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Alternative to Investment Banks The Lending Business Revolution: P2P Lending & Crowdfunding Company Sponsored Dissertation CAPCO By Exam Number: B060614 Dissertation Presented for the Degree of MSc in Finance & Investment 2014/2015 ABSTRACT After the 2007-2009 financial crisis, the financial industry started to experience a structural change that was accompanied by the introduction a new regulatory frame. Simultaneously, the Alternative Finance Market appeared in the scenario, challenging the traditional lending model. This paper examines from a theoretical approach the P2P Lending and Crowdfunding business in the UK, its origin, evolution and the regulation. In parallel, a theoretical review of the Investment Banking Industry was carried out. In the second part of the paper, two empirical analysis were implemented. The first one analyses the relation between the volume of origination from the industry, based on data from the Liberum AltFi Volume Index UK and certain macroeconomic variables. The findings permit us to infer that the volume of origination in the Alternative Finance Industry is directly related to the volume of origination from the conventional sources of fundraising. The volume also depends on the state of the economy, and that until the moment a relation between the industry and the stock market does not exist or cannot be determined. The second study used information from the loan books from Zopa and RateSetter. The way in which some variables affect the probability of default for a P2P Lending loan was investigated, using logistic regression. The results showed that the probability of default increases for loans issued for longer terms and low amounts. In the last part of the paper, how Investment Banks will adapt to this changing environment and how they can take advantage of this new opportunity, was examined. Due to the limit public data and the novelty of the business not deeper or further research was performed. This paper contributes to the literature by doing a further exploration of the industry, taking a different approach and analysing distinct topics from those that the literature have studied until now. Finally, for encouraging more research some inquiries and proposals for further research were left. Key Words: Alternative Finance Market – P2P Lending – Crowdfunding – Investment Banks – Lending Business. THE UNIVERSITY OF EDINBURGH BUSINESS SCHOOL – MSC IN FINANCE & INVESTMENT- 2014/2015 ACKNOWLEDGMENTS Firstly, I would like to express my gratitude to CAPCO, company that provided me an opportunity to develop this research project. In particular my sincere thanks to Tianxiu Yang, who provided insight and expertise that greatly assisted the research. I would also like to extend my gratefulness to AltFi Data, especially to Sam Griffiths for supporting this research and providing me with data from the Liberum AltFi Volume Index UK. Secondly, I would like to express my sincerest recognition to my supervisor, Professor William Rees, who provided me with guidance and advice through this process. As well, I wish to express my heartfelt thanks to The University of Edinburgh Business School and Colfuturo, entities that awarded me with scholarships for undertaking this Master degree. On third place, special thanks to my beloved fiancé Daniel, who has been my support this whole year. Thanks for share with me this adventure and walk by my side throughout this process. I would like to express my special appreciation to my dear family, for their support and encouragement, both during the writing of this dissertation and through this academic year. Even though we are far away, I can always feel your love and care. Thanks for always helping me to make my dreams come true. Also I would like to thanks to the Camargo Latorre family for their support and love. Finally, I also place on record, my sense of gratitude to one and all, who directly or indirectly, have let their hand in this venture. I thank my classmates, for the sleepless nights and the weekends we were working for successfully complete our dissertations. THE UNIVERSITY OF EDINBURGH BUSINESS SCHOOL – MSC IN FINANCE & INVESTMENT- 2014/2015 ABBREVIATIONS USE IN THIS PAPER AFM: The Netherlands Authority for the Financial Markets BBA: British Banking Association BIS: Bank of International Settlements BOE: Bank of England E.U.: European Union FCA: Financial Conduct Authority FED: Federal Reserve Bank of the United States of America FSA: Financial Services Authority FSB: Financial Stability Board G-SIBs: Global Systemically Important Banks IBs: Investment Banks IMF: International Monetary Fund OECD: The Organisation for Economic Co-operation and Development OFT: Office of Fair Trading P2P Lending: Peer-to-Peer Lending PRA: Prudential Regulation Authority from the BOE SIB: Securities and Investment Board SMEs: Small and medium-sized enterprises U.S.: The United States UK: The United Kingdom THE UNIVERSITY OF EDINBURGH BUSINESS SCHOOL – MSC IN FINANCE & INVESTMENT- 2014/2015 TABLE OF CONTENT INTRODUCTION .......................................................................................................... 1 CHAPTER 1: THE INVESTMENT BANKING INDUSTRY ............................................ 3 1. Background and Context .................................................................................... 3 1.1 Investment Banking Industry and regulation in the UK......................................... 3 1.2 Breaking Point: 2007-2009 Financial Crisis ......................................................... 4 1.3 Architecture of the Investment Banking Business ................................................ 5 1.4 Current Business Environment: Taking a breath and seeking for the recovery .... 6 1.5 Lending business ................................................................................................ 8 1.5.1 The Investment Banking Lending Business ................................................... 8 1.5.2 Drought in the credit sector, where can we raise funds? ............................... 9 1.5.3 Sources of fundraising for SME´s and Individuals ....................................... 10 1.5.4 The Online Era ............................................................................................ 10 CHAPTER 2: LITERATURE REVIEW…………...……………………………………………..13 Exploring the existent literature about P2P Lending and Crowdfunding ................... 13 CHAPTER 3: ALTERNATIVES TO INVESTMENT BANKS ....................................... 17 The Lending Business Revolution, Peer-to-Peer Lending and Crowdfunding .......... 17 3.1 Industry Overview .............................................................................................. 18 3.2 Advantages ....................................................................................................... 20 3.3 What can go wrong? ......................................................................................... 21 3.4 Current regulatory environment ......................................................................... 22 3.5 Alternative Finance Industry Snapshot .............................................................. 24 CHAPTER 4: EMPIRICAL ANALYSIS ....................................................................... 27 4.1 Methodology and data ....................................................................................... 27 4.1.1 Empirical Analysis 1: The forces behind P2P Lending and Crowdfunding ... 27 THE UNIVERSITY OF EDINBURGH BUSINESS SCHOOL – MSC IN FINANCE & INVESTMENT- 2014/2015 4.1. 2 Empirical Analysis 2: Zopa & RateSetter Loan Book Analysis .................... 34 CHAPTER 5: RESULTS AND ANALYSIS ................................................................. 38 5.1 AltFi Data ....................................................................................................... 38 5.2 Zopa & RateSetter Loan Books...................................................................... 42 CHAPTER 6: LIMITATIONS ....................................................................................... 46 CHAPTER 7: PERSPECTIVES AND CHALLENGES ................................................ 47 7.1 Alternative Finance Market ................................................................................ 47 7.2 Investment Banks .............................................................................................. 50 CONCLUSIONS AND FURTHER RESEARCH RECOMMENDATIONS .................... 52 REFERENCES ........................................................................................................... 56 APPENDICES ............................................................................................................ 62 Appendix 1: FCA Rules for Loan-Based-Crowdfunding: .......................................... 62 Appendix 2: AltFi Data Definitions ........................................................................... 62 Appendix 2: Independent Variables number correspondence .................................. 64 Appendix 3: Logistic Regression Assumptions ........................................................ 65 THE UNIVERSITY OF EDINBURGH BUSINESS SCHOOL – MSC IN FINANCE & INVESTMENT- 2014/2015 List of Figures Figure 1: IBs Fees (%) by product................................................................................................. 7 Figure 2: IBs Net Income before Extra items/Preferred Dividend ................................................. 8 Figure 3: Liberum AltFi Volume Index UK, Cumulative Volume by year....................................
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