The might of the Square Mile
The attractions of the peer-to-peer lending sector are obvious to retail and institutional investors alike. But will the latter’s financial firepower push out the former as platforms look to scale up?
THE PEER-TO-PEER lending sector was borne out of a need to connect individual lenders and borrowers.
The concept took off in the UK in the wake of the credit crisis, as banks curtailed lending activity and interest rates tumbled. This resulted in paltry interest rates on savings accounts, which encouraged disappointed savers to look elsewhere for income.
Fast forward nine years and the sector is thriving. By the end of March 2018, the UK’s largest P2P platforms were responsible for almost £9bn of cumulative lending, according to the Peer-to-Peer Finance Association (P2PFA). This represented a 57 per cent year-on-year increase.
While the sector continues to expand, so too does the role of institutional funding. In the US, institutional money accounts for more than two thirds of P2P funding – and although the UK remains some way off, it is fast making up ground. The Cambridge Centre for Alternative Finance found that institutions were responsible for 32 per cent of P2P consumer lending, 28 per cent of P2P business lending and 25 per cent of P2P property lending in the UK in 2016. Since then, institutional involvement has grown.
For example, the British Business Bank has invested £135m through a number of P2P platforms in recent years, including Funding Circle, Zopa, RateSetter and MarketInvoice. What’s more, the state-backed development bank is currently in talks to provide Funding Circle with £150m for SME lending.
MarketInvoice is one of the platforms that has piqued the interest of institutions. In early August, Barclays took a minority stake in MarketInvoice and said it would provide funding to the business finance platform. As part of the deal, the high street bank will also roll out the platform’s invoice financing technology across its network.
“It’s exciting to be combining the knowledge and footprint of a 325-year old British banking institution with MarketInvoice’s tech-led online finance solutions,” said MarketInvoice chief executive Anil Stocker when the deal was announced.
In addition, MarketInvoice secured £135m of fresh funding from Portuguese bank Banco BNI Europa and Germany’s Varengold Bank to support larger invoice finance deals in March. This followed a tie-up with Investec, announced last December, which saw the bank commit £50m of funding during the first year of the partnership.
Institutional funding provides platforms with scale and allows them to balance lending and borrowing activities. However, critics warn that a growing reliance on institutional investors is causing the P2P sector to move away from its original intention of helping savers to earn an attractive income on their savings.
In addition, there are concerns that institutional money may come with strings attached, with pressure applied to platforms to cherry-pick the best loans.
RateSetter represents a P2P platform that is not reliant on institutional money, with around 96 per cent of funding coming from retail investors.
“If corporations or an institutional investor wanted to invest with us, they could do so and we would be happy to talk to them, but the requirement is there can’t be different treatment for one type of investor compared to another,” explains John Battersby, RateSetter’s head of policy.
He said the platform is looking to diversify its funding and is open to all types of investors – retail, corporate and institutional – who will be treated fairly.
“We think a deep, liquid market is advantageous to all of our investors,” he says. “We can achieve a more liquid market in different ways. Number one is to attract more retail investors. Another is to diversify the type of investors as well. They are both things we are open to.”
Even if RateSetter attracts more institutional investors in the future, Battersby said the platform is keen to ensure that retail investors continue to gain access to the asset class.
“We want to open up the asset class in a way that is very simple and easy for investors of all types to access,” he adds. “This lies at the heart of what we are about.”
ArchOver, which specialises in P2P business lending, currently has an 80:20 funding split in favour of retail investors. Chief executive Angus Dent hopes that retail investors will continue to provide the majority of loans via the platform.
“ArchOver’s ethos has always been to give the ordinary person access to a higher rate of interest, a higher return on their money, as well as access to this asset class,” he explains. “Therefore, the majority of the lending we have over the platform is from individuals, smaller family offices and familycontrolled companies.”
Dent is concerned that the growing involvement of institutions runs the risk of blocking ordinary savers from investing in P2P.
“I like the idea of proper P2P, which is about individuals and smaller family offices lending to businesses they like,” he says. “That’s the power that the internet brings and the ability to have that matching. I think ultimately that is the way forward.
“If it goes down the route that the US has gone down, there is a risk of getting lost. Businesses like ArchOver will just become another institutionally-funded lending house. We have had those for hundreds of years. There is nothing new in that.”
While he is keen to keep the retail investor at the heart of ArchOver’s proposition, he adds that diversification of funding is important. To that end, he suggests that institutional funding on ArchOver’s platform may increase to 30 per cent over the coming years.
Carl Posern, a structured finance partner at law firm Pinsent Masons, believes the positives outweigh the negatives when it comes to institutional involvement in the P2P sector.
He describes the pre-funding of loans by institutions as a “common-sense approach”. This is because it is not financially effective for platforms to pre-fund loans using their equity, particularly as this can prove expensive. With this in mind, cash-rich institutions provide a logical solution.
“Currently with low interest rates, it becomes attractive for a platform to fund itself not through peers but through cheaper institutional funding,” he adds.
Jake Wombwell-Povey, chief executive of P2P investment manager Goji, agrees that it is expensive for platforms to rely solely on retail investors for funding.
“It helps these guys [platforms] to get big ticket funds under management – rather than going to investors asking for £1,000 a pop, which takes a lot longer and can be quite expensive,” he explains.
If a platform receives institutional backing, Wombwell-Povey says it should be viewed as a sign of credibility. This is because the institutional investor has undertaken extensive due diligence and tested the platform’s systems and controls.
Neil Faulkner, founder of P2P analysis firm 4th Way, believes institutional investors are essential to the future success of P2P. If there were no institutional involvement in the sector, he says this would represent a “massive warning sign” to retail investors, indicating an unattractive risk-reward trade-off.
“Institutional investment is also essential for some platforms to work properly,” he asserts. “They need to attract large amounts of money in order to be profitable. They have to get to a certain scale, and without institutional money a lot are simply not going to do it.”
Faulkner notes that institutional funding helps platforms to balance investors and borrowers at any one time, providing stability. If there is any kind of imbalance, this can hold back a platform’s future growth.
John Goodall, chief executive of buy-to-let P2P lender Landbay, believes it isn’t simply a question of institutional versus retail funding in the sector because both have a place.
“We still give retail investors the opportunity to invest in buy-to-let loans, so nothing has changed there, but we can also get additional sources of capital into the buy-to-let mortgage market which didn’t exist in the past,” he says.
When Landbay first started, it was exclusively funded by retail investors. Over time, the platform has attracted institutional funders and today they account for a significant proportion of lending via the platform.
“My general view is from our borrowers’ perspective, diversification of the source of capital is a good thing,” he affirms. “It means as a business we are more stable and consistent through the cycle.”
He believes it is important to consider where criticism towards institutional backing is coming from.
“Often, the loudest critics of platforms that take institutional capital are those platforms that have been unable to get institutional funding themselves,” he says.
Goodall explains that loans are allocated randomly on Landbay, so preferential treatment cannot be given to any type of investor.
“In terms of P2P businesses, we need to get to a certain scale to become profitable,” he adds. “Helping us to scale means we can get there earlier and quicker, which is also reassuring for retail investors.”
As institutional funding continues to pour into the sector, what lies ahead?
Faulkner expects institutional involvement will continue to increase, with the potential for further investment trust launches.
“It [the industry] will become more institutional and I think there will be a lot more investment funds,” Faulkner predicts. “The platforms will do it themselves and there will be more funds available on the stock market. That will occur as the industry scales.”
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Goodall agrees that institutional funding in P2P represents an inexorable trend.
“I would expect to see different types of institutions funding loans,” he comments. “From where we sit, we see quite a lot of potential interest in the types of loans we are doing from institutional investors. We would certainly expect to attract more institutional capital over the next 12-24 months from different types of institutions.”
The growing presence of institutions in the P2P sector appears to be unstoppable – whether this will benefit or disadvantage the retail investors who helped build the industry into what it is today is yet to be seen.
This article featured in the September issue of Peer2Peer Finance News, now available to read online.