Peer2Peer Finance News March 2020 by Alternative Credit Investor

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INVESTOR OR CREDITOR?

More clarity is needed

Special report on insolvency supported by

PROPERTY, BONDS AND BREXIT

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Wellesley's Andrew Turnbull talks to P2PFN

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ISSUE 42 | MARCH 2020

Industry calls for greater FSCS protection for P2P investments PEER-TO-PEER investments – including money put into Innovative Finance ISAs (IFISAs) – should be covered by the Financial Services Compensation Scheme (FSCS) in the same way as stocks and shares ISAs, industry figures have suggested. The scheme, set up under the Financial Services & Markets Act 2000, provides the fund of last resort for customers whose financial services firms are unable, or likely to be unable, to pay claims against them. Money put into savings accounts, such as high street banks and cash ISAs, are covered up to £85,000 per person, per firm. Meanwhile, certain investments – including stocks and shares when held in an ISA or purchased through an

investment firm – are covered up to £85,000 per person, per firm. For investments, the scheme offers compensation when the provider goes bust, but does not offer protection for losses, unless this is due to bad advice. In contrast, P2P investors would not be compensated

if a platform collapsed. However, they may be able to claim if they received poor investment advice or if they had untouched cash sitting in an FSCS-protected bank account used by the P2P platform. Brian Bartaby, founder and chief executive of P2P property lender

Proplend, questioned why the scheme does not cover the IFISA when it covers stocks and shares ISAs. “Why isn’t and why shouldn’t P2P be covered by the scheme?” Bartaby said. “The scheme does not cover for losses so why should stocks and shares ISAs be covered and the IFISA not be covered? “It may make wealth managers and independent financial advisers more happy to promote it and people would then put it on the same level as stocks and shares. “At the moment some people mistakenly believe that they are covered for losses with stocks and shares or that it’s safer because it has the scheme’s backing. “The chance of losing >> 4 money because

RSM writes off £400k as Lendy admin costs spiral RSM has written off £400,000 associated with the spiraling costs of the Lendy administration. By February 2020, RSM had estimated that the

administration costs for the first year would reach £2.5m. In July 2019, the Lendy creditors committee approved a first-year fee cap of £1.025m plus

VAT. However, between 24 May 2019 and 23 November 2019, RSM incurred time costs totalling more than £1.7m, which led to a new request for

£2.1m to be made available to cover costs. The peer-to-peer property development platform fell into administration in May 2019, following >> 4

EDITOR’S LETTER

Published by Royal Crescent Publishing

WeWork, 2 Eastbourne Terrace, Paddington, London, W2 6LG info@royalcrescentpublishing.co.uk EDITORIAL Suzie Neuwirth Editor-in-Chief suzie@p2pfinancenews.co.uk +44 (0) 7966 180299 Kathryn Gaw Contributing Editor kathryn@p2pfinancenews.co.uk Marc Shoffman Senior Reporter marc@p2pfinancenews.co.uk Michael Lloyd Senior Reporter michael@p2pfinancenews.co.uk Andrew Saunders Features Writer Emily Perryman Features Writer Hannah Smith Features Writer PRODUCTION Tim Parker Art Director COMMERCIAL Alamgir Ahmed Director of Sales and Marketing alamgir@p2pfinancenews.co.uk Tehmeena Khan Sales and Marketing Manager tehmeena@p2pfinancenews.co.uk SUBSCRIPTIONS AND DISTRIBUTION info@p2pfinancenews.co.uk Find our website at www.p2pfinancenews.co.uk Printed by 4-Print Limited ©No part of this publication may be reproduced without written permission from the publishers. Peer2Peer Finance News has been prepared solely for informational purposes, and is not a solicitation of an offer to buy or sell any peer-to-peer finance product, or any other security, product, service or investment. This publication does not purport to contain all relevant information which you may need to take into account before making a decision on any finance or investment matter. The opinions expressed in this publication do not constitute investment advice and independent advice should be sought where appropriate. Neither the information in this publication, nor any opinion contained in this publication constitutes a solicitation or offer to provide any investment advice or service.

ife can be tough as a small business. The new Chancellor Rishi Sunak recently argued for a retail bond market for small- and medium-sized enterprises (SMEs), which would help fill a £35bn funding gap. Such a move has been supported by Ablrate chief David Bradley-Ward, who made the point that peer-to-peer lenders have been helping to fill this funding gap for many years now. This got me thinking about the broader challenges facing SMEs and how they are still overlooked in terms of funding and policy. More than 99 per cent of UK businesses are SMEs – they collectively account for three fifths of the employment and around half of turnover in the UK private sector. Furthermore, around 96 per cent count as small businesses – the ‘S’, rather than the ‘M’. Media coverage of small and growing businesses is dangerously skewed, focusing on ‘overnight success’ and creating an overly cheery picture of entrepreneurship. The fact is that the majority of new businesses fail; entrepreneurs are more likely to suffer with mental health issues; and when it comes to the law, hefty legal fees and a lack of start-up support mean that you are dangerously exposed if something goes wrong. Filling the funding gap is only part of the problem – SMEs, on the whole, are still expected to comply with taxes and rules in the same way as their larger counterparts, despite the likelihood that they are under resourced to support this. It’s time that the government woke up to the fact that small businesses aren’t the same as large businesses and shouldn’t be treated us such. Hopefully Sunak’s proposed SME retail bond market is just the beginning. SUZIE NEUWIRTH EDITOR-IN-CHIEF

We hope you’re enjoying the latest edition of Peer2Peer Finance News! We have now moved to a paid-for subscription model. If you would like to continue reading the magazine, please go to www.p2pfinancenews.co.uk/subscribe/ to find out about subscription options.

NEWS

cont. from top of page 1 stocks go down is the same as losing money with P2P investments.” He called for more education on what the FSCS covers when it comes to investments. Roxana MohammadianMolina, chief strategy officer at P2P property lender Blend Network, also called for P2P to be FSCS protected in the same way as stocks and shares. “This is important because we believe P2P can play a strong role in helping the government achieve its housebuilding targets by channelling private funding into housebuilding efforts and being covered by the FSCS would obviously bring more trust into the sector,” she said. ‘Big three’ P2P platform RateSetter also agreed that it would make sense for P2P to be included under FSCS protection that applies to investments. “It wouldn’t work for P2P to be covered by the FSCS for savings as this would be at the

expense of value,” a spokesperson said. “However, we are interested in whether the type of FSCS that applies to stocks and shares could be applied to P2P and we’d like to talk to the regulator about this.” However, Charter HCP director and P2P veteran Terry Pritchard said that FSCS could not be extended in the same way as stocks and shares until the P2P sector introduces standardised reporting. Furthermore, Carl Davies, chief operating officer at The House

Crowd, warned that FSCS protection could make investors lazier in their due diligence. The Financial Conduct Authority (FCA) takes the view that consumers receiving advice on P2P agreements should, in relation to that advice, have the same access to the ombudsman service and the FSCS as they do when receiving regulated investment advice on other investments. However, this does not apply to self-directed investors, who do not

obtain advice before putting money into P2P platforms. The City watchdog said in March 2014 that it did not consider there is enough justification to include P2P within the FSCS remit when it comes to company failures. “Bringing these firms within the FSCS remit would impose additional regulatory costs, which may be quite significant,” the statement read. “As loan-based crowdfunding is not currently within the FSCS remit, we do not expect this to lead to a reduction in new investment. “Firms should ensure that investors understand the risks involved. “Other protections that we are introducing – such as the minimum capital standards and the requirement for firms to have arrangements in place to continue to administer loans in the event that the platform fails – should provide adequate protection at this time.”

case. “But we’ve only asked for £2.1m – we’re writing off the remaining £400,000.” Webb told Peer2Peer Finance News that “this is not an ordinary administration”, and “a lot

of the issues that we’ve identified I’ve never come across before.” He added that he and his partner Philip Sykes have been spending at least 2.5 days per week on the case, as well as having a

full-time member of staff managing the loanbook, with two to three other team members working on other related matters. They have also seconded lawyers to advise on recovery action.

cont. from bottom of page 1 months of speculation about mounting defaults in its loanbook. “We believe the costs in the first year will be £2.5m,” said Damian Webb, RSM’s lead administrator on the Lendy

NEWS

Lendy ‘distribution waterfall’ queries head for court THE LEGAL position of the Lendy ‘distribution waterfall’ is set to be clarified in court, despite warnings that the process could be costly and unsuccessful. The Lendy Action Group (LAG) is moving ahead with plans to appoint a solicitor to represent investors who are concerned about “mis-selling and misleading materials, and structure of notes, terms and conditions since Lendy's inception.” The proposed ‘distribution waterfall’ sees former Lendy investors split into two groups: model 1 and model 2, which impacts how they receive funds recovered from the collapsed peerto-peer lender. Lendy initially operated a structure whereby investors lent to Lendy itself, which then gave the money to

borrowers, known as model 1. However, this was not deemed as a P2P arrangement and a new structure – model 2 – was set up from 2015, meaning that investors began funding the P2P loans directly. Model 1 investors are defined as creditors, meaning their eventual pay-outs will be pooled with other creditors – including the Lendy directors. Meanwhile, model 2 are defined as investors, meaning that they may be able to recover funds directly from the loans that they helped to fund. By mid-February, LAG

had raised almost £70,000 towards its legal fees on the crowdfunding website CrowdJustice. Damian Webb, lead administrator at RSM, said that he supports LAG’s attempts to gain legal clarity on the position of investors. However, he warned that the legal costs could become prohibitively high. “It’s right that the Lendy investors can get a lawyer to represent them,” said Webb. “My only concern is that they could spend a lot of money on it. “It doesn’t make any difference to us – it doesn’t affect our fees. We just present the evidence. “But that’s why we’ve

asked the court for direction on that matter – this is the evidence that we can see, but we want assistance on this. We want the court to decide it.” Writing on the crowdfunding page, LAG representative Lisa Taylor told potential crowdfunders that they will use the funds to fight the waterfall and push back on administration fees. “Lendy originally promised only to deduct charges for administering the defaulted loans, then they would pay back investors,” she said. “Then after the portfolio started defaulting en masse and we were stuck, Lendy sent an email, retrospectively changing this. “The issue is how Lendy defined a fee in a way that paid penalty interest and many other items to themselves first. This is a hole LAG is focused on plugging.”

Insolvency expert calls for clarity on investor vs creditor debate PEER-TO-PEER investors could become embroiled in a “contractual jigsaw” if a platform becomes insolvent, an expert has warned. Currently, P2P investors can be classified as either investors or creditors and this status dictates their financial position if the platform goes into

administration. While an ‘investor’ may be able to claim back their capital on an individual loan and thereby avoid substantial losses, a ‘creditor’ will be repaid from the general pool of assets and may end up receiving pennies on the pound. “What it comes down to is how the investors

are treated,” said Frank Wessely, partner at Quantuma. “Are they treated as investors who can claim the proceeds and repayments of the loans they have invested in, or are they pooled as creditors? “In an ideal world the platform would make

this information available from the outset. But on the other hand, the investor should make sure they are asking the right questions. “Investors have to have sufficient awareness to ask the right questions around borrower risk and the nature of the contractual jigsaw that they are signing up to.”

PROMOTED CONTENT

Picking the right Innovative Finance ISA

Frazer Fearnhead, founder and chief executive of The House Crowd, explains what investors should look for when choosing their tax-efficient product

How comfortable are you with risk? It is vital that investors understand that the rates quoted are not guaranteed. These are investment ISAs and they are not covered by the Financial Services Compensation Scheme £85,000 guarantee. IFISAs which incorporate P2P property-backed loans offer

£1,000,000 £800,000

Investment valuation

INCE THE INCEPTION of the Innovative Finance ISA (IFISA) in 2016, the number and variations of products available have proliferated. So how should investors choose between them? Most IFISAs fall into one of three main categories: consumer loans, small business loans and property loans. Consumer loan IFISAs typically offer returns of around four or five per cent per annum on unsecured loans and some platforms allow investment from just £10. Business loan IFISAs generally offer returns in the six to seven per cent range, with minimum investments typically starting at just £100. Property-backed IFISAs democratise investing in property and are suitable for individuals who want to avoid the hassle and associated costs of investing in bricks and mortar. Minimum investments typically start at £1,000. Interest rates are typically higher than other loan types, often ranging between eight and 10 per cent per annum on self-selected investments and five to eight per cent on a diverse portfolio.

£600,000

Compound interest

£400,000

Without interest

£200,000 £0

10 15 Years of investment

potentially good returns with the downside protection based on the value of the property. However, there are still risks. A property loan can go wrong through a mistake by a valuer, a mistake in securing the asset or through fraud. It is therefore important to choose a level of risk you are comfortable with. Generally, the higher the target rate, the bigger the risk that loans may run into trouble with late payments or defaults. How diversified are your investments? Diversification is a critical factor in mitigating risk. While we offer both auto-invest and self-select products within The House Crowd’s standard account, we made the decision purely to allow auto-invest products within our IFISA wrapper. We decided that we would enforce a degree of diversification for ISA investments, so that any potential losses can be mitigated by abovetarget returns received on other loans in the portfolio.

Is your money working for you 365 days a year? Self-select products may offer higher target rates, but chances are there will be some downtime between investments where your money will not be earning interest and this will reduce your overall return. In contrast, with an auto-invest product, such as our IFISA, it’s working for you 365 days a year. Furthermore, you receive regular interest which can be rolled up, so, your overall return is likely to be better in auto-invest than self-select, even before taking the tax-free consideration into account. Does the ISA enable you to compound your returns? Compounding, as every investor knows, is essential for maximising long-term returns and an autoinvest product does that best with interest paid twice a year. If it is rolled up – especially in a tax-free wrapper – it will massively increase the size of your investment pot over a 25-year period. Some acceptance of risk is required if you want to build up your capital. IFISAs offer attractive returns without the volatility of the stock market but the target rates are not guaranteed. You should ensure your investments are diversified across a pool of different loans. In order to mitigate risk further you should either ensure you have the security of a property-backed loan or check that there is some sort of provision fund to cover defaulting loans.

NEWS

P2P mergers predicted in 2020 CONSOLIDATION in the peer-to-peer lending industry may finally come to fruition, stakeholders have predicted. Tougher regulations on the sector are forecast to speed up this process, with executives predicting mergers to share costs, as well as more platform closures. “The costs of regulation, technology and marketing all quickly add up, and when added to the core business of deal origination, due diligence and oversight, many platforms could not make the economics work,” said Jatin Ondhia, chief executive of Shojin Property Partners. “I do expect many more to close. “Some of those will close because of poor quality

deal flow, but many more will close because the business just could not make the numbers work, which is a real shame. “To succeed in this space, businesses will need to be well capitalised and will need to monetise the business properly. “I totally believe that there will be some M&A or joint-venture activity. “While no market player is significant enough to warrant buying them out or merging, amongst some of the stronger players there is already talk of tie-ups to open up the investor base while reducing overheads and sharing resources.” John Cronin, financial analyst at brokerage Goodbody, said he expects to see much more industry consolidation during 2020

and beyond. “This is a function of the degree of fragmentation which has seen many new entrants in recent years as well as the fact that some platform owners will look to a sale as a rescue play,” Cronin said. “The refreshed Financial Conduct Authority regulations will only accelerate this trend in my opinion – indeed, I believe

that these regulations will facilitate a deeper recognition on the part of interested market participants that there are players of strength in the P2P market who will survive for the long-term.” However, newlylaunched property lender Nexa Finance said that changes to business models are more likely than consolidation. “There is always the possibility that some property P2P platforms may consider cease trading and either run off their book or look for a platform to buy them, but we believe it is more likely that they will change or adapt their model, such as withdrawing from retail investors,” said Mark Williams, chief operating officer and director of credit risk at Nexa Finance.

IFISA awareness drive hoped to boost inflows INNOVATIVE Finance ISA (IFISA) providers are hopeful that efforts to boost awareness of the tax wrapper will reap benefits this ISA season. Narinder Khattoare, chief executive of Kuflink, said the peer-to-peer property platform has seen steady increases in new IFISA investment year-on-year with 2019/20 set to continue this upwards trend.

“As interest rates on standard building society and bank accounts remain as low as they are, we believe that our IFISA will continue to be a strong candidate for further investment inflow, offering a good balance between risk and reward,” he said. Meanwhile, Stuart Law, chief executive of Assetz Capital, said that the platform expects “anoth-

er strong performance this ISA season”, having already broken the £100m investment milestone into its tax wrapper. Other platform executives were a little more cautious. Uma Rajah, co-founder and chief executive of property investment firm CapitalRise, called the IFISA “a fantastic product” and noted that more and more people are becoming

aware of it. However, she highlighted that there is still some way to go. David Bradley-Ward, chief executive of assetbacked lender Ablrate, said that IFISA inflows have been increasing as there has been greater awareness of the IFISA over the past few years, but agreed that more education is still needed on the range of products in the market.

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JOINT VENTURE

Credit where credit’s due

Simon Betty, Wellesley’s head of credit, explains why the personal touch is such an important part of the platform’s credit process

N THE SEVEN YEARS since Wellesley was founded, the property lender has gone through many changes. But one thing has always remained the same – a strict commitment to follow the best possible credit practices. “We are always striving to improve our credit function,” says Andrew Turnbull, director and cofounder of Wellesley. “Every time we've upgraded our credit function, we've seen the benefit of it.” One of these upgrades involved the hiring of Simon Betty in 2018 as head of credit. Before any loan is approved for the Wellesley platform, Betty will have reviewed it several times. But he insists that “credit in Wellesley Finance is not just me in a dark room”. “What happens is essentially a member of our lending team will have a proposal,” he explains. “They will come to me right at the start and ask what I think. We have a quick two minutes and they go away and get more information. They come back with a lot more information which they will use to prepare a very brief paper which then goes to our pre-investment committee. “We then discuss if the proposal has merits. If it’s a no, then the lender moves on. Alternatively, we might say ‘OK, it’s got legs, lets address these issues’. “As head of credit, I will then go to the site with the lender and interrogate the developer about the project and their experience. This gives me a good idea of

whether the developer has the appropriate level of experience and knowledge to complete the project, and what issues may affect its deliverability.” If he is happy with the fundamentals, Betty then considers issues such as whether the costs in completing the development are broadly appropriate, the appropriateness of the procurement strategy and planning consent. And then comes the enhanced due diligence. “At the moment contractor risk is a real issue so I expect almost as much due diligence undertaken on the contractors as the person or company we're lending to,” says Betty.

Next, the proposal and due diligence goes in front of a business acceptance committee, where all the details of the loan are again discussed in detail. This meeting will end in one of three ways: the loan is declined; an unconditional loan will be offered; or the loan will be approved subject to some conditions. And the credit process doesn’t end once the loan has been made. Wellesley will appoint a project monitoring surveyor who visits the site and provides the platform with monthly reports. “The monitoring of the loans as they start to draw is as big an issue as the investigations and due diligence we undertake in the first place,” says Betty. He stresses that this entire process is driven by expert in house analysis and reliance on experienced professionals, not algorithms. This commitment to a personal touch is important to him and explains why Wellesley has had such a strong track record over the past few years. “At the end of the day, I don't see how you can replace someone like me speaking to a developer asking questions, and actually standing on the site and seeing what it is that we're being asked to lend on,” he says. “I don’t see how software could replace the personal element and the experience that some of us have. However, we clearly rely upon it to analyse the profitability of schemes.”

INSOLVENCY

A stronger industry Tougher rules on wind-down plans should reassure investors in the wake of high-profile platform insolvencies, as Emily Perryman reports

IGH-PROFILE insolvencies in the peerto-peer lending sector have shone a light on the poor business practices being carried out by some of the industry’s less scrupulous platforms. Business misconduct, poor governance and the substandard underwriting of loans are just some of the accusations made against the collapsed platforms. With many investors still out of pocket, it’s no surprise that confidence in the sector has been knocked. Many industry onlookers are hopeful that new rules aiming to boost transparency and improve underwriting standards will raise

the bar for platforms, thereby ensuring poor practices and messy insolvencies are a thing of the past. Platform closures So far there have been three insolvencies in the P2P lending sector: Lendy and FundingSecure in 2019 and Collateral in 2018. It’s a small number when compared with the number of platforms that have entered the market over the years, but because everyday investors have lost money the failures have garnered a lot of media and regulatory attention. The reasons behind the insolvencies vary from one platform to another – Collateral

was operating without the proper regulatory permissions; FundingSecure had deficiencies with its client accounts and a purported lack of management expertise; and Lendy suffered longstanding issues with borrowers falling into arrears or defaulting. There are, however, some common themes that unite the failures. “I think it's fair to say that some of the collapses have demonstrated that some platforms have been more accomplished in fintech than in loan underwriting,” says Lisa Best, head of financial services content at Intelligent Partnership. “Despite recent strengthening of the regulations, the insolvencies

INSOLVENCY

“ Administering a complex loanbook, with

each loan potentially having multiple lenders, is not straightforward don’t mean that Financial Conduct Authority (FCA) regulation hasn’t applied – it’s been in place since 2014. But it does seem that the FCA finds the internet – the breeding ground for P2P – a difficult regulatory challenge.” Negative publicity has also played a role in the demise of some platforms. MoneyThing cited the fall in investor confidence following the Lendy and FundingSecure insolvencies as one of the reasons for its decision to wind down in December. Damian Webb, partner at RSM Restructuring Advisory, which is Lendy’s administrator, says poor publicity has meant the sector has struggled to attract new investors, which has subsequently undermined platforms’ growth and income. “During a period in which their income has, in many cases, declined or stagnated, their costs have increased exponentially as they have had to invest in their infrastructure to meet the new regulatory requirements,” he says.

”

“Consequently, many platforms become uneconomic as they lack the income and scale to meet the required costs to comply with the current regulatory requirements.” Angus Dent, chief executive of P2P lender ArchOver, adds that lending money is a tough game with thin margins and lots of competition. “I suspect that the businesses that failed tried to replicate what others had done before in a more efficient manner and this wasn’t sufficient,” he says. “Other failures have

exposed the myth that property – especially property development – represents good security for loans. We have seen that it isn’t and, furthermore, that it is often illiquid.” Insolvency process The platform failures have brought to light the challenges and complexities involved when a P2P lender goes into administration. Many investors have found it difficult to collect what remains of their money – to the extent that some of Lendy’s investors plan to take legal action. Prior to December 2019, it wasn’t mandatory for platforms to have wind-down plans in place and, upon an insolvency event, the administrator would take control of the company’s business and assets.

THE RIGHT ADVICE AT THE RIGHT TIME Specialist advice to mitigate platform risk www.quantuma.com Frank Wessely, Partner

✉

frank.wessely@quantuma.com

 07770 210 628

INSOLVENCY

“The way the loanbook would be dealt with would depend on whether or not there was a security trustee in place and contractual arrangements regarding the manner in which the loans would be administered,” explains Geoff Bouchier, managing director in the global restructuring advisory practice at Duff & Phelps. “Recent developments in failed platforms have highlighted the challenges that can arise due to the differences in interpretation of insolvency legislation and investors’ understanding of the contractual arrangements in place with investors and borrowers. It is apparent that the structure and quality of agreements can vary significantly from platform to platform.” This complexity means that years after an insolvency, administrators are still unpicking loanbooks and investors are out of pocket. In one instance, an administrator was accused of ignoring a third-party bid for the loanbook of a collapsed platform – another example of the often-contentious nature of insolvencies. Sam McCollum, legal director at law firm TLT, says the reasons why an administrator might be unable to sell a loanbook can include issues over title to the assets and whether the administrator is contractually entitled to sell the loans. “Administering a complex loanbook, with each loan potentially having multiple lenders, is not straightforward,” he says. “Debt

purchasers may also be put off by the resource required to do this – especially if they cannot get the firm’s IT platform to speak to their own systems – as well as by issues with the terms governing the loans.” If the platform itself has poor recordkeeping, it can make the process even more time-consuming, difficult and expensive. Orderly wind-down Given the challenges involved, avoiding an insolvency is the best course of action – and this is where the FCA’s new rules on wind-downs could help. Since 9 December 2019, all P2P platforms must have arrangements

“ The new regulations, combined with improved transparency and investor due diligence, should ensure that best practice is adopted

”

in place to ensure the P2P agreements they facilitate will have a reasonable likelihood of being managed and administered, in accordance with the contract terms, if the platform fails. Firms must also consider the cost of winding down the business and how those costs will be covered. Ben Arram, consultant at Bovill, says if wind-down plans do what they are meant to do, it should result in investors getting more of their money back and the industry as a whole becoming more robust. However, he points out that the rules offer scope for interpretation and are yet to be tested. “No one really wants to think about their firm failing so it’s easy to see why some businesses have shied away from writing wind-down plans,” says Arram. “They are now being forced to put plans in place and disclose them to investors. Those not on board need to up their game a bit.”

INSOLVENCY

The wind-down rules are part of a package of measures that provide for higher underwriting standards, more transparency about the information provided to potential investors and ensuring investors know the risks they are taking. New marketing restrictions mean that new individual investors who don’t qualify as sophisticated or high-networth can only put 10 per cent of their overall portfolio into P2P. December also saw the

introduction of the Senior Managers & Certification Regime (SMCR), which makes senior managers personally accountable for business failings. Together with the P2P regulations, it is hoped this will improve governance, conduct and controls over time. However, Symbat Tynshimova, compliance associate at FinTech Compliance, says the onus is on firms to change their culture and attitude to ensure continuity of business, which cannot be achieved by imposing stricter rules alone. “The P2P providers who we have seen deliver target returns to their lenders and operate more efficiently in general are the businesses whose underwriting practices are very strict and credit risk assessments are robust,” she adds. “Hopefully, the new regulations combined with the recent developments in the industry can incentivise firms to review and improve their systems and controls.” Looking ahead The new rules aren’t expected to prevent platforms from collapsing in the future – external events such as a major economic downturn will most likely result in firms failing in the P2P sector, as they will in any other industry. But it is hoped that some of the issues seen in previous

“ This is a

Darwinian process that results in a stronger, better P2P sector

Helping you to make informed decisions on P2P investments

✉

frank.wessely@quantuma.com

”

cases – poor governance, allegations of misconduct and poor underwriting of loans – will become a thing of the past. “The new regulations, combined with improved transparency and investor due diligence, should ensure that best practice is adopted and poor practices are eliminated,” says Webb. At the same time, however, the new regulations will lead to an increase in costs which have to be absorbed by platforms in a period of tough competition and low investor confidence. This could result in short-term consolidation. “The P2P industry is similar to any other in the sense that businesses that are not up to scratch, due to being badly run or weak business models, cannot continue for long,” a spokesperson for RateSetter says. “But well-run businesses that put the customer at the heart of their model thrive. This is a Darwinian process that results in a stronger, better P2P sector.”

INDEPENDENT ADVICE FOR INVESTORS

Frank Wessely, Partner

 07770 210 628

THE RIGHT ADVICE AT THE RIGHT TIME Specialist advice to mitigate platform risk ➢

Wind down plan reviews

➢

Advice on security structures

➢

Underwriting policies advice

➢

Pre-lend due diligence and borrower reviews

➢

Back-up services

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Borrower default

Frank Wessely, Partner

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 07770 210 628

frank.wessely@quantuma.com

JOINT VENTURE

The reality of the wind-down Insolvency and restructuring specialist Frank Wessely, partner at Quantuma, explains why there is still so much work to be done on platform wind-downs

N THE WEEKS AND months leading up to 9 December 2019, peer-topeer lending platforms raced to implement a slew of regulatory changes – most notably, the requirement for a suitable winddown plan to be in place in case the platform enters into an orderly wind-down, or becomes insolvent. But insolvency specialist Frank Wessely, partner at Quantuma, believes that the current rules are merely a starting point for a complex and constantly evolving issue which is often misunderstood. “The industry has little precedent of how wind-downs play out in practice,” he says. “Even though we have only seen three platform failures to date, there are significant differences in each one.” According to Wessely, there is no ‘one-size-fits-all’ option when it comes to wind-down plans, and it doesn’t help that there is a lot of misinformation around the finer details of the wind-down process. A platform might become insolvent, but that does not automatically mean it will go into administration, which is only one of the statutory procedures available to a distressed business. However, the choices made by the platform’s board at this stage can have very different consequences for investors. “Insolvency is essentially the financial state of the business,” explains Wessely. “In simple terms that means it can't afford to pay its

bills as and when they fall due, or its liabilities exceed its assets. “Whereas administration is one of the statutory processes that is available to an insolvent company and it has a particular hierarchy of processes which initially are either to save the company so it gets back on its feet, achieving a better result than a liquidation, or to realise assets for the secured and preferential creditors.” In the world of alternative finance, the majority of wind-downs involve the sale of the business and the realisation of the assets. But even within this administration process, there can be plenty of variation. “Administrators don't just have an obligation to the client (the platform),” says Wessely. “They have a very broad set and scope of obligations to the complete range of stakeholders.” These stakeholders can include the platform’s directors and founders, as well as investors and creditors who are left out of pocket. The recent Lendy administration has cast a spotlight on the confusion between the terms ‘investors’ and ‘creditors’ – under the current rules,

creditors are repaid from the general pot of assets after any secured creditors have been satisfied, while investors could be reliant on the recovery proceeds from the specific loans which they have invested in. Retail investors might be classified as either creditors or investors, depending on the type of loans they are funding, and the wording of their investor contracts. “It should be much clearer at the outset how an investor would be treated,” says Wessely. “On some platforms, you might have different types of loan contracts with different borrowers so you could have some investors being treated as investors and some investors being treated as creditors all under the same platform.” This is just one area where more clarity is needed in order to protect P2P investors and ensure that all future platform wind-downs run smoothly. Quantuma is one of a small number of advisory firms which has Financial Conduct Authority approval to advise investors on P2P agreements, and Wessely says that while the new regulations will help improve the professionalism of the industry, wind-down plans need to be “a living, breathing document” which can be updated as platforms develop and refine their processes, and also when the regulations change. The regulations may still be in their infancy, but there is clearly a long way to go before wind-down processes are fully understood.

IFISA

Universal appeal The IFISA is growing up. Kathryn Gaw investigates the evolution of the taxfree wrapper and what this means for platforms and investorsâ&#x20AC;Ś

HEN THE Innovative Finance ISA (IFISA) first launched, it was hailed as a game changer for the then-nascent peer-to-peer lending sector. With this shiny new tax-free investment product, surely retail investors would be quick to realise the benefits of P2P lending?

Fast forward four years and P2P lending is an established part of the investment landscape, with more than ÂŁ1bn invested in IFISA accounts. But the role of the IFISA has changed. The introduction of new regulations last year and an influx of institutional investment means that platforms are no longer

reliant on large numbers of retail investors to grow their brand. ThinCats and Landbay have both stopped accepting new retail investment and are focusing solely on institutional investors going forward. Landbay closed its IFISA in December 2019 and refunded all of its IFISA investors; while

IFISA

a ThinCats representative told Peer2Peer Finance News that “no new IFISAs can be opened and we cannot accept any ISA transfers from other ISA managers.” Other platforms have repositioned their IFISA offerings as a taxefficient add-on, rather than their star product. LandlordInvest’s managing director Filip Karadaghi told Peer2Peer Finance News that his IFISA is “not the priority that it once was”, as the P2P property platform focuses on institutional funds. “We were one of the first platforms to offer the IFISA,” he says. “But now it is less of a strategic goal. We are looking to attract institutional funds, although we will still offer our IFISA product to retail investors.” Meanwhile, Paul Sonabend, commercial director of Relendex, predicted that this ISA season will see “less IFISA joiners than could

“ It’s not like IFISAs are the very first ISAs that have risk attached to them”

have been anticipated,” although he added that the quality of IFISA investors will be better as they now have a better understanding of the product. Just because the IFISA is no longer the focus of platforms’ attention, doesn’t mean it is becoming less important. Instead, the IFISA’s rapid evolution is a sign of maturity in the P2P sector. No longer are platforms racing to win over new retail investors – now they have an established user base of loyal investors. Furthermore, as the P2P sector has begun to attract a range of different types of investors – both retail and institutional investors, as well as independent financial advisers

(IFAs), sophisticated investors, and high-net-worth individuals (HNWIs) – this has naturally led to a shift in the way that the IFISA is used and marketed. Lisa Best, research manager at Intelligent Partnership, believes that the IFISA is a “no brainer” for sophisticated investors, HNWIs and advised investors. “If you put £50,000 into P2P lending because you decide that it works for you as a sophisticated investor or because your IFA told you, then there is no reason why the first £20,000 shouldn’t be invested in an IFISA,” she says. This may explain why so many platforms have been courting the adviser community of late.

IFISA

RateSetter and Proplend have both launched dedicated portals for financial advisers, while Octopus Choice has been almost exclusively targeting the IFA market since it launched in 2016. However, in off-record conversations, several industry experts have told Peer2Peer Finance News that there is still a sense of mistrust between the adviser community and P2P platforms. Some platforms feel that they have survived thus far without substantial IFA money, so why should they spend time and money chasing them? Meanwhile, most IFAs take a conservative approach to portfolio management and are in no rush to add a relatively new asset class to their portfolios. The IFISA may prove to be the perfect way to introduce the IFA community to the world of P2P. A regulated, tax-free product which offers inflation-beating returns is an easy sell to any type of investor. And as Best points out: “It’s not like IFISAs are the very first ISAs that have risk attached to them. Stocks and shares ISAs can have much higher risks attached.” Another selling point for IFISA newcomers is the fact that the P2P sector has just adopted some sweeping regulatory changes, including marketing restrictions and appropriateness tests for investors. While it’s no secret that most platforms found it a challenge to apply these new regulations within their existing business model, the benefits are already being seen. “The new regulations give further

comfort to potential investors that the P2P market is approved by the Financial Conduct Authority (FCA) and HMRC,” says Stuart Law, chief executive of Assetz Capital. “The FCA confirmation that 10 per cent of all retail investors’ assets could be invested in P2P means that more than £50bn of the £500bn of ISA money could still move over to P2P in due course. “Given that the IFISA is still a relatively new element of the ISA offering from HMRC, we don’t see any negative effect on the horizon as savvy investors are still looking

“ The new regulations give further comfort to potential investors”

to maximise their returns with ISAs outside of the traditional cash and stocks and shares versions.” Sonabend says that the regulatory changes will mean that Relendex’s marketing approach will be evolving. “Our lenders appreciate the ability to be able to take advantage of the IFISA as part of their investment strategy,” he says. “We are confident that once the public realises that those companies that have survived the regulatory changes are soundly run and providing consistently superior returns, the IFISA will come into its own. “We certainly anticipate that it will be not only relevant but also a play a vital part in the democratisation of savings.”

IFISA

This democratisation will likely lead to an even more diverse investor base, where HNWIs and students can invest on the same terms, accessing the same tax-free benefits through the same P2P platform. “We’ve seen some companies bringing in people who invest a small amount and accumulate a small amount in their IFISA accounts,” says Best. “Younger investors like the look of P2P. They like that it's sort of alternative and they can choose where their investment goes. It’s still an interesting route, especially because its online. I think that’s a potentially important audience, especially when it comes to the treatment of inter-generational wealth and the passing down of money through

“ It will play a

vital part in the democratisation of savings

”

inheritance.” This diverse demographic can already be seen in the minimum investments set by different platforms. EasyMoney has set a minimum investment threshold of £10,000 for its IFISA account – a clear signal that their products were intended for a sophisticated and/or institutional investor base. By contrast, Assetz Capital has a minimum threshold of just £1 – a

reflection of its commitment to retail investors. “We are targeting savvy retail and up,” explains Law. “People who are looking to get a better balance of risk/reward and avoid capital erosion on their funds in traditional investment/savings offerings.” Karadaghi describes the IFISA as being “as relevant as ever” and adds that it is now “just an extension of what we do – it just adds a tax-free element.” This repositioning of the IFISA as just one cog in the P2P machine lends an element of familiarity to the tax-free wrapper, which tracks with the evolving role of the IFISA – and of P2P lending in general – over the past few years. A FTSE investor is not attracted to the stock market because of the existence of the stocks and shares ISA – that is simply a useful tax-efficient bonus. A few years ago, the IFISA may have been held up as a beacon to attract newcomers to the P2P market, but now it is the P2P market that attracts investors of all stripes, and the existence of the IFISA is almost taken for granted. In the four years since the IFISA first launched, the P2P sector has grown, diversified and tightened up its regulations, opening the door to a whole new wave of investors and advocates along the way. P2P lending is not just for retail investors, nor institutional investors. It is for everyone – from the very wealthy to the novice investor, and everyone in between. And while the IFISA may have been initially viewed as a way to attract more retail investors to the sector, it has now proven to be as versatile as a stocks and shares ISA – a simple tax shelter for existing and emerging investors who don’t need to be convinced of the benefits of P2P lending.

JOINT VENTURE

Leave it to the experts

The House Crowd’s Frazer Fearnhead explains why he thinks the auto-invest model represents the future of peer-to-peer lending

“H

ISTORY HAS proven that only a very small percentage of stock pickers can beat FTSE tracker funds over the course of any one year,” says Frazer Fearnhead, founder and chief executive of property-backed peer-to-peer platform The House Crowd. “I think this situation is analogous to our auto-invest product, where it makes sense for people to go into a fund that diversifies their money over a number of different loans.” This is the ethos at the heart of The House Crowd’s auto-invest products – to mitigate risk and diversify investor portfolios by relying on the expertise and extensive due diligence at the platform. The House Crowd introduced its auto-invest model a few months ago, and so far the feedback has been positive, “especially from those people who had experienced some of their self-select loans going into default and had to wait longer than they anticipated for their returns to be paid,” says Fearnhead. For the time being, The House Crowd still caters for these self-select investors. However, Fearnhead believes that auto-invest will “most likely” become the default P2P model of the future. “It seems to be the way most platforms have gone or are going,” he says. “For most people, selecting a fund with decent diversity and better liquidity makes good practical and financial sense.

“Most people aren't experts at picking loans,” he adds. “Our team goes through lots of due diligence and our investors can see all the information we've gathered. There’s not really a lot an investor can add on top of the work we've done other than just review our own due diligence.” The House Crowd’s auto-invest model works by inviting investors to choose the term time of their loans and the level of security they are comfortable with. The platform then automatically distributes each investment across all available loans that fit the criteria for that fund pot, and the investor earns target rates of up to seven per cent per year, plus occasional bonuses.

This means that if something unexpected does go wrong with an individual loan then it only represents one small part of the portfolio, thereby minimising the impact of any potential losses. Unlike index-tracking funds, The House Crowd does not charge any fees to investors. “We make our money from charging the borrowers a fee, usually one or two per cent for making the loan,” explains Fearnhead. “And we make a margin of approximately four per cent on top of the rate we pay investors.” While auto-invest lending has been welcomed by the majority of The House Crowd’s investors, selfselect loans are still available for experienced investors who prefer to hand-pick loans according to their own specific criteria. “Some people want that extra level of control, which is why we will continue to offer that for those people,” says Fearnhead. “At least for the time being. “However, if people continue to self-select high-risk loans, they may find themselves in that unfortunate position of having several loans in default. It’s not a good position for them to be in, so we are trying to guide people into auto-invest which we believe is a more sensible investment strategy.” Like index-tracking funds, autoinvest could prove to be the key to democratising P2P lending and reducing risk in the long term.

PROFILE

A considered approach

Wellesley co-founder Andrew Turnbull speaks to Andrew Saunders about the transition to listed bonds, the property market post-Brexit and the benefits of cautious growth

TICKING TO YOUR knitting may not be the most exciting business strategy around, but in these turbulent times, cleaving tightly to what you know best does have advantages, says Andrew Turnbull, director and co-founder of The Wellesley Group. “We're a development lending business – we consider ourselves to be a traditional financier to wellbacked creditworthy developers who want to build frankly ordinary housing,” he explains. “I take great pride in that, even though it might be rather boring.” Wellesley continues to provide retail investors with exposure to property development lending opportunities, at a time when some alternative property lenders – such as Landbay and ThinCats – have decided to withdraw from the retail market in favour of institutional funding, he adds. “When you've got [platform failures] like Lendy, and also perfectly legitimate firms just pulling out of the market for various reasons it does sign some instability in the peer-to-peer lending industry,” Turnbull states. “But that give us an opportunity – we were one of the early players and we are an established, credible brand. People can see that we've been through good times and difficult times and that we're still here. We have that track record.” That track record as a property

development lender dates back to 2013 when City veteran and forex entrepreneur Graham Wellesley – aka the 8th Earl of Cowley – founded the business. The company's goal was to help finance regional developers to play a bigger part in tackling the housing crisis, and at the same time to provide reliable and competitive returns to investors. It's what Wellesley still does today, says Turnbull – financing affordable homes in regional markets that typically sell for

£200,000 to £300,000 each. “We've funded the construction of 3,000 houses at sensible prices – nonracy housing that's appropriate for the ordinary man or lady by its design,” he comments. “A lot of our competitors jumped into prime residential in London but we took the opposite view. We wanted to be in places like Bristol, Canterbury and Newcastle. Places where people have normal mortgage multiples and are able to buy their first or second home from one of our local developers

PROFILE

– we've found that is not only a social good but that it's actually been a really good credit risk, because those houses sell.” But if the basic premise of the business has remained fixed, the way Wellesley serves its investors and borrowers has undergone several substantial changes. Although Wellesley began life as a P2P lender, it hasn’t operated as a P2P platform since 2017. Why not? Turnbull says the founders quite quickly discovered that the model did not work well for their chosen funding niche. “We started off as a P2P platform, but we weren't a very popular one,” he recalls. “What we found was that P2P wasn't a perfect match with development lending.” While P2P continues to work well, he believes, for relatively simple products such as personal loans or

“

P2P wasn't a perfect match with development lending

”

asset-backed business loans, the combination of a fairly complex lending product – development loans are typically issued in tranches based on progress and subject to approval at each stage by the lender – with a fairly complex funding model in P2P, was too much for borrowers and investors alike. “We found that what our investors wanted was simplicity – they wanted the exposure to the underlying real estate risk, they just didn't want the complexity of dealing with P2P,” Turnbull asserts. In its quest for a more investor-

friendly alternative, in 2014 the business issued its first minibond programme. “Our investors preferred the predictability of a bond, in the sense that with a bond they can see that I'm paying them interest once a month, and that this is the end date.” The new mini-bonds with their regular payments and fixed terms were a better fit with Wellesley's target investors. “[These are] people in their 30s, 40s, 50s, or 60s with some disposable wealth that they have chosen to invest,” Turnbull explains. “There was a time when they could have expected five per cent from the bank, but times have changed and now they realise that they have to take some risk to get five per cent.” Wellesley provides them with

PROFILE

an “alternative” element for their portfolios, he adds, because it is property rather than shares based. “It's not really correlated to the stock market and it can give some consistent income,” Turnbull adds. Three years later, Wellesley took the bold step of ceasing to accept new money into its P2P offering, in order to focus completely on bonds. A move which might seem at odds with Turnbull's previous comments on those leaving the sector more recently, but which was actually, he says, driven not by a search for alternative institutional funding but rather by the desire to keep servicing the firm's established retail investor base. “We took the decision to exit that [P2P] market. It was primarily driven by the desire to deliver the investments that our customers wanted.” The firm's next big decision – to transition from unregulated minibonds into fully regulated listed bonds, a process started in 2018 – followed some heavy criticism from the media and analysts both of the performance of the mini-bond and of Wellesley’s lack of profitability. This was a wise move, given the Financial Conduct Authority’s (FCA) recent ban on the marketing of mini-bonds to retail investors, in the wake of the £230m collapse of mini-bond provider London Capital & Finance in January 2019 – a scandal which resulted in over 11,000 investors, many of them pensioners and smaller retail customers, losing their money. But Wellesley had completed its move to listed bonds by July, four months ahead of the FCA ban. Turnbull says that the move was driven largely by fears around the wider state of the mini-bond market. “By 2018 we were seeing headwinds,” he reveals. “We felt

“

You can’t computerise this kind of lending

”

uncomfortable, because the lack of regulation around mini-bonds meant that you could have people who were clearly not doing things properly. We thought something might happen, although LCF was

way worse than we expected.” Although the shift to fullyregulated listed bonds was not without its own challenges – it took some months for Wellesley to secure the necessary regulatory permissions to hold the bonds itself – it has been more than worth the trouble, says Turnbull. “It was a wise move – it meant that our customers could feel fully reassured that they were investing in our regulated product. Every listed bond has to issue a

PROFILE

“ We want to keep doing things in a high quality, considered and measured way”

prospectus that is approved by the regulator. That's really important, because it means that they are all done to a common standard.” On the lending side, Wellesley’s niche is regional developers with local market expertise. “We have good relationships with regional developers who have decent net worth behind them,” says Turnbull. “They probably do three or four developments a year, they have an office and some infrastructure. They aren’t one-man bands

but neither are they among the Barratt’s of the world.” These kinds of borrowers are underserved by high street banks because of the cost of serving smaller loans and the inherent complexity of development finance, he says. “The banks don’t really want to do development lending – the capital requirements for a bank are significant and having a book of lots of £5m loans is hard for them to manage,” Turnbull explains. And because development finance involves an ongoing relationship between lender and borrower, it’s also hard for banks to automate. “You can’t computerise this kind of lending because construction risk has lots of moving parts,” he says. “You need senior people to be able to take risk decisions at short notice – they are not usually very big risk decisions, but they are not the sort of thing that a bank can do with a computer.’ That all means, says Turnbull, that Wellesley can provide a speedy, reliable and competitive service in a market which is not yet awash with competition. It’s a lending model which has only really been subject to one significant tweak: in 2015, the decision was made to increase the average loan size from around £1m to its current level of between £5m and £10m. “What we used to do was back one or two-million-pound loans – those developers were often doing a great job socially, but they tend to be less experienced and less well capitalised, and you still have to monitor the credit risk,” he states. “Our strategy since 2015 has

been a winner – you don't get higher returns but you do have much better credit quality.” In terms of that conversational staple of British middle-class life, the state of the property market, Turnbull is sanguine. He doesn’t believe there will be a serious recession and says that the combination of greater clarity on Brexit and an end to worries over the impact of a Corbyn government on house prices is already translating into better sales. “I’m pleased there is clarity on the political position over Brexit, because political uncertainty is risk, and irrespective of whether you take a leave or remain position that risk has now reduced,” he says. “We’ve seen reservations starting to increase on all the developments we back, whether in the North or the South. People feel comfortable enough to move forward.” So what of the future for Wellesley in post-Brexit Britain? More of the same is the essence of Turnbull’s position, with a focus on careful, steady – and yes, perhaps even slightly boring – growth. “We’ve been wanting to deal purely in listed, regulated bonds for years and we’ve finally got there,” he comments. “Our greatest challenge now is to get the business to a point of scale, to drive a profit and become a larger player. But as ever we want that growth to be temperate, we want to keep doing things in a high quality, considered and measured way. It’s very important to us that we don’t get into a position where we are trying to grow too quickly.”