Peer to Peer Lending Regulation: the benefit for SMEs

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Date

9th October 201517th May 2016

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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.

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.

Productivity, Interest Rates and SMEs

Author

Angus Dent

Date

6th October 201517th May 2016

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Last week, the Office for National Statistics (ONS) announced that productivity in the UK grew at the fastest rate in four years, finally exceeding the pre-economic crisis levels of 2007. A rise in productivity is significant because it is seen as a crucial measure of an economy’s strength and future GDP growth, taking in to account living standards, capital and labour resources. For too long the UK has lagged behind the other G7 countries in terms of productivity: this looks set to continue despite the good news, as gains in productivity are offset by persisting low confidence in UK manufacturing. The incoming UK minimum wage hike will also have a marked effect on productivity as labour hours will cost businesses more.

So what is the effect of macroeconomic productivity on small businesses? Productivity is a key measure that the Bank of England uses to determine interest rates, which are currently kept at record lows. There has been a huge amount of speculation as to when the interest rates will be increased and this news should support those who think a rate hike will be sooner rather than later. Small businesses looking to borrow money will be amongst those monitoring the situation, particularly those with loans with a variable rate. However, the Bank of England typically follows the lead of the US Federal Reserve when altering the interest rates, and it is hard to see any great change any time soon. In the current uncertain global financial and geopolitical climate, analysts are not predicting the first rate rise until spring next year. When that does happen, Mark Carney, the Bank of England’s governor, has stated that increases will be “limited and gradual”. Any changes will take time to filter through to the real economy and SMEs in particular.

A raise in productivity is undoubtedly a good sign the UK economy is finally dragging itself out of the doldrums, yet we are still 18% worse than we would have been if the pre-crisis productivity rates had been maintained. It is not just a case of everyone working a bit harder; investment in public infrastructure and fiscal policy will be the defining factors that will hopefully see the UK catching up with everybody else. Small businesses can expect to benefit from increased productivity and subsequent better living standards for its workers, but should be carefully monitoring an imminent interest rate hike when budgeting for the next couple of years.

Demystifying Peer to Peer Lending

Author

Angus Dent

Date

1st October 201517th May 2016

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Following on from the two posts that explain equity and reward based crowdfunding, we move on to debt-based crowdlending, also known as Peer to Peer (P2P) lending, sometimes Market Place lending and in FCA speak as debt based investing. For brevity I’ll use P2P, although this is somewhat confusing as some of the borrowers are businesses, or P2B. A newcomer to alternative finance, whether it be through conversation or news, is more likely to have heard of crowdfunding, largely due to press interest in that specific area of FinTech and in particular the innovative crowd raises that businesses and individuals have employed. Yet in the UK, the P2P lending industry is worth just under £4.5 billion, compared to £132.5 million cumulative total raised through crowdfunding. Borrowers are attracted by a less clunky process that is competitively priced and easy to use. The vast range of alternative finance solutions available means that both businesses and consumers can find a loan tailored to their needs. Lenders, meanwhile, are drawn to the sweet spot of statistically lower risk investment at interest rates that go beyond the bounds of anything offered by a bank.

The P2P lending sphere can be broadly broken down into three categories: P2P consumer loans, P2P business loans and invoice financing. The biggest player in the consumer loans market is Zopa, who are the oldest and arguably the biggest alternative finance company in the world. They have lent over £1 billion to consumers at an average loan size of £7,500, offering investors a return of 5%. Every consumer loans company is only as good as their borrowers; Zopa have reported 0.04% actual defaults so far this year, a figure which is made even lower by the Zopa Safeguard Trust which helps pay-out in case of bad debts. The fund is taken from the fee that each borrower pays when their loan is approved. Another of the major P2P consumer lenders, RateSetter, have their own provision fund to help bail out lenders to borrowers who have defaulted. RateSetter operate a platform that allows lenders and borrowers to pair up through a process of bidding, over four set term lengths. The model has proved very popular with both individuals who appreciate the transparency of the loan structure and lenders enjoy decent interest rates. RateSetter also offer business loans in the region of £25k to £1 million.

The business lending market is diverse for both investors and borrowers; loan size, terms, length, funding and structure vary from platform to platform. Just dipping a toe into the water in terms of range and variety, you can facilitate finance for property loans through Assetz Capital, Wellesley have their own listed bond that offer lenders 4.75% per annum over three years or 5.5% per annum over five, Folk to Folk specialise in regional lending in the South-West, Landbay secure lenders’ money against residential mortgages, MarketInvoice and Platform Black allow investors to access funds in outstanding invoices and factoring. The list goes one: the Best place to explore the full array of P2P operators and the services they provide is on the AltFi news website. The banks do not appear to have the will or resources to compete, despite their own admission that most of the platforms are supplying an updated version of services that they have provided for years.

Mitigate the risks and P2P Lending is a fantastic way to save wisely whilst helping SMEs and consumers drive UK economic growth. The incoming Alternative Finance ISA will bring in a whole host of new lenders; it is crucial that the industry is properly regulated and that platforms adapt sufficiently to ensure that the optimism continues.

Financing the Journey from Startup to SME – Busting the Jargon

Author

Angus Dent

Date

2nd July 201517th May 2016

The varied funding structures used by new companies can be a bewildering topic for the uninitiated, not least due to the fact that it is mired in financial jargon. How many of the British public could explain how seed funding differ from mezzanine finance for example? Or who supplies these different types of funding? Not too many, I would wager. But we live in a country where small businesses are integral to our economic prosperity, so understanding how these companies gain the funding that underpins their development is a useful accolade. Let’s cut through the jargon and take a look at the key concepts.

Source: http://edtechfrontier.com/tag/financing-cycle-of-investment/

When any company is being created, or in the early stages of operation, it is often described as a startup. Companies at this stage of their life cycle are often not profitable or even generating revenue. They thus desperately require a financial lifeline to help them navigate through this formative period. This seed capital, as it is known, is usually equity rather than debt and allows startups to invest in areas such as product development and general operations to get them on their feet. So where do they look to obtain it? It is hard to come by from traditional funders such as banks, or venture capitalists as it considered a very high risk investment, so startup directors must often look to friends, family and their own savings for this initial cash injection. It is also likely that some angel investors will be interested in investing at this very early stage. These investors are often wealthy veteran entrepreneurs who invest their own money and can also offer advice based upon their own experiences. Latterly, of course, crowdfunding platforms have also offered funding solutions to these ventures.

If this seed capital is deployed successfully and the startup moves forward, the business may then be in a position to launch a new round of funding and attract new investment when the initial funding runs out. This next round will likely be referred to as a Series A funding round and may be followed by a Series B, C, D and so on. Unsurprisingly, these post-seed funding rounds are sometimes termed alphabet rounds. Much like the initial seed investment these rounds will usually be for a stake in the equity of the business, though some businesses may offer debt instead if their balance sheets are robust enough and directors don’t want to dilute their ownership. Unlike the initial round, however, the business will now likely be able to attract institutional investment from venture capitalists to stabilise them over the medium-term. Venture capitalists invest through a business, rather than as individuals or part of a syndicate as angel investors do, and also tend to offer larger amounts than angels. They will likewise offer a growing business support and contacts to help them, but will generally take a more active role in the running of the business and require a seat on the board too.

Where small businesses choose to turn for their funding from this point onwards depends on their unique predicaments. Numerous options are available, and these will be explored and explained in part two of this jargon-busting blog.