Tag: alternative finance

Peer to Peer Lending Regulation: the benefit for SMEs

Author
Angus Dent
Date

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A recent article written by Dr Avinash Persaud of Intelligence Capital caught my eye this morning in which he discussed the major issue of financial regulation and the difficulties facing SMEs in trying to raise finance through the traditional lending avenues. Persaud is a well-qualified source of knowledge: a former governor of the London School of Economics, a former member of the UN Commission on Financial Reform and a visiting scholar in both the European Central Bank and the International Monetary Fund, as well as the Chairman and former employee of a range of private, public and investment banks. The article is written for an Indian digital newspaper, but it certainly is written from a global outlook. It can be found here:  http://www.livemint.com/Opinion/fQpaevJ8DX7KUpwBVdeXQK/Crowd-financing-is-not-banking.html

I have identified two important points from his article. Firstly, he is at pains to highlight the importance of facilitating finance to SMEs to drive economic growth, and he recognizes that banks cannot be expected to provide all of the finance. He recognizes that “a large part of the problem of financing development is not the absence of cash but an inability to mobilize it“. In my view, this is the result of the lending vacuum left in the wake of the Basel III rulings that ensure banks must have proportionately more capital in the bank when lending to small businesses than they would lending to more established businesses, tying up more of funds than banks would like. Dr Persaud recognizes the need to “use technology to match untraditional borrowers with untraditional lenders and provide opportunities for diversification and other forms of risk and information management.” Persaud fails to recognize that the bulk of the lending can come from institutions who will pledge alongside individuals on the same terms. Dynamic, flexible and secure Peer to Peer (P2P) crowdlending platforms that are properly regulated will fill the SME lending vacuum, facilitating finance from SMEs from a range of institutions and investors whose money would otherwise be unavailable to borrowers.

Dr Avinash Presaud
Dr Avinash Presaud

This leads me to the second main point: regulation. I think Dr Persaud is right to highlight the importance of differentiating lending platforms from traditional banks, a job that the regulators must do to ensure that prospective lenders know exactly what the risks are. The P2P industry itself wants FCA regulation for clarity as much as credibility. Regulation needs to be a long, drawn-out process to avoid simply bracketing it with banking regulation. Persaud reasons that “regulating crowd financing platforms as a bank and not an exchange would not only undermine the point of it, but would create systemic risks”. However, Persaud’s belief that P2P alternative finance platforms should drop “conventional” nomenclature is not necessarily the answer. I disagree with his statement that the banking terminology “Market Place lending” shouldn’t be used by alternative finance P2P lenders because that is exactly what is on offer to SMEs wishing to borrow money and individuals willing to lend.

In the words of Dr Persaud, “moving to the next level of social and economic development depends on these borrowers getting through”, which in turn depends on regulated Peer to Peer crowdlending platforms facilitating the finance from a range of savvy individual and institutional investors.

A Response to Robert Reoch’s article on The Growth Outlook for Market Place Lending

Author
Angus Dent
Date

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Thomson Reuters recently published an informative blog post in which Robert Reoch offered his views on the “growth outlook for marketplace lending.”

In his role as Global Head of Products and Strategy at Crowdnetic, a provider of technology and market data solutions to marketplace lending companies (MPLs), Robert is part of a team which aims to educate investors and institutions on the direction in which the  alternative finance industry is moving. MPLs have been quick to offer an alternative finance source to SMEs, providing a service distinct from the antiquated and costly financing options that banks in particular had been providing. And as the industry has grown, innovation by FinTech companies has seen the provision of increasingly niche and bespoke services, as competitors attempt to stand out from the crowd and bid to woo investors. Yet I agree with Robert’s statement that “there is real economic benefit for banks to actively collaborate with MPLs” in order to attract prospective borrowers.

MPL subsets

The MPLs that are most successful could be those that actively maintain a symbiotic relationship with a specific bank or banks. The banks would provide the MPL with a network of suitable borrowers who at the moment just aren’t aware of the opportunities out there.In return, as pointed out by Robert, banks can keep their fee-paying client “without the associated balance sheet and the capital cost”. In light of such exposure, the cost is minimal for the MPL, who would also save on often unnecessary and expensive advertising campaigns, especially as a much smaller group of institutions rather than a large pack of individuals is increasingly seen as the future of the ‘crowd’. This in turn helps Borrowers, who can receive funding faster and with a lessened prospect of a project going unfunded.

MPL bank lending

As Robert alluded to, it remains to be seen how much of the enormous market MPLs can gain access to. After all, a percentage point or two would transform the MPL industry and create a flood of funding to SMEs. The timing couldn’t be better. UK business lending from banks in June 2015 saw the sharpest fall – almost £5.5 billion – in at least four years (since records began). And with SMEs positioned as the main drivers of UK GDP, it is in the best interest of all involved that these businesses receive the finance they need to grow. Marketplace lending companies will be chomping at the bit to fill the void left by the banks; it remains to be seen when the shift happens.

The Case for Diversification across the Crowdfunding Risk-Reward Spectrum

Author
Angus Dent
Date

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Ten years on from the creation of the world’s first peer-to-peer lending platform, the alternative finance sector’s stupendous rate of growth has rendered it unrecognisable. This has been a decade in which cumulative funding by UK platforms has risen from under £50,000 to almost £3.4 billion, driven by a proliferation in the number of platforms in existence as well as in the scope of their models and products.

The factors that have catalysed the development of alternative finance and allowed the sector to shake off its “cottage industry” credentials are manifold and too broad to discuss in this particular post. Symptomatic of its increasing importance, though, is the level of interest with which national authorities have begun to approach it; the FCA stepped in with a raft of legislation in April 2014 to begin the process of regulating the sector, whilst the government continues to postulate the benefits of including P2P lending within the ISA framework. Both of these activities serve to validate the growth that has taken place and to further legitimise alternative finance as a new investable asset class.

Indeed, it is hoped that such high-level involvement will encourage those who have been watching the space’s growth from afar, such as the IFA community, who have so far trodden a cautious line, to begin to engage more readily with the sector for the benefit of themselves and their clients. Underpinning the reticence that can still be found in some quarters, though, is the question of how alternative finance should be approached as an asset class and included within an investment portfolio. After all, the growth that has taken place has engendered much greater complexity, with the numerous products now on offer carrying different rates of risk and return.

In my opinion, the answer is to look for diversification. Diversification is a central tenet of Modern Portfolio Theory and its benefits have been frequently extolled since the 1950s. In recent years, however, the concept has come under some scrutiny. Active fund managers who heavily diversify their funds are often lambasted as “closet-indexers” – those whose funds simply replicate the performance of their benchmarks, but at a greater cost to the consumer due to their hefty fees. As cheap passive investment vehicles such as ETFs become more common, it is argued that this approach is unsustainable and active managers should maintain a smaller, “conviction based” portfolio to achieve outperformance. Yet whilst the world’s foremost investor, Warren Buffet, conforms to this viewpoint, casting over-diversification by professionals as mere “protection against ignorance,” he acknowledges that the concept retains its relevance for those without his powers of prescience, namely individual investors. And with the majority of investors gaining exposure to alternative finance without professionally managed vehicles, diversification remains important.

Strategies for achieving diversification are potentially numerous, and could include spreading investments across different platforms, geographies, products and risk-grades. A well-constructed portfolio that adopts such strategies should grant good exposure to this exciting sector, whilst simultaneously mitigating the risk to the investor. For example, an investor might look to higher grade business loans, higher grade consumer loans, and loans secured against property as the low-risk bedrock of their portfolio. The next risk band might contain medium-grade business loans as well as loans facilitated by foreign platforms, which whilst achieving geographic distribution could also bring in the risk of currency fluctuation. Finally, the highest risk section of such a portfolio would likely be composed of equity crowdfunding propositions, which carry the greatest potential rewards of all but also a significant risk of failure.

Whilst lowering risk for the non-professional investor is perhaps the most obvious benefit of diversifying a portfolio in this way, it also serves to allocate investors’ capital in a way that is equitable and consistent with the aims of a sector that developed to bolster investment to individuals and undercapitalised businesses. With reference to businesses specifically, it has been estimated that there will be a funding shortfall for SMEs of £84-191 billion between 2012 and 2016 as traditional sources of finance remain stifled. Spreading investment across the spectrum of opportunities, investing in the debt and equity of diverse businesses at different phases in their growth cycles, which are united by their need for a cash injection, spreads the benefits of this new mode of funding. It is best for investor security, and best for the economy.

Banks ‘Straitjacketed’, Alternative Finance Growth ‘Fantastic’

Author
Charlie Mahalski
Date

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Thanks to the jaded approach to economic policy of the two main political parties we have no balanced, imaginative and focused ideas to provide hope for pulling us out of recession and rebuilding the economy. At ArchOver, we believe that an economic policy focused on small companies is the ‘big idea’ that is needed.

Small businesses are the lifeblood of our economy. They dominate employment and vital innovation. There are five million such businesses giving direct employment to at least 11 million people. A further circa four million aspire to work for themselves.

We recognise good ideas when we see them and the right wing but independent think tank, The Centre for Policy Studies, has produced a paper ‘The Road From Serfdom’ which brilliantly outlines the importance of small companies to the economy.

The paper was written by Lord Saatchi, a former chairman of the Conservative Party and a Thatcherite to his bootstraps. Margaret Thatcher was excited by the idea of popular capitalism and, in the context of attracting secured and insured capital to fund small companies, so are we.

In a closely reasoned paper, Lord Saatchi suggests that if all corporation and capital gains taxes were removed from small companies, the £11 billion cost to the Treasury would be eradicated in the life of one Parliament and then we would have the annuity benefit of small companies to lift and revitalise the economy for the future.

We are sceptical about the political appeal to our jaded leaders of the £11 billion cost, in these straightened times, but we like the imaginative approach.

Small companies are about economic growth but they are also about social well-being. People who run small companies are able to follow their own instincts and ideas. They avoid the frustrations revealed in a study of 1,000 young employees by the financial services firm EY. It has found that fewer than a third believe that the companies they work for are sufficiently innovative and 82 per cent claim they have ideas that might have been used to create new opportunities for their organisations had they been not ignored. As a result, a stonking 70 per cent of these young people would rather set up on their own than work for somebody else.

The two major parties have paid lip service to helping small businesses and credit must be given to Government initiatives to make it easier to register patents and making it less onerous to set up companies. There is also the support that’s been given to small businesses and, in particular, to the alternative finance, crowd-lending sector, through the Business Bank. These are worthy initiatives but they are tinkering at the edges of the issue. Now, radical policies are needed to rebalance the whole UK economy in favour of small companies.

The fact that the banks have been put in a straight jacket by European Union Basel III agreements, which stop them from lending, is killing small business. The Bank of England has pointed to the fact that just four banks control more than 80 per cent of all lending to companies. It identifies a £14 billion annual shortfall in lending to those vital engines of our economy.

The alternative finance sector can be a major source of finance for these small companies. It is growing at a fantastic rate partly because low interest rates attract investors who are seeking higher returns and also because both lenders and borrowers are sick of dealing with the banks and other large financial institutions. The brand new sector shows every prospect of being able to fill that £14 billion gap and more.