FCA Feedback Statement II

Author

Date

15th December 2016

Last week’s Interim Feedback Statement from the FCA on its review of the rules governing the Crowdfunding industry was a masterclass in British fair play. No one will ever be able to accuse the regulator of not giving anyone and everyone the opportunity to have their say – the knockers of P2P lending have certainly made maximum use of the opportunity. Many of the comments contained in the document, and some made since publication, have been negative and one-sided. Some, outside the document, have verged on the vitriolic.

It has even been implied that, in light of this report, the British Business Bank has acted irresponsibly in entrusting £85m of its funds to a number of business lending platforms, using the argument that the entire P2P sector has somehow been discredited.

First, surely it is a core part of the BBB’s mandate to use its funds to stimulate the economy, which it is doing by using the expertise of P2P platforms to channel money to creditworthy SMEs. And second, the sector has not been discredited at all. In fact, P2P lenders have created something good, but not yet perfect.

Within certain boundaries, the industry should be encouraged, not suffocated by a mass of complicated rules that will prevent the winds of change from blowing away the cobwebs from a stale financial market place that has been devoid of competition for too long.

Take, for example, the criticism of provision funds which, I might add, has not been the method by which ArchOver has chosen to protect its lenders; we handle the issue differently, through credit insurance. But our competitors who have created contingency funds have made an honest attempt to try to protect lenders against losses and loan defaults. Can the system be improved? Probably and I’m sure this work is in-hand. But let’s not attack the effort or the thinking behind it.

Similarly, much has been said about misleading lenders. For sure, they know the difference between a 0.1% return on their money and 7%: one is outrageous and the other fair. The price they pay for this differential is risk, which I am sure the majority of lenders understand perfectly well. Where a platform invests lenders’ money in a pool of multiple loans, is that misleading or against their interests? Do they really care so long as they receive the return they were promised?

Again, this is not the ArchOver way because we only provide access to individual loans to specific businesses, which are identified along with terms and conditions and purpose of the loan. But the multiple loan route provides a measure of security through diversity – lenders’ interests are being safeguarded. Do the banks tell shareholders who they lend money to, or when loans go wrong? We know the answer is ‘no’. So, even if the P2P lender cared in the first place, is this misleading? The answer to the question is also ‘no’ because the lender has delegated the responsibility of care to the platform of their choice.

Rules alone have never been the answer; experience teaches us that it is more important to embrace the spirit rather than just the letter of the law. To validate that stance, you need look no further than the High Street banks and their behaviour both before and even after the 2008 financial crisis.

When the FCA’s new rulebook is published next summer, let us hope that common sense shares equal billing with legislation that is fair, relevant and practical. The P2P sector needs room to evolve if it is to fulfil its potential.

The outcome is that we are unlikely to see the result of its deliberations until next summer.

FCA Feedback Statement

Author

Angus Dent

Date

13th December 2016

No one ever said that the FCA’s task of setting out a definitive set of rules and regulations for the crowdfunding industry was going to be easy, but last week’s interim feedback statement underlines just how far the regulator’s deliberations still have to go. It doesn’t help that the report talks about the dangers of “regulation arbitrage” – I imagine that most people had to look up what it meant! – or that crowdfunding was the descriptor used to cover both equity and debt finance. Commentators had just about got round to calling the latter crowdlending, or P2P lending, to make the distinction between the two very different forms of investment.

But be that as it may, the crux of the matter appears to be that some of platforms are pushing the boundaries of ‘interim permissions’ to the point where, to all intents and purposes, they are acting like a bank, but are not governed by the same jurisdiction or restrictions as a bank. As P2P Lending evolves and new business models appear so the lines are bound to become blurred. The FCA’s dilemma is that any set of rules made at a given point in time is almost certainly going to be out of date very quickly. And so, reluctantly, I have to agree that it is better to wait and to get it right than to rush something out for commercial expediency.

In the meantime, I can confirm that ArchOver does not try to operate like a bank and has no plans to become one. Our proposition is clear and fair, starting with our policy to treat all lenders equally.

One of the major problems is that, in its efforts to be fair and transparent, the FCA is creating more confusion. If it knows which platforms and services conform to its idea of what is good and clear, perhaps one way ahead would be to name them, authorise them and set them up as an example for everyone else to follow. Surely it would be far more instructive to benchmark the industry than to use opaque expressions (e.g. regulation arbitrage) to try to get its point across.

It would also be better to show us what is acceptable than to wait until someone does something wrong and then to beat them with a big stick. Everyone would understand that.

In the meantime, the P2P lending sector is continuing to provide invaluable support to the SME sector and interest-starved investors are still receiving a reasonable return on their money. Where’s the harm in that?

Bank stress tests herald an opportunity for P2P sector

Author

Angus Dent

Date

7th December 2016

The 2016 stress tests conducted by the Bank of England’s Prudential Regulation Authority (PRA) revealed that three of our major banks would not to be able to withstand another financial crisis on the scale of 2008. RBS, Barclays and Standard Chartered were all found to be vulnerable while the remaining four – HSBC, Lloyds Banking Group, Nationwide and Santander – were judged to be sufficiently robust.

However, the reality is that, although the tests replicate the Armageddon scenario of another synchronised global recession (which includes, for example, the prospect of UK residential property prices falling by 30%), there is no real chance that the Bank of England would ever allow any of them to go bust. In the meantime, the three banks that failed the tests are being granted leave to boost their financial resilience as a precaution.

Some commentators have been quick to suggest that perhaps the P2P lending industry should undergo similar stress testing on the basis that the vast majority of the operators have never experienced an economic recession. While this argument may have some headline appeal, it ignores the fact that banks are balance sheet lenders whereas P2P lenders are not – they simply match borrowers with lenders via internet trading platforms and the terms and interest rates applicable to both parties are fixed throughout the lifetime of the arrangement. Loans can still go bad, of course, but that outcome should not have a direct impact on the solvency of the platform operator. It is a non-argument.

One useful reminder from history is that the last time we had a recession the first instinct of the banks was to draw in their horns and stop lending, especially to the hard-pressed SME sector which, according to the FSB, provides 60% of private sector jobs and accounts for nearly half of private sector turnover. It was against this economic backdrop that the P2P lending industry was born in the first place. Difficult conditions represent opportunity.

Of more concern, perhaps, was the recent announcement by Zopa – the one company that was created pre-recession in 2005 – that it is to stop taking in funds from investors without there being sufficient loans in which to put their money.

Zopa, which had accumulated losses of £20m over 11 years of operations, specialises in consumer loans, but there is evidence to suggest that SMEs, too, are not so eager to borrow money as they once were. Commenting on Q3 this year, Mike Conroy, the British Banking Association’s MD for Business Finance, stated that: “…there is clearly lower demand for finance for businesses overall than in the same quarter a year ago. This subdued demand reflects reduced or postponed investment plans and confirmed deposit holding, particularly by smaller firms, as they operate within an uncertain trading environment.”

In the circumstances, it seems the arrival of the Government’s new Bank Referral Scheme, which officially went live on November 1, could not be more timely. Growth-minded SMEs and interest-starved lenders could both find what they are looking for through a vibrant P2P business lending sector.

Jargon Busting

Author

Angus Dent

Date

1st December 2016

The varied funding structures used by new companies can be a bewildering topic for the uninitiated, not least because they are mired in financial jargon.

How many non-financial people could explain how seed funding differs from mezzanine finance for example? Or who supplies these different types of funding?

Let’s cut through the jargon and take a look at the key concepts.

When any company is created, or in its early stages, it is described as a startup. They are often not profitable or even generating revenue.

Thus, they desperately require a financial lifeline to help 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 financers 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. It is also likely that some angel investors (like TV’s dragons) will be interested in investing at this very early stage. These are often wealthy veteran entrepreneurs who invest their own money and can offer advice based on experiences.

Latterly, of course, crowdfunding platforms have also offered equity-based funding.

If 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 is likely be referred to as a Series A funding round and may be followed by a Series B, C, D and so on. These are sometimes termed alphabet rounds.

These will usually be for an equity stake in the business, though some businesses may offer debt instead if their balance sheets are robust and directors do not 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 its running and require a seat on the board.

All these companies will now have traded for at least a few years, acquiring a financial track record and hopefully a steady customer base. This increased business maturity and stability tends to translate into lower risk (and lower reward) for potential investors, something that changes the nature of the available sources of finance.

Some companies with more robust balance sheets will now be in a position to seek out senior debt in the form of loans secured against assets of the business.

Senior debtholders are those that are most likely to be repaid in the event that a business gets into financial difficulty. Gaining a loan from a bank at this this stage of development is notoriously difficult however. As such, businesses are increasingly turning to newer sources of finance, such as peer-to-peer lending platforms, to provide them with the credit lines they need.

Others businesses that lack assets against which to secure debt, or the stable cash flows to service it, may look to invoice financing to improve their cash flow.

Invoice financing can be split into discounting and factoring, both of which involve the third party finance provider advancing the money owed to a business by its customers, minus a service fee. With factoring, the finance provider takes control of the debtor book, while with discounting the relationship between a business and its customers is left untouched.

For businesses in certain sectors, manufacturing particularly, there is an increasing availability of supply chain finance (SCF). SCF links buyer, seller and financier, providing short-term credit to optimise working capital for both buyer and seller. More simply put the buyer uses the financiers money to pay the suppliers invoices, with the financier taking title to the raw materials provided and the goods that the buyers manufactures from them. SCF is available from both banks and P2P business lenders.

For those businesses that seek to expand aggressively though, either of these forms of financing alone may not be enough, leading them to seek out mezzanine finance to help them achieve their goals.

Mezzanine finance is usually unsecured and sits behind senior debt in terms of repayment priority. Because of this increased risk for the lender, it carries a much higher interest rate and often a clause that converts the debt into equity in the company if the loan is not repaid.

These types of funding will suffice to meet the business requirements of many companies, allowing for growth while keeping ownership in private hands. The next step, if the company chooses, is to go public with an IPO (Initial Public Offering).

There are a number of reasons why a company might consider going public, such as reducing the burden of interest payments or generating publicity. Over and above any of these considerations though is the ability that being publically listed brings to raise large amounts of capital on a consistent basis.

That said, firms must take into account the significant costs of the listing process, as well as the increased regulatory requirements.