Institutional money already dominates the US peer-to-peer lending market and now it’s making waves in the UK. Is this a natural evolution or is it eroding the true essence of P2P?
There was a time when marketing peer-to-peer lending was straightforward – the solid certainty of a mass of consumers standing on both sides of a P2P platform was enough to make its bank-disruption mission a success story.
People lending to people was a healing and redeeming message at a time when banks were still cleaning up the mess they had scattered around the globe by mixing consumers’ savings and investors’ bets.
With the real economy still grappling with the daunting ramifications of the banks’ subprime social experiment and grasping for credit, bringing the lending business back to basics and scrapping the evil middleman altogether seemed an irrefutable proposition.
But then the idealism of youth needs to make room for the pragmatism of maturity, and an insidious realisation started to cloud P2P’s coming of age: retail money alone is not enough to keep the ball rolling and let platforms become believable competitors of traditional lenders.
In the US, where institutional money now accounts for more than 80 per cent of the sector, this was a natural progression that magnified funding possibilities for both the platforms and the borrowers they cater for.
Institutional presence has been increasing on this side of the Atlantic too, albeit at a slower pace.
“It’s very likely that institutions will continue to bulk up the percentage of cash flowing into this sector, purely because it is a simple way to make money at competitive interest rates,” says Daniel Tunkel, head of financial regulation at law firm Howard Kennedy.
“A fund that needs to return a coupon of five per cent will be no more interested in a pointless bank deposit than an individual offered a rubbish rate at the bank.”
However, justifying such a shift in the UK may prove a tougher job, as the P2P sector here is still split by the burdensome dilemma of whether to welcome money from institutional investors with open arms or relegate it to a ‘diversification allowance’ pot.
On one hand, platforms such as MarketInvoice and Landbay make no mystery of the benefits of involving institutional money, first and foremost as a catalyst for business growth.
Some argue that amassing decent volumes from retail funds would cost a disproportionate amount of time, money and resources.
“Without it, growth would be much slower, making it difficult for many platforms to survive before they reach a large enough scale,” affirms Neil Faulkner, managing director of P2P research and comparison website 4th Way.
Without a little help from institutional friends, “individual lenders would thus have less choice of platforms,” he adds.
And retail clients stand to benefit from the institutional investors’ seal of approval, as it means the platform in question has passed its criteria.
“Institutional investment shows that the platform and its underwriting has passed serious due diligence,” says Landbay’s chief executive John Goodall.
“They validate the credit and risk underwriting models,” agrees MarketInvoice’s head of investor development Aman Mehra.
“They also ensure better standards of protection for all investors through enhanced reporting and through feedback on presentation of risks, which ultimately results in improved legal frameworks and operational procedures.”
However, other platforms are not so convinced of the validity of such an argument.
For them, the involvement of institutional investors should be restricted to the bare minimum necessary to diversify a platform’s client base.
Any other type of involvement could jeopardise the platforms’ independent decision-making process. Far from strengthening their underwriting and transparency standards, it could actually push them in the opposite direction.
“There is a danger that the platform becomes reliant on this capital and may be forced to make changes requested by that investor, which it would otherwise be unwilling to make,” says a RateSetter spokesperson.
“We’ve had cases where a certain type of institutional investor was looking for higher returns and therefore tried to influence the underwriting process,” affirms a spokesperson from a platform, on condition of anonymity.
“But we have declined to do business with them – we’re not willing to look at higher-return deals or changing our underwriting criteria just to accommodate single requests.”
Howard Kennedy’s Tunkel warns that this is a feasible scenario, whereby institutional investors would try to direct the platforms’ business. Some platforms would then arrange loans tailored to the institution’s needs and risk appetite.
However, the spokesperson speaking on condition of anonymity that the vast majority of institutional investors interested in P2P tend to be on the cautious end of the risk/return spectrum.
“Most institutional investors are not particularly creative – those investing through our platform are at the lower-risk end of the spectrum and have an interest in the process complying with strict due diligence requirements,” the spokesperson explains.
Nonetheless, their presence seems to prompt an equal level of optimism and concerns.
“Their involvement would be a way of getting money into the economic system, which can offer marvellous opportunities,” comments Tunkel. “But it could be calamitous if the same money goes around, which is what happened with Lending Club in the US – there must be a means to an end.”
The largest US P2P lender was running a 70 per cent ratio of institutional funds when its corporate governance scandal started to unfold.
According to an industry source, the mix-up of retail and institutional money could be the main hurdle standing between some of the UK’s largest platforms and Financial Conduct Authority (FCA) approval.
In the not-so-distant future, regulators could go as far as requiring a clear separation of retail and institutional investments through P2P platforms, the source says.
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Transparency is pivotal to the P2P sector – both from a regulatory and reputational standpoint. The City watchdog’s recent enquiry into P2P wholesale lending activities has raised awareness of the risk of losing track of the end borrower.
But wholesale lending can take place on the other side of the P2P equation and the FCA may soon take steps to head off risks of losing track of retail money.
“The last thing the FCA wants to see is the retail element of the business being diluted or disadvantaged,” says Relendex’s chief executive Michael Lynn.
“[Retail investment] is still such a strong selling point to so many people, and such a big issue in terms of the platforms’ reputation, that I believe many of them will always hold on to the original ideals, and profit by doing so,” says Faulkner, who believes that platforms who fall short of prioritising this vital aspect may be doomed to fail.
“I would consider that a failure of many major P2P lending platforms, if they are unable to communicate to individuals that they offer the key benefits of investment funds without the additional layer of costs,” he adds.
If institutional investment penetrates the UK market as heavily as it has done in the US, individuals could end up paying institutions an extra layer of fees to pick P2P loans for them when they could easily avoid those fees and diversify across thousands of loans for themselves by lending directly.
“That would be a lot of intermediation in a market we’re trying to disintermediate,” comments one industry source.