2019 IS SHAPING UP TO become the year of the institutional investor. Over the past few months, hundreds of millions of pounds has flooded into UK-based peer-to-peer platforms from a variety of global institutions, all seeking to access the competitive returns of a well-regulated alternative finance provider.
According to the most recent figures from the Cambridge Centre for Alternative Finance, 32 per cent of P2P consumer loans and 26 per cent of P2P business loans were funded by institutional investors as of 2015, and the share of institutional money is likely to have grown since then. This was widely viewed as being a good thing for the UK’s P2P sector.
But then we were contacted by a former Trustbuddy executive who had a very different experience with institutional money. Stockholm-listed Trustbuddy was the first high-profile P2P platform to collapse, filing for bankruptcy in 2015 amid allegations of misconduct.
The anonymous employee told Peer2Peer Finance News that “there is way more to the Trustbuddy story than was ever told in the media.”
“The real truth about what happened in Trustbuddy took place during the years 2013-2015, when fund managers in London and New York were desperate to get into Prosper and Lending Club but they had to settle for Trustbuddy,” the former employee said. “The effect this had on the company was actually quite extraordinary.”
This influx of institutional money led to rapid growth at Trustbuddy – which was at that point the only listed P2P platform in Europe. In the first six months of 2015, the platform processed more than £10m in of loans and planned an expansion into the UK market. Then in the summer of 2015, an executive reshuffle led some new board members to suspect financial mismanagement. Once this became public, the company’s share price took a nosedive, a legal case was filed and the company ultimately went into administration.
In May 2017, state prosecutor Ted Murelius completed his investigation by concluding that there had been no evidence of misconduct at the firm.
This story raises some serious concerns about the unintended consequences of institutional investment. Trustbuddy’s fate was sealed when it became over-reliant on institutional money, which could be withdrawn as quickly as it was invested.
The Trustbuddy story is particularly relevant in the current investment environment, where institutional money is increasingly being viewed as an easier alternative to the much more complex world of retail investment. “To be brutally honest, it’s easier dealing with five institutions than with tens of thousands of individuals,” says one industry insider who asked to remain anonymous. “And if you think about what we’ve got coming up in terms of upcoming regulations, we are going to have to have all these appropriateness tests and that’s likely to involve a lot more hard work.”
Influx of money
To date, retail investors have been seen as the priority among P2P lenders. They have been courted with television ads and social media campaigns, while platforms have pushed consumer education and risk management to the forefront of their websites. For many of these individuals, institutional investors represent a threat to their funds. There are concerns that the size of these institutional investments could result in fewer opportunities being left over for retail investors. There is also a fear that through the sheer weight of their wealth, institutions may be able to request certain changes to the platforms’ risk assessments and credit checks. Several platforms told Peer2Peer Finance News off the record that they have had to change their lending criteria in order to make themselves eligible for certain institutional funds.
“There are some drawbacks of institutional involvement in P2P that retail investors should be aware of ” says Iain Niblock, chief executive and co-founder of Orca. “The main concern is the potential conflicts of interest that may arise, which could see institutions choosing the best deals from platforms to the detriment of retail investors.
“But while there may be some concerns, growing institutional involvement, on balance, should be seen as a positive sign for the P2P sector.
“Institutional involvement means more capital for lending and an increased demand for robustness in the credit and business models involved, which in turn helps to grow the sector and stabilise the businesses of the platforms. As platforms become larger and more profitable, we could also see cost savings passed onto retail investors.”
It should be added that Financial Conduct Authority (FCA) regulations prevent institutional investors from selecting the best loans from consumer-focused platforms, and many P2P platforms have introduced their own measures to protect retail investors from being outbid.
“We will not permit cherry-picking of loans by institutions and we have a randomiser to prevent adverse selection against any investor, retail or otherwise,” says Law. “Nonetheless, there is a greater mitigant to cherry-picking risk and that is our unique marketplace which today allows retail and institutional investors to share the fractional funding of loans on pari passu terms, rather than institutions taking whole loans only.”
Assetz Capital is one of the many platforms which has created its own retail-friendly model. For instance, property-backed P2P lender Loanpad employs a hybrid model of lending, which sees institutional investors take on the higher-risk pieces of any given loan, leaving the lower risk remainder for retail investors. Although retail and institutional investors are still investing in the same loans, that institutional element effectively shields individuals from the higher-risk portions of each loan.
Read more: Assetz launches institutional fund
Other platforms have opted to accept institutional money specifically so that they can grow the retail side of their business and create more lending opportunities for existing users.
Flender, Lending Crowd, Growth Street and CapitalRise have all accepted growth funding from institutions in recent months. And in March, MarketInvoice announced that it had secured £100m of institutional funding to enable the platform to offer larger deals. But the two biggest institutional moves of the year were made by Funding Circle and Assetz Capital.
In April, Funding Circle announced that it would be launching a UK private direct lending fund and a UK bond product, with the aim of attracting more than £200m from institutional investors over the next few years.
The following month, Assetz Capital launched its first Luxembourg-based private fund in order to attract more institutional money to scale up its lending. Earlier in the year, Assetz signed a series of funding agreements with institutions including Germany’s Varengold Bank, a European family office, and an unnamed credit fund. The total value of these investments is believed to have been upwards of £110m.
However, Assetz Capital’s Law insists that this institutional influx has not come at the expense of retail funds. In fact, he says, retail investors can take comfort from the fact that institutions have chosen to back their platform.
“We see substantial institutional investment into P2P lending in the coming years but only into those platforms which can provide great credit quality, strong net returns as well as good liquidity,” he says. “Our growth has been very strong and now there is a lot of capacity for institutional investment.”
ThinCats has taken a similar approach. It was one of the first platforms to pivot towards institutional funding, raising more than £700m from institutions over the past two years, compared with just £100m from retail investors. However, chief executive John Mould has reassured retail investors that their money is treated no differently to institutional money, adding that they will actually benefit from the enhanced due diligence that attracted those institutions to begin with.
Finding a balance For now at least, it seems that the P2P sector is managing the balance between retail and institutional investors. According to the latest figures, cumulative lending from the Peer-to-Peer Finance Association’s eight member platforms totalled more than £10bn – and that is not representative of the entire P2P industry.
Meanwhile, Innovative Finance ISAs (IFISA) – which are only open to retail investors – are thought to have attracted £1bn. In the same month that it launched its institution-only investment fund, Assetz Capital attracted a record £13m into its IFISA funds, bringing its total IFISA investment to £90m.
This suggests that there is plenty of room for both retail and institutional investors, just as long as platforms don’t get carried away by the lure of the multi-million pound investment.
Some industry onlookers have suggested that what happened at Trustbuddy could possibly have been avoided if its institutional investors had a better understanding of the platform’s business model, and were prepared to commit their money over the long term.
“Maybe the secret for all these platforms is to just pick the right type of investor,” says John Mould, chief executive of ThinCats. “Be that the retail investor who understands the asset class, or the institution that is committed to making long-term investments. In both cases, it’s about making sure that the investors understand the risk and the importance of diversification, as well as the fact that they are investing in a long-term illiquid asset.”
As more and more institutional funds start to pay attention to P2P, platforms will need to be extra careful to prove that they have best-in-class credit processes, and a sustainable plan for growth which does not rely on just one or two high-profile backers.
Fortunately, the vast majority of UK platforms appear to be taking a prudent approach to institutional investment, which should hopefully spur them on to their next stage of growth without alienating the individual investors who made the industry what it is today.
This story first appeared in the print issue of Peer2Peer Finance News, which can be read in full here.