The peer-to-peer lending sector has evolved considerably in recent years, thanks to new platforms, new innovations and new regulations. What does the future hold for the industry and its customers? Emily Perryman reports
THE PEER-TO-PEER lending industry has gone from strength to strength since the sector’s first platform, Zopa, launched back in 2005. The past decade-and-a-half has seen a multitude of platforms come into existence, the creation of the Innovative Finance ISA (IFISA) and the UK’s first P2P listing on the London Stock Exchange.
The next decade looks set to bring a whole host of fresh opportunities and challenges for the sector. It is widely expected that another recession is just around the corner, which could see more consumers and businesses turning to the P2P industry for finance. P2P lending surged in popularity during the last recession as traditional bank lending was severely curtailed and interest rates were slashed.
“There is bound to be a recession fairly soon – not necessarily because of the UK or Brexit specifically, but because the global economy is turning down and there are big challenges ahead,” says Stuart Law, chief executive of secured business and property lender Assetz Capital. “When the next recession comes, interest rates will drop again to near zero or even go negative and, regardless of the Countercyclical Capital Buffer (CCyB) that banks have been building up, I don’t believe they will lend more than they did in the last recession. The CCyB might help banks lend to very big corporates and microbusinesses, but the mass of small- and medium-sized enterprises will see a complete drying up of bank lending like they did last time.”
Some experts don’t think the next downturn will have quite as big of an impact on the P2P sector as the recession of 2008-09 did. The last recession was accompanied by a huge credit crunch, resulting in a serious shortage of capital for potential borrowers. New lenders were able to step in and fill that gap through an innovative approach to technology and heightened demand from investors and borrowers.
“This time round we have had platform failures and we have larger platforms with live loanbooks. When the recession hits we will see if the lending they have done is robust enough to still generate a positive net yield,” says Andrew Holgate, chief executive of fintech consultancy Equitivo. “P2P has the potential to provide liquidity to underserved markets again, but only if the platforms remain robust through the cycle.”
Regardless of the extent to which P2P lending replaces traditional bank lending in the next recession, it’s likely platforms will increase rates and lend with a lower loan-to-value (LTV) to protect against the risk of security values dropping. When Assetz Capital first launched, it was offering loans with an LTV of 50 per cent and interest rates of around 15 per cent. “That was entirely acceptable to businesses who needed finance because they couldn’t get it anywhere else and it was necessary to protect lenders,” says Law.
Another consequence of the next recession could be higher default rates, particularly as the P2P lending industry matures. Brian Bartaby, founder and chief executive of P2P property lender Proplend, argues that we are already in a recessionary environment and, as a result, he expects to see an increase in default rates from previous years’ originated loans.
However, he says good platforms should be able to determine where they are in the credit cycle for their specific asset class, and then tailor their credit decisions in order to mitigate defaults. How well platforms are able to do this could be an important factor in attracting new investors.
“The ability to continue to grow investor numbers is linked to the ability to originate creditworthy borrowers and this will vary across different P2P loan asset classes,” says Bartaby. “New investors will be drawn to platforms that have shown they are capable of monitoring where they are in the credit cycle and manage their credit policy appropriately. This should deliver consistent creditworthy borrowers within their loanbook.”
The pace of market growth is expected to be slower than in the past, simply because the industry is considerably larger than when it first started out. Neil Faulkner, founder of P2P ratings and research firm 4th Way, says the industry is more likely to be impacted by economic events and competition. “This means that in terms of ongoing growth we may start to see some interruptions along the way,” he warns.
IFISAs, on the other hand, account for less than 0.5 per cent of all ISA investments, which suggests there is still plenty of room for growth for the P2P industry’s taxfree wrapper.
“I think the market overall is still looking positive,” says Frank Brown, managing consultant at Bovill, a financial services regulatory consultancy. “We’re seeing new entrants into the market and platforms expanding their offerings and propositions – for example with IFISAs, which as a very new side of the market offer plenty of opportunities.”
The biggest challenge facing the industry in the near term will be incorporating the Financial Conduct Authority’s (FCA) new P2P rules, which come into effect in December. Platforms’ marketing will be restricted to high-net-worth and sophisticated investors, those who have received regulated advice and everyday investors who pledge not to channel more than 10 per cent of their portfolio into P2P loans. Platforms will also need to check investors’ knowledge and experience of the asset class, as well as comply with higher regulatory standards and new conduct of business rules.
It is thought the higher standards will help to pull some platforms into line, ensuring they make their offering clearer to potential investors. Restricting how much can be invested in the first year will also give people time to get to grips with how P2P lending works before parting with larger sums of money.
“The huge downside is that it sends the wrong message about the industry,” says Faulkner. “Money lending, including P2P lending, contains lower intrinsic risks than share investing, on average. Many retail investors will incorrectly consider the restriction to be a warning that it is higher risk and so I foresee a sharp drop in new investors at many platforms when the new rules come into force. Some platforms will choose to offset this with greater focus on sales to institutions and through financial advisers.”
Many experts think the new rules will force some platforms to exit the market, particularly if higher compliance costs come alongside tougher economic conditions. Frank Wessely, partner at advisory firm Quantuma, says platforms on the whole have taken a long time to achieve profitability, which could be a deterrent to smaller firms.
“We’ll probably see more platforms interested in acquiring other platforms’ loanbooks and growing that way,” he suggests. It’s possible the ‘big three’ – Zopa, RateSetter and Funding Circle – will increase their dominance of the sector as smaller, more niche players struggle to compete. “Consolidation of the number of P2P platforms – and across fintech more generally – is inevitable,” a spokesperson for RateSetter says.
“In the P2P sector, just like any other, businesses that are not up to scratch simply do not continue for long, while those that are well-run with solid business models grow. It’s a Darwinian process that will result in a stronger, better P2P sector. Our view is that tighter regulation, by design, will also hasten the exit of sub-standard platforms, ensuring that well-run platforms which put the customer at the heart of their model will endure and grow.”
Tougher competition could also fuel greater innovation in the industry, especially once platforms have finished embedding the new FCA regulations. Industry onlookers predict Open Banking will mature and that artificial intelligence will be increasingly used in credit decisions. There could also be innovations that improve the way retail investors engage with the market.
“The ASMX platform [a new blockchain-backed secondary market for trading private debt] has the potential to revolutionise how retail investors engage with multiple platforms and provide market-wide liquidity,” says Holgate. “I also think the way in which retail investors are exposed to risk will change and there are some exciting ideas being discussed on this.”
Bartaby reckons the future will see more collaboration between “fin” and other forms of “tech”, such as property, insurance and regulatory tech. “There is a very interesting ecosystem of companies evolving that could enable P2P platforms to become more efficient and hopefully write better loans,” he says.
“They could be providing new data sets, helping to make the origination or underwriting of loans become more efficient, or providing data to assist with the monitoring of loans through the life of the loan. New proptech companies are springing up every month and we continue to monitor these to see if they can help us in any way.”
With new technology, regulations and a tougher economic environment on the horizon, the next decade could prove to be just as exciting as the last.