset class and get a handle on the sector.” ADVISING ON P2P LENDING WHAT YOU NEED TO KNOW sense of the options. Nonetheless, We’ve listed a selection of the P2P WAYS TO INVEST: CONCLUSIONS Of course, for advisers their work goes financial promotions clarify to potential capital contact’ under FCA rules. their presence re-introduces an comparison websites here, some of way beyond simply understanding the investors situations where they are not The FCA’s review suggests that it So, it’s clear that there are a number of 176 intermediary into a disintermediated which are more lender focused and investment case, risks and benefits providing regulated advice . ways to get exposure to P2P lending, may consider the implementation industry and most will not be doing others which take a greater interest in of an asset class. They also need to all with their own unique advantages of a similar set of rules for P2P this for free. Investors and their borrowers: understand where it will fit into their SUITABILITY and disadvantages. The research lenders. This would not remove the advisers need to carefully consider client proposition, which clients it will 4thway: financial comparison carried out finds that most advisers The FCA has decided to apply its responsibility from advisers though, the benefits which will be clearer for be suitable for and how it works when featuring a ‘Risk Rating’ and also a preference will be for aggregator Conduct of Business suitability as advising on P2P lending is now some aggregators than for others. they get down to the brass tacks on more in-depth ‘Insight Report’, for models that provide whole-of- rules to firms making a personal a regulated activity requiring all of Those which serve as useful tools issues like Professional Indemnity (PI) some platforms aimed at explaining market diversification and simplified recommendation involving advice on the standard checks specified when for simplifying and centralizing cover and the investment process. all the highlights and key features. It administration, while allowing the P2P agreements. advising on investments. opportunities, saving time and energy, provides links to platform websites, adviser to retain a hands-on role and Advisers would probably be the first are likely to come out on top. Suitability has been high on the FCA In fact, as a result of advising on P2P but has no functionality to allow for to admit that they need to better oversight on behalf of their clients. agenda in 2016 with Megan Butler, lending becoming a regulated activity One factor which is certainly in favour multiple platform investments in one understand the sector and the And the additional due diligence layer director of supervision at the FCA, in April 2016, as noted in the Regulation of the aggregators is connected to transaction. opportunities available for them and provided by the aggregators is a useful stating in May that “wealth managers section of this report, unsuitable advice the Innovative Finance ISA as a result their clients, so this section aims to Alternative Business Funding: a resource as advisers navigate a new should be aware suitability remains to invest in P2P lending may now be of the HMRC decision that investors give some clarity on the intricacies collaboration rather than a straight asset class and get a handle on the one of our main concerns in the covered by the FSCS. The FSCS has will only be able to contribute to one of advising on P2P lending. (It is broking site; all listed funders (over sector. sector”180. And in the FCA’s 2016 confirmed this on its website, including Innovative Finance ISA account per tax not intended to be an exhaustive 50) agree to act in the same way This kind of efficiency and control regulatory review of crowdfunding, the amount of compensation it may be year. But, HMRC’s announcement in summary of how regulations govern and refer rejected SMEs back to the may come at a cost, but the benefits including loan based crowdfunding, able to provide - up to £50,000, if all of March 2016 that several P2P lending advising on P2P lending.) portal. Borrowers can choose which suggest that the aggregator model for one of the items under review is the following criteria are met: platforms can be chosen by an interested lenders they approach. whether platforms should carry out accessing the investment world of P2P ADVISER PERMISSIONS the advice to buy the investment adviser/investor – using an aggregator suitability checks for investors: as an Better Business Finance: managed lending does indeed make most sense must have been given on or after 6 platform, is fantastic for investors… From 6 April 2016, the FCA indication of what new rules could 173 by the British Bankers’ Association for advisers. April 2016 and aggregators . Not only does it automatically varied the permissions be introduced, it is interesting to (BBA) in collaboration with its allow cross platform diversification, of all firms who held at that time, note that investment-based (equity) the advice firm must have been business and finance partners. Asks but it is a strong justification for using the permissions of ‘advising on crowdfunding platforms are already authorised by the appropriate SMEs about their finance needs aggregators as it allows all gains from investments’ to add the new required to gauge the suitability regulator to do so at that time and then directs them to various all the platforms invested in through regulated activity of ‘advising on P2P of investors prior to allowing them options such as P2P lending sites. It the investor must have lost money the aggregator to be sheltered from agreements’. This means that only to invest. Currently, equity based provides links to platform websites, as a result of the advice given tax in a way that is not possible by authorised persons with appropriate crowdfunding platforms must not sell but has no functionality to allow for investing directly into a number of permissions can now provide to retail customers unless they fall the firm (or its principals) must no multiple platform investments in one different platforms. Depending on the regulated advice on P2P agreements, within the following other categories: longer have sufficient assets to meet transaction. amounts invested, this tax saving is although the new permission does claims for compensation likely to offset the aggregator fees and certified as high net worth – annual BusinessAgent: hosts not bring any additional regulatory the P2P loan agreement meets the leave the investor better off. income over £100,000 or net assets Crowdfunders and crowdlenders on requirements or additional fees175. of £250,000 (excluding primary requirements for the FCA to consider its website. Asks borrowers about As an example of aggregator fees, Nevertheless, there may be situations residence, pension and insurance it to be a ‘P2P agreement’, which will their finance needs and then directs 181 LendingWell charges an annual fee of where advisers provide advice that benefits) depend on individual circumstances . them to various options such as P2P 0.5% of AUM charged once a month. doesn’t involve making a ‘personal lending sites. self-certified as a sophisticated In addition, a recent report recommendation’ or carrying on the investor – sufficient knowledge to commissioned by the P2PFA found OTHER COMPARISON SITES Informed Funding: a division of regulated activity of advising on P2P understand the risk that, “investors are broadly aware of Knowledge Peers, Informed Funding agreements; this could be the case if These sites facilitate fast comparison the risk and liquidity profile of P2P offers platforms and other lending an adviser recommends that a client certified as a restricted investor of platforms, much like the already lending, and their behaviour does partners representation via a microsite invest in an IFISA with a particular ISA – investing less than 10% of net familiar sites for comparing credit not suggest that they are confusing managed by each funding platform on manager, but does not recommend investible assets cards or insurance, although they are it with deposit accounts provided by the Informed Funding Site. a specific loan investment. To ensure 182 unlikely to provide the real like for like the firm (or another authorised banks” . consumers understand whether they comparisons that are so important. Nurture Money - independent firm) has complied with the ‘suitability’ are receiving regulated or unregulated Interestingly, some of the traditional crowdfunding comparison and requirements in the FCA rules advice, in order to satisfy the fair, comparison sites are also beginning to content site174. clear and not misleading rule, it would the customer is classified as a cover P2P lending. be sensible for firms to ensure that ‘corporate finance contact’ or a ‘venture

62 63 “Wealth managers should be aware suitability remains one of our main concerns in the sector” – “Of course, due diligence will not guarantee the successful repayment of a loan, but it will give an Megan Butler, FCA important indication of the chances of success.”

USING DIVERSIFICATION TO procedures to set reasonable interest indemnity cover for firms that client to invest in that product…”186 Are the fees, charges and incentives FCA P2P AGREEMENT rates to indicate creditworthiness. recommend P2P Agreements; this INFLUENCE RISK Selecting a P2P platform is the first reasonable and competitive? DEFINITION AND INFORMATION Security features will also vary – from means that the same regulations will Diversification is achievable within step in checking that investments Does the platform focus on specific The FCA introduced the following in a provision fund to insurance. apply as those applicable to firms that P2P lending because platforms are in P2P lending are sound: there are industry sectors such as renewable March 2016: recommend investments to clients. Given these features, the sector many variations in the operations of energy, or is it a generalist? able to fractionalise loans into parts These firms are generally required A ‘P2P Agreement’ is an agreement which gives the investor the ability to exhibits a significant degree of P2P lending sites and being aware of to meet minimum capital resources What contingency plans are in place between the borrower and the lender lend to many different borrowers. suitability for retail investment, in the these will inform how due diligence requirements and, in some cases, to should the platform get into financial by which the lender provides the This is done by the P2P sites creation right amounts and at the right risk progresses; questions to think about hold a minimum level of professional difficulties? borrower with credit and (a) either and diversification level, particularly are: of multitudes of electronic contracts indemnity insurance. whilst yields are so low in traditional Are borrowers asked to provide the lender provides the borrower to ensure that each lender has, in a Who can invest? Retail, institutional, asset classes. Recent research on the Advisers can choose the excess level any type of security to offset potential with credit of up to £25,000; or (b) the technical sense, a direct connection high net worth investors? agreement is not entered into by the to a borrower, despite the fact that P2PFA members has also suggested of their policy, but there are additional losses to lenders, such as charges over borrower wholly or predominantly the lenders experience of the site has that the underlying risk characteristics capital adequacy requirements if the How is the credit assessment property? 183 of P2P lending are comparable to firm has an excess of over £5,000. carried out? Completely online, face for the purposes of a business carried largely been to click a button . How does the site arrive at the on, or intended to be carried on, by those of other retail investments such This also applies if the firm has any to face meeting with borrowers, visit Within P2P lending, it is also possible returns that it quotes? Does it deduct the borrower. If neither (a) nor (b) is as bonds and equities, without more exclusions in its policy for activities that to their site, analysis of their accounts to gain various levels of diversification fees, tax liabilities or likely default satisfied, then the agreement is not inherent risk, complexity or lack of the firm is or has been involved in185. and business plan? - across platforms, levels of asset rates? an article 36H agreement and the liquidity184. backing security, sectors, risk levels Does the team running the site article 36H regulated activity will not DUE DILIGENCE What information does the and loan terms: one of the beauties Nevertheless, it is worth noting have experience in assessing the 177 platform publish about its track record be applicable . (Article 36H of the that the larger platforms seem to Of course, due diligence will not creditworthiness of borrowers and of P2P lending is the very low as a lender? Does it provide figures Regulated Activities Order refers to be the best bets in terms of risk of guarantee the successful repayment lending money? minimum investment levels of many on the number of loans that have Operating an electronic system in platform meltdown. Individually of a loan, but it will give an important of the platforms - from as little as What sort of opportunities does the defaulted in the past and how much relation to lending and in this article picking platforms and products indication of the chances of success. £10 on some websites - which allows platform offer? Fixed-rate offers, with of the lenders’ money was eventually the definition of a ‘P2P agreement’ could see better results but the time investments to be split across a When it comes to due diligence, the lenders accepted on a first-come-first- recovered? is described as an ‘article 36H consuming nature of this is likely to variety of loan types and platforms, FCA has provided some guidance: served basis? Competitive “reverse agreement’.) make it an unrealistic option for most How accurate are the platform’s allowing exposure to a whole raft “We would expect an adviser to auctions”, where lenders bid against advisers. This is why funds, which projected versus actual loan default At the same time, the FCA of options at low levels and limiting understand the distinctions in risks each other to offer funding at the do that hard work for them after an rates? implemented a: the possible default loss from any between different product types, lowest rate? individual loan. initial due diligence exercise, might be ban on the payment and receipt especially those that may appear Do institutional investors have preferable. Another viable alternative Is there a minimum rate below of commission by FCA regulated similar. For example, advisers should advantageous access to the best Investing into a mix of personal would be to use an aggregator, some which competitive bids cannot fall? firms in relation to personal consider the risks of P2P agreements deals? loans, business loans, and the of which have pre-selected portfolios recommendations made to retail when compared to bank or building Does the platform allow lenders to various different models of property- which have been carefully constructed Advisers’ should be considering clients on P2P agreements (see society deposit accounts… Our existing pick individual borrowers? connected loans, provides another by an experienced management team. what this means for their clients - if rules also set out situations where firms COBS 6.1A; COBS 6.1B; and COBS type of diversification. Moreover, Are specific interest rates the platform offers credit to various can place reliance on other persons 6.2A); investing in more than one sector can PROFESSIONAL INDEMNITY guaranteed? (Interest rates are never types of borrowers, are there any give exposure to different benefits [see, for example COBS 2.4.6R]. It is application of the rule on COVER ‘guaranteed’ despite protections in they are not comfortable with - buy and disadvantages. For example, generally reasonable for a firm to rely inducements (COBS 2.3.1R) to place such as contingency funds etc.) to let landlords, small companies? If loans into the technology market are In March 2016, the FCA published on information provided to it in writing personal recommendations Does the platform complete the platform does larger volumes of generally affected by different factors its PS16/8 Policy Statement, entitled by an unconnected authorised person involving advice on P2P loans using its own money and then business, it is likely to mean a greater in terms of potential default issues, FCA Handbook Changes Regarding or a professional firm, unless it is aware, agreements, in the same way that it let investors buy portions of these likelihood of the ongoing operation to loans into the renewable energy the Segregation of Client Money or ought reasonably to be aware, of is applied to other retail investment completed loans from it? (Balance sheet of the platform as it means more sector. In other words, different asset on Loan-based Crowdfunding any fact that would give reasonable business; business is written and this is the Platforms, the Innovative Finance grounds to question the accuracy of lender) Or does it simply link lenders classes behave differently in different point at which fees are generally ISA, and the Regulated Activity of that information… Advisers must form with borrowers without lending any of application of its training and macro-economic conditions. taken. Although volume at the competence rules to ensure that Advising on Peer to Peer Agreements their own opinion of the risk of any its own money? (Marketplace lender) The same can be said of platforms expense of quality in order to gain size financial advisers who advise on Including Feedback to CP16/4 and investment and advise their clients Is the site run by people with which may have varying strengths and for an IPO is unlikely to be beneficial P2P agreements are appropriately CP16/5, and Final Rules. This policy based on this opinion. If an adviser is banking/financial services experience weaknesses in different conditions. to lenders, so are the risk ratings supervised and assessed as statement confirmed that the FCA unable to form an opinion based on who are actually involved in the No platform will lend in exactly the reasonable and are the platforms competent to carry out that activity was implementing its proposal in the information available, then the company operations? Was it founded same way and each will have its own interests aligned with retail lenders? (see TC 2.1)178 the CP16/5 Consultation Paper of correct response is not to advise the and run by technology specialists? lending criteria and risk assessment February 2016 regarding professional

64 65 “It is likely that, as the market continues to grow and become more mainstream, the FCA requirements “The FCA is keen to remind advisers of the need for ongoing monitoring of investment portfolios for advising on P2P investments will change, so that independent advisers are required to do so. and P2P loans are no exception.” If the market size and reach into retail circles keeps rapidly expanding, there is good reason to assume that this will happen sooner rather than later.”

In the event of the platform having an The FCA is keen to remind advisers of the market. Moneysupermarket.com RESEARCH WHOLE OF MARKET THE INVESTMENT PROCESS auto-bid function, the adviser should the need for ongoing monitoring of provides simple P2P lending product Since the beginning of the 2016 tax be thinking about whether or not they investment portfolios and P2P loans information as do Fundshare.co.uk and year, advisers have had the right to feel more at ease to examine each are no exception. It is important to Orcamoney.com which allow users to START HERE > advise on P2P investments. However, individual loan himself, including who track an overall portfolio to ensure compare p2p lending rates, but not in March 2016, the FCA stated “We the borrower is, the credibility of the that it matches the specified criteria all platform options are quoted. As believe that, with the sector still in an business plan and how secure it? Or, - e.g returns levels received on time previously noted, this information in early stage of development, it is not are they confident, perhaps from a at the correct risk level and over the itself is interesting, but generally more appropriate at this time to oblige firms review of the platform’s historical agreed term. It is also vital to liaise with research needs to be done in order to to have to consider P2P agreements loan books, to allow the platform’s the client to ensure the investment ensure that platforms and products REGISTER on the DEPOSIT FUNDS into the CHOOSE the product or when holding themselves out as programmed algorithms to make the criteria originally decided are still are comparable on a like-for-like basis, platform’s website chosen P2P platform submit the amount to independent. This is something we will investment choices? suitable – this is particularly applicable which is one of the benefits of the with a few personal accounts. lend and choose the keep under review.”187 So currently, when automatic reinvestment is aggregator LendingWell. details such as name desired interest rate The platform operating model will even ‘whole of market’ advisers have and address, to create and loan term. selected. And the overall success and also have a bearing on the potential 4thway.co.uk also publishes P2P no regulatory obligation to include an account.* risk levels of platforms can change for cash drag in the event of investor platform data on its website for P2P lending in their considerations for over time, so being able to utilise funds sitting idle in the lending around a quarter of the market, with advice to clients. transparency to review published account before being matched with some also featuring a 4thway Insight redemptions rates, bad debt levels and The present situation may suit some a borrower or reinvested into new Report, giving a more in depth review data regarding calls on contingency advisers who are concerned about loans. Does the platform demand a of the platform. funds, is a useful feature. regulatory risk and have had difficulty large minimum investment in each loan in accessing P2P lending information Either the platform will which is above the income that will be Getting a good overview of the sector, to make informed decisions on a then split the investment received from the initial loan? Does it checking platform due diligence, whole of market basis. Nonetheless, across a range of loans, automatically re-invest the money paid looking at the products available, for a set loan term, or In terms of more detailed analysis, clients who seek whole of market by borrowers into suitable new loans deciding whether active or passive it will allow the investor In:review, provides a live comparison advice might not benefit from the THE INVESTOR BORROWERS through an auto-bid function? If not, is investment is most suitable for receives draw to manually select the absence of P2P lending as a strategy the interest on the -down the loan and it too time-consuming for the adviser the investor and ongoing review of of platforms, expected to become loans. possibility; P2P lending can provide capital investment repay the debt with to do this manually? risks and performance of P2P loan fully live in early 2017 with 7 main a relatively liquid, relatively low risk, and can watch as it interest, under the investments involves some work from aspects discussed: Some platforms package up loans near cash asset, achieve better risk matures. watchful eye of the the adviser. And this is an important LIQUIDITY. Early repayment, P2P platorm. and offer them as products with a adjusted returns than other asset way that he or she can show that redemption, cancellation, transfer small range of loan terms and interest classes and allow clients’ money to be they have added value and had an rates for investors to choose between. REGULATORY COMPLIANCE. High level put to work in investments they have a influence over a portfolio. For clients Products and auto-bid functions, which controls, CASS, AML, capital adequacy, strong desire to support. who understand that P2P is not just should ensure all underlying loans client reporting, promotional material saving, but an investment with the It is likely that, as the market continues meet the same criteria, can be helpful and complaints procedure associated risks of loss of capital, who to grow and become more mainstream, Where a platform has a secondary market, access to the funds may be possible before the with P2P investing via a SIPP where are looking for returns that cash just TAXATION. Only really relevant in the the FCA requirements for advising on maturity of the loan term if a third party is willing to buy the outstanding debt. there is a perceived need to carry out cannot currently give them, these are context of SIPP or SSAS P2P investments will change, so that due diligence on each individual loan. This is all likely to take place within a matter of a few days and virtually all of the justifications for advisers charging for independent advisers are required to This could make them more acceptable PARTIES. Operator, counter-parties process can be carried out online. P2P assets under management. Some do so. If the market size and reach into for IFAs to advise on as they assess - provenance, experience and aggregators and platforms will even retail circles keeps rapidly expanding, the platform, then select the correct regulatory record collect the adviser fees on their behalf. there is good reason to assume that this risk return profile for their client - like SECURITY attached to loans (how and will happen sooner rather than later. assessing a provider and then their managers, the ease of whole of market of consolidation. These can allow REVIEWS when it can be enforced, operator’s product. It may also provide a less research may have benefited from advisers to get their arms around process to assess potential When that happens the wide appeal Some websites offer very simple some consolidation of the platforms. In a sizeable chunk, if not all, of the time intensive method for reviewing borrowers, default, late payment and diversity of P2P lending, with P2P investments in general as, once platform reviews with a very limited and contingency fund analysis) models attracting institutions, the meantime, there is a growing list of whole of the market. For example, the platform due diligence is completed number of platforms included. unadvised consumers, financial resources to assist advisers, particularly LendingWell intends to provide to the satisfaction of the adviser, the MoneySavingExpert.com falls into this BUSINESS CONTINUITY and disaster advisers, SIPP or SSAS operators, platform reviewing resources and independent platform due-diligence auto- bid/reinvestment function can be category. In addition, some customer recovery plan (triggers, costings, workplace pension trustees or asset aggregators, which may be the drivers on its website. set to pre-set criteria, meaning there is reviews are available at P2Pmoney. timings) no need to assess each individual loan co.uk, along with basic comparison LOANS ANALYSIS. Returns and fees *(On an aggregator’s site, such as LendingWell, this only needs to be done once, regardless of the number of platforms investment is made through.) invested in. data taking into account virtually all of On over 90%188 of platforms, basic Know Your Client information is requested in order to verify the account holders’ identity. It is a very simple process, good for those looking for fast access, not necessarily so good if those looking for fast access have little investment experience or knowledge.

66 67 “The adviser has to charge fees directly to the client for the provision of their advice, but some “The market for potential P2P lenders with the right risk appetite and for whom considered platforms make this a very straightforward process.” financial advice could add significant value, is potentially huge.”

○REMUNERATION The FCA is not proposing to extend the today’s low-interest-rate environment, PEER TO PEER commission ban to other situations, the pressure is on for advisers to add ADVISING ON: CONCLUSIONS Many platforms will facilitate adviser such as unadvised sales arranged on value when it comes to fixed income LENDING PROCESS charges when investing their clients For advisers and their compliance aggregator websites via firms who do allocations and the appealing yields into P2P, making the transition from functions, there are practical not provide regulated advice189. are very likely to have an interested commissions to client charges quite issues to address before they Consumers and businesses apply for audience among a proportion of painless. Of course, advisers still The FCA’s view is that adviser firms can recommend P2P lending to loans on a P2P website, specifying the investors, even after a thorough need to be able to justify their fees will already have processes in place to their clients, including PI cover, amount they wish to borrow and the explanation of the risks involved. and show that they are actively meet its requirements for other types research and due diligence and (not loan term. The website conducts a credit As a result, those clients may well earning them, but the platforms’ of regulated investment, including least) client suitability. It seems check and successful loan requests are be unhappy if they are denied P2P LOAN or aggregators’ involvement can in relation to adviser charging and that there is some work ahead if added to the online marketplace. lending opportunities by whole of APPLICATION mean that there’s no awkward record-keeping. As a result, they will the P2P industry is to overcome market advisers who know little conversation with the client, asking not need to develop new processes these issues and make it easy about the asset class other than the them to write a cheque! to use in this sector when advising on for advisers to recommend P2P received wisdom that it is too risky, APPROVED P2P agreements190. investments, but none of these Since the start of the 2016/17 difficult to assess and clients do not obstacles is insurmountable and financial year, advisers need a However, the rule changes do prevent understand it. the benefits to both investors and charging model that doesn’t require the payment of commission to Investors bid to lend money and declare The market for potential P2P advisers could be huge. commission as this is now banned platforms such as those run by self- how much they will lend and the interest lenders with the right risk appetite by the FCA in transactions which invested personal pension scheme rate they will charge. Those who use such and for whom considered financial involve the regulated activity of operators191. sites pay an annual fee, plus a sale fee. advice could add significant value, giving personal recommendations is potentially huge: A 2015 survey to invest in P2P agreements. RISKS OF NOT ENGAGING by the Financial Conduct Authority Consequently, both of the following When discussing the implementation found that savers had £160 billion of now apply: of its regulatory changes on advice in cash in savings accounts earning the AGREED ban on the payment and receipt respect of P2P Agreements, the FCA same as or less than the 0.5% Bank of of commission by FCA regulated has stated that, “we expect limited England interest rate, and over 80% MONEY firms in relation to personal provision of investment advice. The of easy-access accounts had not been recommendations made to retail market primarily operates on a non- switched in the previous three years193. Once the loan is arranged, the consumer clients on P2P agreements (see COBS advised basis and few firms currently Bearing in mind it’s likely to be just a or business pays a fee to the website and 6.1A; COBS 6.1B; and COBS 6.2A) provide advice that would constitute a matter of time before client demand, receives the money. FEE personal recommendation from next P2P growth and resultant FCA the application of the rule April [2016]. From discussions with regulation bring P2P lending into the on inducements (COBS 2.3.1R) the industry, there is little expectation investment scope of all independent to personal recommendations that this situation will change advisers, perhaps it is time for more involving advice on P2P agreements, 192 rapidly.” IFAs to take a look. in the same way that it is applied to other retail investment business; For those who see the benefits of growing the industry, this is This means that the adviser has to Investors can then choose to resell all or disappointing, but, to a degree, it is charge fees directly to the client for part of the loan on a secondary market understandable that IFAs are on their the provision of their advice, but at a premium, or wait for repayment plus guard. They know clients are cautious, some platforms make this a very interest. having been stung in the past by too- straightforward process. good-to-be-true investment offerings. And the lack of the type FSCS LOAN RESOLD protection afforded to funds held in bank deposit accounts does not help.

However, advisers who continue to dismiss P2P lending out of hand may have some hard questions to answer from increasingly eager clients; in

68 69 LENDINGWELL AGGREGATOR

LendingWell is a disruptive financial technology company that aims to provide the most comprehensive solution for financial advisers and private individual investors. FINAL CONCLUSIONS As a P2P aggregator, the streamlined investment process reduces the administrative burden, empowering investors with a single point of access to a curated list of loan originators, due diligence resources, research and data to drive a well- considered approach to decision making in P2P investments. The P2P lending universe has continued to expand although this has come at the expense of increasing difficulty for retail investors to conveniently and confidently diversify their exposure to this new asset class within the much anticipated arrival of the Innovative Finance ISA. LendingWell’s simple, innovative structured bonds offer a clear point of access for investors to achieve diversification across sub-asset class verticals, platform loan originators, loan maturities and asset security offered.

LENDINGWELL: HOW IT WORKS

CONSUMER LOAN PLATFORMS

INVESTORS LENDING WELL BUSINESS BORROWERS LOAN PLATFORMS

• NOTE HOLDERS • INNOVATIVE • LOAN OWNERS PRODUCTS • PRINCIPAL AND PROPERTY BACKED INTEREST RETURNS • ARRANGERS LOAN PLATFORMS

• DUE DILIGENCE

• IF ISA WRAPPER ASSET BACKED LOAN PLATFORMS • PLATFORM INTEGRATION

• LOAN CONTRACT RECEIVABLES BACKED HOLDER LOAN PLATFORMS

• LOAN ORIGINATORS

• LOAN SERVICES

• FRACTIONALISED LOANS

• CASH COLLECTION

CONTACT DETAILS

lendingwell.com 0203 6334668 [email protected]

70 71 FINAL CONCLUSIONS SWOT KEY TAKE AWAYS STRENGHTS, WEAKNESSES, OPPORTUNITIES AND THREATS

There is a compelling case for advisers SAMPLE RISK / RETURN TABLE to consider P2P lending, largely based around the ability to give their STRENGHTS WEAKNESSES LOWER INTEREST PAYMENTS HIGHER INTEREST PAYMENTS clients exposure to risk adjusted returns in a new asset with a range LOWER EXPECTED LOAN LOSSES HIGHER EXPECTED LOAN LOSSES Cost advantage over traditional financial institutions Lack of long term track record of risk rated investments that offer LOWER EXPECTED RETURNS HIGHER EXPECTED RETURNS inflation beating yields currently hard Choice of risk levels and associated returns with risk Lack of independent verification of platform’s published LOWER EXPECTED VOLATILITY HIGHER EXPECTED VOLATILITY to come by. However, despite being mitigators such as diversification, asset backing and loan book information an attractive proposition, as with any contingency funds Historical monopoly of UK banks over UK borrowers still new asset class, advisers will naturally Attractive/often outperforming rates available to restricting loan originations be cautious. They will be keen to investors and borrowers understand all of the associated No automatic FSCS protection for funds invested into risks as well as the benefits, and REWARD / RISK Investors can control what their funds are invested into P2P loans with several methods of investment, Each grading will refer to a small range of interest rates that are applicable to that risk grade. they will need to identify the most The higher the risk grade, the higher the applicable interest rate range. Speed of deployment of investment cash and Liquidity disadvantage of P2P platforms when compared appropriate way to invest on behalf of SOURCE: INTELLIGENT PARTNERSHIP administration of loans to banks which can access money market funding or their clients. central bank liquidity provision One method of investment that is ANNUAL P2P LOAN ORIGINATION (£M) Bespoke FCA regulation giving investor’s confidence, likely to have a particularly strong providing barriers to participation to less serious providers Lack of a simple comparison benchmark for £3,500m appeal for advisers is the “aggregator” and preventing the types of issues other countries P2P performance of platforms, P2P products and loans model. Aggregators, such as the £3,000m markets have encountered report sponsor LendingWell, will be able to give advisers low cost £2,500m diversification across a number of £2,000m S W the platforms and lending models discussed in this report, whilst also £1,500m OPPORTUNITIES THREATS sheltering returns from tax with use of £1,000m the innovative finance ISA wrapper*. Potential partnerships with traditional banking Potential for deteriorating economic conditions, increasing Crucially, they also provide an £500m institutions – increasing awareness and credibility of the defaults and negatively impacting returns additional layer of due diligence and sector Delays in full FCA authorisation of platforms allow advisers to manage their client’s £0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 lending portfolio on an ongoing basis, Increasing comfort levels of UK consumers with online Possibility of institutional investors cherry picking the best so advisers can ensure that it remains SOURCE: P2PFA finance transactions P2P investments using their expertise and resources, leaving suitable for the client. retail investors at a disadvantage AGGREGATOR PROCESS Innovative Finance ISA providing a tax-free wrapper for With the favourable prospect of Online fraud undermining the security of internet-based up to £20,000 of P2P lending investments from 2017 tax changing regulation, including the loan transactions eventual requirement for whole of year Potential for platform collapse (e.g resulting from lack of market advisers to consider P2P ACCESS LENDING APPLYING FOR LOANS* Banking regulation such as Basel III (to be phased in loan originations/bad underwriting generating significant lending for suitable clients, it would PLATFORM BORROWERS up to 2019), causing banks to reign in lending to smaller defaults), dealing reputational blows to the entire P2P sector seem sensible for them to evaluate the customers, leaving them to seek finance elsewhere P2P lending arena and the positives it Investor confusion, (e.g over the difference between P2P can deliver, sooner rather than later. lending and deposit account risk profile/limits of protection Deeper liquidity provided by institutional investment/ ACCESS LENDING APPLYING FOR LOANS* provided by provision funds), leading to investor detriment *Tax treatment is dependent on the fundification LENDER PLATFORM BORROWERS individual circumstances of each Bank Referral Scheme requiring banks to refer individual and may be subject to ONE ACCOUNT change in the future. Availability of borrowers they reject to P2P platforms the Innovative Finance ISA may vary LENDING ACCESS APPLYING FOR LOANS* O T between platforms. BORROWERS AGGREGATOR - DUE DILIGENCE - ON PLATFORMSAGGREGATOR PLATFORM

72 73 APPENDIX I REFERENCES REFERENCES

1 Bank of England Inflation Report, November 2016 February 2015 Business Forums, 30 March 2016 Guardian, 25 July 2016

2 Pushing Boundaries, The 2015 UK Alternative Finance Industry Report, 27 A review of the regulatory regime for crowdfunding and the 51 Bank referral scheme goes live, Altfi Data, 1 November 2016 77 2015 UK P2P lending market review, BondMason Nesta, February 2016 promotion of non-readily realisable securities by other media, FCA, 52 Pushing Boundaries, The 2015 UK Alternative Finance Industry Report, 78 “Adviser-friendly” P2P – An interview with Octopus Choice, AltFi News, February 2015 3 UK Peer to Peer Lending Volume is Down for the First Time, Business Nesta, February 2016 27 June 2016 Insider UK, July 27 2016 28 Letter to Andrew Bailey, Chief Executive of the FCA, from Christine 53 Santander in peer-to-peer pact as alternative finance makes gains, 79 Guidance: Peer to Peer Lending, HMRC, 6 April 2016 Farnish, Independent Chair of P2PFA, 26 July 2016 4 Aggregate P2PFA Member Data, 4th Quarter 2015, P2PFA, 2015 Financial Times, June 17 2014 80 Call for input to the post-implementation review of the FCA’s 29 Letter to Andrew Bailey, Chief Executive of the FCA, from Christine 5 Housing supply in 2015-2020: Key issues for the 2015 Parliament, 54 RBS strikes peer-to-peer alliance, Financial Times, January 22 2015 crowdfunding rules, FCA, July 2016 Farnish, Independent Chair of P2PFA, 26 July 2016 parliament.co.uk 55 Metro Bank strikes deal to lend through P2P site, Financial Times, May 81 P2P Lending Basics: How it Works, Current Regulations and 30 Grant Thornton, 2015 6 Pushing Boundaries, The 2015 UK Alternative Finance Industry Report, 19 2015 Considerations, Morrison Foerster Nesta, February 2016 31 Treasury to allow bonds and other ‘debt securities’ for Innovative 56 Inside J.P. Morgan’s Deal with On Deck Capital, Wall Street Journal, 30 82 Peer-to-Peer Lending - Can you really get 7% returns? Finance ISA, AltFi News, 16 August 2016 7 UK Peer to Peer Lending Volume is Down for the First Time, Business December 2015 MoneySavingExpert.com, 11 July 2016 Insider UK, July 27 2016 32 Individual Savings Account (ISA) Statistics, Gov.uk, August 2016 57 Santander UK teams up with Kabbage to offer fast loans to SMEs, 83 Borrowing from a peer-to-peer lending website, Moneyfacts.co.uk, 15 8 Call for Input to the Post-implementation Review of the FCA’s 33 Pushing Boundaries, The 2015 UK Alternative Finance Industry Report, Financial Times, 3 April 2016 March 2016 Crowdfunding Rules, FCA, July 12 2016 Nesta, February 2016 58 Marketplace Lending, A Temporary Phenomenon? Deloitte, 2016 84 Should you use your Isa for peer-to-peer lending? Financial Times, 9 P2P Money 34 Pushing Boundaries, The 2015 UK Alternative Finance Industry Report, March 2016 59 Competitions and Markets Authority (CMA) Retail Banking Market Nesta, February 2016 10 Pushing Boundaries, The 2015 UK Alternative Finance Industry Report, Investigation, August 2016 85 Marketplace lending A temporary phenomenon? Deloitte, 2016 Nesta, February 2016 35 Financial advisers could be banned from taking commission for 60 Fintech’s data problem, FT Alphaville, 23 September 2016 86 Value of negative-yielding bonds hits $13.4tn, Financial Times, 12 recommending peer-to-peer investments, This is Money, November 11 Pushing Boundaries, The 2015 UK Alternative Finance Industry Report, August 2016 2015 61 Peer to Peer Lending Markets: The leading countries for alternative Nesta, February 2016 finance and the next high-growth markets, Business Insider UK, June 17 87 UK peer-to-peer lending volume is down for the first time, Business 36 The economics of peer to peer lending, Oxera, September 2016 12 Marketplace Lenders and Banks: An inevitable convergence, Deloitte 2015 Insider UK, July 27 2016 Center for Financial Services, 2016 37 Call for input to the post-implementation review of the FCA’s 62 The State of P2P Lending, Techcrunch, January 30 2016 88 A review of the regulatory regime for crowdfunding and the crowdfunding rules, FCA, July 21016 13 Bank of England, Staff Working Paper No. 598 Peer-to-peer lending promotion of non-readily realisable securities by other media, FCA, 63 Does securitisation of online loans have a future in Europe? The and financial innovation in the United Kingdom, April 2016 38 Peer to Peer Finance Association, October 2015 February 2015 Financial Times, May 10 2016 14 Banks behind a quarter of loans on peer-to-peer websites, the 39 Call for input to the post-implementation review of the FCA’s 89 Borrowing from a peer-to-peer lending website, Moneyfacts.co.uk, 15 64 Does securitisation of online loans have a future in Europe? The Financial Times, 17 February 2016 crowdfunding rules, FCA, July 2016 March 2016 Financial Times, May 10 2016 15 Marketplace Lending, A Temporary Phenomenon? Deloitte, 2016 40 Parliamentary Commission on Banking Standards: “Changing Banking 90 P2P Lending: Why You Need a New Uncorrelated Asset Class, Lending 65 UK Property Steadies After Brexit Shock, Primesite Developments, 23 for Good”, June 19 2013 Memo, May 1 2016 16 Marketplace Lending, A Temporary Phenomenon? Deloitte, 2016 September 2016 41 Guidance, peer to peer lending, Gov.uk, 6 April 2016 91 The Economics of Peer to Peer Lending, Oxera, September 2016 17 The Economics of Peer-to-Peer Lending, Oxera, September 2016 66 UK peer-to-peer lending volume is down for the first time, Business 42 Personal savings allowance oversight means some funds will be Insider UK, July 27 2016 92 Bank of England, August 2016 18 GLI Finance Ltd, Intelligent Partnership Alternative Finance Report needlessly taxed for an extra year, The Telegraph, April 13 2016 2015/16 67 UK peer-to-peer lending volume is down for the first time, Business 93 The FSCS’ £75,000 limit: a beginner’s guide, Money Observer, May 9 43 British Business Bank - Annual Report and Accounts 2016 Insider UK, July 27 2016 2016 19 Marketplace Lending, A Temporary Phenomenon? Deloitte, 2016 44 Small Business Finance Markets 2015/16, British Business Bank, 2016 68 The economics of peer to peer lending, Oxera, September 2016 (Based 94 Peer to Peer Finance Association, Members page 20 Guidance, peer to peer lending, Gov.uk, 6 April 2016 on analysis of the P2PFA members) 45 Bank of England, Staff Working Paper No. 598 Peer-to-peer lending and 95 Marketplace lending A temporary phenomenon? Deloitte, 2016 21 Alternative Lending: A Regulatory Approach to Peer to Peer Lending, financial innovation in the United Kingdom, April 2016 69 Default Rates and Provision Funds, Orca Money Grant Thornton 96 The Business Models and Economics of Peer-to-Peer Lending. 46 Councils give entrepreneurs £7m leg-up by investing in small firms 70 The economics of peer-to-peer lending, Oxera, September 2016 Alistair Milne and Paul Parboteeah School of Business and Economics, 22 The FCA outlines how it will regulate crowdfunding: 24 October 2016 through lend-to-save pioneer Funding Circle, This is Money, 21 October Loughborough University, UK, 5th April 2016 71 The economics of peer-to-peer lending, Oxera, September 2016 23 FCA to probe peer-to-peer lending sector, Financial Times, July 8 2016 2014 97 The Great British Money Survey 4, April 2016, One poll for Abundance 72 Brexit Brings on a New World in Europe, LendIt Blog, June 24 2016 24 FCA cites concerns in P2P review, regulatory arbitrage tops list, AltFi, 47 British Business Bank - Annual Report and Accounts 2016 98 Small business loans through Funding Circle boost UK economy by July 2016 73 Can it really be “business as usual”? AltFi Data, 19 July 2016 48 Small Business Finance Markets 2015/16, British Business Bank, 2016 £2.7 billion, CEBR, August 11 2016 25 Bank of England, Staff Working Paper No. 598 Peer-to-peer lending and 74 LendInvest revises lending criteria after Brexit vote, 30 June 2016 49 EIB and Funding Circle announce groundbreaking £100 million 99 Call for input to the post-implementation review of the FCA’s financial innovation in the United Kingdom, April 2016 investment into UK small businesses, Press Release, European 75 Brexit could create opportunities for alternative credit lenders, says crowdfunding rules, FCA, July 12 2016 26 A review of the regulatory regime for crowdfunding and the Investment Bank, 20 June 2016 Partners Group, Professional Adviser, September 8 2016 100 Pushing Boundaries, The 2015 UK Alternative Finance Industry promotion of non-readily realisable securities by other media, FCA, 50 Government extends Bank Referral Scheme for small businesses, UK 76 NatWest paves way for introduction of negative interest rates, The Report, Nesta, February 2016

74 75 REFERENCES REFERENCES

101 Financial Stability Review, November 2015 -,The impact of the Basel III 124 FCA to probe peer-to-peer lending sector, Financial Times, July 2016 25 2015 the regulated activity of advising on Peer to Peer agreements 16/03, CPA leverage ratio on risk-taking and bank stability1, ECB, November 2015 audit, February 2016 125 Pushing Boundaries, The 2015 UK Alternative Finance Industry 150 Funding Circle Runs Stress Test on Platform, Crowdfund Insider, 102 Alternative Lending: A regulatory approach to Peer-to-Peer lending, Report, Nesta, February 2016 December 31 2014 177 Crowdfunding and FCA Authorisation, Cummings Law, November Grant Thornton, 2015 2015 126 The ex-finance watchdog who trashed peer-to-peer lending now 151 AltFi Europe Summit 2015, AltFi, 27 February 2015 103 The Business Models and Economics of Peer-to-Peer Lending. says it could ‘make credit crunches less likely’, Business Insider UK, 11 178 P2P lending: (a) the FCA’s client money rules; & (b) advising on P2P 152 Marketplace lending A temporary phenomenon? Deloitte, 2016 Alistair Milne and Paul Parboteeah School of Business and Economics, October 2016 loans as a regulated activity, Cooley, 23 March 2016 Loughborough University, UK, 5th April 2016 153 Statistical Bulletin: UK Labour Market: September 2016, Office for 127 P2P industry hits back at Lord Turner’s warning as ‘ill-informed’, 179 P2P lending: (a) the FCA’s client money rules; & (b) advising on P2P National Statistics 104 Fintech to bridge $2 trillion SME funding gap - World Economic Financial Times, 10 February 2016 loans as a regulated activity, Cooley, 23 March 2016 Forum, Finextra.com, 27 October 2015 154 Inflation Report, August 2016, Bank of England 128 Lending Club’s woes raise questions for Britain’s peer-to-peer 180 Suitability processes take centre stage for advisers, FT Adviser, 2 105 Will The New Funding For Lending Scheme Work? Sky News, 24 April lenders, The Telegraph, May 11 2016 155 Brexit latest: IMF cuts UK 2017 growth forecast again, The August 2016 2014 Independent, 4 October 2016 129 LendingClub’s 42% Tumble Failed to Turn It Into a Cheap Stock, 181 Advice to invest in peer-to-peer lending may now be covered by FSCS, 106 2015 Growth Report, Albion Ventures Bloomberg, May 12 2016 156 UK Inflation hits 20-month high at 6%, The Guardian, 16 August 2016 FSCS, 14 April 2016

107 2016 Growth Report, Albion Ventures 130 Marketplace Lenders and Banks: An inevitable convergence, Deloitte 157 Inflation Report, Bank of England, November 2016 182 The Economics of Peer-to-Peer Lending, Oxera, September 2016 Center for Financial Services, 2016 108 YouGov survey, Marketplace lending A temporary phenomenon? 158 Inflation Report, Bank of England, November 2016 183 The curious state of UK peer to peer lending, FT Alphaville, February Deloitte, 2016 131 Marketplace Lenders and Banks: An inevitable convergence, Deloitte 11 2016 159 Interest rates fall, P2P platforms overwhelmingly positive, AltFi News, Center for Financial Services, 2016 109 British Business Bank, Small Business Finance Markets 2015/16 August 4 2016 184 The Economics of Peer-to-Peer Lending, Oxera, September 2016 132 GLI acquires FundingKnight, AltFi Data, 28 June 2016 110 British Business Bank, Small Business Finance Markets 2015/16 160 Kevin Caley, founder and chairman of peer-to-peer lender ThinCats 185 Professional Indemnity Insurance: a buyer’s guide for financial Infographic 133 Trouble in P2P Paradise, FT Alphaville, July 14 2016 advisers, Howden 161 Call for input to the post-implementation review of the FCA’s 111 RBS, Lloyds, Barclays and HSBC have an even worse reputation than 134 Acquisition of FundingKnight, London Stock Exchange, 28 June 2016 crowdfunding rules, FCA, July 2016 186 PS16/8 Policy Statement, FCA Handbook changes regarding the the Co-op, Management Today, April 2016 segregation of client money on loan-based crowdfunding platforms, the 135 P2PMoney.co.uk (Not including Gradurates which was taken over by 162 Natwest and RBS warn of negative interest for business customers if Innovative Finance ISA, and the regulated activity of advising on peer- 112 Moody’s: Conduct litigation charges for Lloyds, HSBC, Barclays, RBS Ratesetter) Bank of England cuts base rate, The Independent, 26 July 2016 to-peer agreements and Santander UK rose 40 per cent to £15bn last year, City A.M, 22 136 The economics of peer to peer lending, Oxera, September 2016 163 How do peer to peer platforms charge fees? Orca Money, February March 2016 187 PS16/8 Policy Statement, FCA Handbook changes regarding the 25 2016 137 Staff Working Paper No. 598 Peer-to-peer lending and financial segregation of client money on loan-based crowdfunding platforms, the 113 How can the UK banking sector win back consumer trust? Igniyte, innovation in the United Kingdom Ulrich Atz and David Bholat, Bank of 164 Madiston, The fees we charge to borrowers, MadistonLendLoanInvest Innovative Finance ISA, and the regulated activity of advising on peer- May 2016 England, April 2016 to-peer agreements, March 2016 165 Positives and pitfalls of peer to peer lending, FT Adviser, 27 July 2015 114 Peer-to-peer lending: everything you need to know about the leading 138 Bank of England maintains base rate at 0.5%, FT Adviser, 14 July 2016 188 Alternative Finance Report 15/16, Intelligent Partnership websites, The Telegraph, 18 July 2016 166 How are the alternative finance industry and the $1.6 trillion wealth 139 SME lending grows for first time since financial crisis, Financial Times, management market approaching each other? City AM, 14 July 2016 189 Consultation Paper CP16/5, FCA, February 2016 115 Call for input to the post-implementation review of the FCA’s February 2 2016 crowdfunding rules, FCA, July 2016 167 Intermediated P2P loans will result in “significant growth”, Financial 190 Consultation Paper CP16/5, FCA, February 2016 140 Marketplace lending A temporary phenomenon? Deloitte, 2016 Reporter, February 5 2015 116 Alternative Finance: A sector in transition, PWC, February 2016 191 Financial advisers could be banned from taking commission for 141 An introduction to Basel III - its consequences for lending, Norton 168 Is it time to invest in peer to peer lenders? Morningstar, June 13 2016 recommending peer-to-peer investments, This is Money, November 117 Pushing Boundaries, The 2015 UK Alternative Finance Industry Rose Fulbright 2015 Report, Nesta, February 2016 169 Funding Circle Investment Fund. No Charge!, 4thWay, 31 July 2015 142 Financial Stability Review, November 2015, The impact of the Basel III 192 Consultation Paper CP16/5, FCA, February 2016 118 Zopa Gets Cloned as Fraudsters Entering P2P Lending Market, 170 Asset managers run risks in the rush into peer-to-peer loans, the leverage ratio on risk-taking and bank stability1, ECB, November 2015 Finance Magnates, May 2016 Financial Times, July 17 2016 193 Peer-to-peer perfection: how new lenders can compete successfully, 143 Marketplace lending A temporary phenomenon? Deloitte, 2016 PBF Solutions, May 9 2016 119 P2P lender TrustBuddy halts operations over ‘misconduct’, Financial 171 The benefits that benchmarking can bring to the growth of Times, October 2015 144 Marketplace Lenders and Banks: An inevitable convergence, Deloitte alternative finance, February 2016 Center for Financial Services, 2016 120 Pushing Boundaries, The 2015 UK Alternative Finance Industry 172 Who will aggregate the aggregators, Marketing Eye, 21 April 2015 Report, Nesta, February 2016 145 Zopa Returns from 2005 to 2016, Zopa, 13 March 2015 173 HMRC bows to pressure to put P2P Isa on platforms, FT Adviser, 121 China’s $7.6 billion Ponzi scam highlights growing online risks, 146 FTSE.com March 18 2016 Reuters, 2 February 2016 147 Peer-to-peer: what would happen to returns in a financial crisis? The 174 Who will aggregate the aggregators, Marketing Eye, 21 April 2015 122 Regulations Galore Part II: Peer to Peer Lending in China, Crowdfund Telegraph, October 17 2015 175 The regulated activity of ‘advising on P2P agreements’ and the impact Insider, 18 January 20 148 I Hope You Stress Test Better Than The Banks, 4thWay, March 2015 this has for your firm’s permissions, Moore Stephens, 5 August 2016 123 UK peer-to-peer lenders talk up regulation after Lending Club ruckus, 149 Landbay: Just 0.3% Bad Debts In A Crash Economy, 4thWay, August 176 Changes to reflect the introduction of the Innovative Finance ISA and Reuters, 10 May 2016

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