Transparency is pivotal to peer-to-peer lending. But can you have too much of a good thing?
PEER-TO-PEER lending been built on a promise of transparency: question any platform founder and chances are that the desire to be more open and accountable than banks will not be far from the top of their list of why they wanted to get into P2P in the first place.
“Transparency is a good thing for investors,” says one such founder, Karteek Patel of business lender Crowdstacker.
“This industry is founded on trying to do things better than they have been done in the past, by providing a better customer and investor experience. That’s a key driver that is pushing the whole industry in the same direction.”
Add to that the launch of the Innovative Finance ISA and fears over an increasingly challenging economic climate, and the pressure on transparency is only going one way. The Financial Conduct Authority’s interim feedback from its review into the sector last December expressed concerns over transparency. The City watchdog was worried about the way that some platforms market themselves to consumers, leading to speculation that regulations might be tightened up.
The full report is yet to be published but the auguries are clear – it’s time to get your disclosure ducks in a row.
Read more: Feature: Playing by the rules
Agreement on something in principle is not the same as agreement on how it should be tackled in practice, however, and this is where the picture gets more complicated. What data should be disclosed, when and to whom? How useful is it to investors? Can you ever have too much transparency?
As the sector expands and seeks to take on both a more mainstream face and more mainstream customers, how it responds to these questions will be an important test in the eyes both of investors and wider public opinion.
“At its heart P2P is very simple but as models evolve, data transparency provides evidence of how they perform,” says Robert Pettigrew, director of self-regulated trade body the Peer-to-Peer Finance Association (P2PFA).
“It puts them under scrutiny to a degree not faced by other financial services sectors.”
Its members, which include Zopa and Funding Circle, notched up £8.45bn of cumulative lending by the end of the first quarter of this year. Platforms must commit to publishing their full loan books, including details of actual defaults and those that are expected, as part of the joining process. The association also provides standard definitions of arrears, defaults and capital losses to help investors compare performance more readily across platforms.
Transparency has also been great for the industry, says Pettigrew – the fact that P2P platforms willingly submit to the kind of public scrutiny that would send most traditional banks into meltdown has allowed this young and innovative sector to operate under a relatively light regulatory regime.
But as the industry matures, quality and accessibility are becoming at least as important as quantity when it comes to data, he adds. “I am from a political background, and in that world the best way to hide something is to conceal it in a massive data dump,” he says. “Then you can say ‘I was open but you didn’t find it’.
“The challenge for this sector as it grows is to turn data into products that are useful and easy to interrogate, so that investors can make better decisions.”
For Crowdstacker’s Patel, whose firm is not currently a member of the P2PFA, the key point to get across is risk. He and his team go to great lengths to ensure that would-be investors are fully apprised of the fact that they are buying an investment product, with the associated risk/reward trade-off that entails.
“There is more risk in P2P and therefore more return than for example on a savings account,” he asserts. “We don’t hide the risks. In fact we have an interactive risk test on our application form, which asks questions to make sure that you understand that your capital is at risk.”
Multiple failures of this test can lead to potential investors being locked out of the platform, he adds. “It’s not a P2PFA requirement but we think it is a good approach; people need to understand the risk.”
Crowdstacker facilitates a small number of relatively large loans to small- and medium-sized enterprises (SMEs) – the maximum loan size it offers is £50m – and the investor decides which projects to back, rather than the platform. The firm has only funded four loans since its 2014 inception, the largest so far being just over £15m – offering a return of up to 5.4 per cent – to another lender, Amicus.
That model means that qualitative information – the type of business being loaned to and the track record and competence of the management team, for example – is as important as quantitative data, says Patel. “If your loan decisions are purely data driven, then providing loan data is enough. But we do a small number of heavily curated loans, so there is more to disclosure for us.”
So while he supports disclosure in principle, the idea of a standard set of data that everyone should have to publish could be more troublesome. “One area we might struggle with is expected default rates, for example,” he says. “It’s too generic. Our default rate is zero but we don’t publish that because we don’t want people to make decisions based on that.”
This highlights perhaps the biggest issue when it comes to transparency – the fact that P2P is a single term used to describe a very broad range of often substantially different business models. “It’s a very wide sector with unsecured loans to consumers at one end and very heavily secured loans at the other,” says Jane Dumeresque, chief executive of Folk2Folk, a Cornwall-headquartered lender specialising in loans to local businesses secured against property.
Coming up with a single set of disclosure standards that are fair, appropriate and useful for all these business models is a challenge. “Everybody wants to provide transparency but the data has to be relevant,” she says. “We also have to protect the privacy of the borrower under data protection rules.”
So if a borrower fails to make a payment on time, how does Folk2Folk tackle the need to treat both the investor and borrower fairly? Immediate disclosure could prompt other creditors to come knocking, causing a potential cashflow problem and jeopardising the loan and perhaps even the viability of the borrower’s business. On the other hand, investors are also understandably keen to know if a loan looks like it might be going bad.
“We have a three-day window between the money being collected by us and going out to the lender,” she explains. “If there is a problem we will sort it in that window. If we can’t, then we tell the lender.”
On the whole P2P providers have done a good job on transparency, says Neil Faulkner, founder of independent sector analysis firm 4th Way. “With P2P you get much more information about loans than you do from the manager of an equity fund, for example.”
But there is more to do, especially when it comes to comparing offerings across different platforms. The launch of the Innovative Finance ISA has even seen P2P products appearing alongside savings accounts on some consumer money websites, he points out. The kind of customers who use those sites are used to much simpler metrics which are not yet widely available for P2P.
“Too many investors assume that P2P is a safe as a savings account, but it is not,” he asserts. “The industry does need to make a unified standard for comparison, but collaborating with your peers in order to standardise is not front of mind for many platforms, which are still in the growth phase of the cycle.”
Faulkner even goes so far as to advocate that P2P lenders should bite the bullet and disclose their spread (that’s the difference between what they get from the borrower and pay to the lender). To many finance professionals the spread is their deepest, darkest and most commercially sensitive secret, and even open-minded P2P types might quail at the thought of such radical transparency. “Platforms don’t like to talk about the spread,” he says. “They worry that revealing it could allow competitors to undercut them or copy their models. But I think they are wrong.”
Well, it would certainly help silence those critics who suggest that as the sector matures it will tend to become more like the institutions it set out to disrupt. “The first one to do it might lose out in the short term but in the longer term they would win,” adds Faulkner. “It would be a real shock to find that the aggregate effect of more transparency was negative.”
It’s one thing to say you are transparent, but the proof is how you act when things go wrong. This was a test recently faced by Ratesetter over bad debts in its now-discontinued wholesale lending division.
In July, the platform announced that it had made “interventions” when a number of its former wholesale lending partners had fallen into financial difficulty, by absorbing their losses onto its balance sheet.
“We had intervened with three borrowers and felt it was important to let investors know how we had acted to protect their interests,” says Ratesetter’s head of policy and communications John Battersby. “They were three unusual sets of circumstances and the numbers involved would not get a bank excited, but we felt it was important to be very clear in our communications.”
The firm also stated that any investor who wished to withdraw their money from the platform as a result of the news could do so, fee free, for a limited time. The platform’s overall expected default rate remains unchanged at 2.9 per cent.
It’s a reminder, he says, of the differences between a bank and a P2P lender – the flipside to the greater levels of transparency is the presence of risk. “Banks promise to be safe and to offer liquidity. We do not make those promises, but we do offer a decent risk/return ratio and P2P lending is safer than the stock market generally.”
Ultimately, while greater standardisation of disclosure should make investors’ lives easier, the variety of the platforms available and the products they offer will always mean that they require more due diligence than a traditional savings product.
Caveat emptor remains good advice, says Pettigrew. “Of course, I would say this but why should anyone operating in the market be shy of adhering to [the P2PFA’s] operating principles? If there isn’t a certain level of transparency, you have to ask what they might be concealing, and why.”