Peer2Peer Finance News June 2017 by Alternative Credit Investor

LENDERS MOVE TOWARDS NICHE ASSETS

>> 9

High risk but high returns BLURRED LINES

Are banks and P2P firms too close for comfort?

>> 16

Modulr boss Myles Stephenson on new payments technology >> 11

ISSUE 9 | JUNE 2017

P2P platforms facing hybrid dilemma THE PEER-TO-PEER finance industry could be on its way to becoming a polarised market, where the biggest firms stick to their core P2P lending activities and the rest are forced to evolve into hybrid models. A wide range of industry onlookers have told Peer2Peer Finance News that it will be impossible for smaller firms to achieve profitability without either expanding into balance sheet lending, merging with direct lenders or morphing into a business model closer to that of a collective investment scheme. "It's incredibly difficult to build a straightforward P2P business to the size where it becomes profitable," said Andy Davis, author of a report

that pointed to hybrid models as an inevitable evolution in the sector. "It's intrinsically more profitable to arrange and lend rather than only arrange. We're going to start seeing hybrid loans emerge." P2P is ultimately just a subset of direct non-bank lending, he argued, but with different technology in place and different market access. When a direct lender sets up a P2P platform, its return on capital goes up exponentially and it can immediately recycle those returns to originate more lending. "Hybrid lending from some providers will increasingly be the chosen solution. This is not an issue or a problem for

investors in and of itself, " added 4th Way analyst Neil Faulkner. While the early adopters "had huge enthusiasm and were emotionally invested in the idea of P2P," the notion of matching

investors and borrowers is no longer a key selling point, according to Conrad Ford, founder and chief executive of business finance aggregator Funding Options. “The borrowers >> 4

Tax guidance unclear on secondary market trades SECONDARY markets where peer-to-peer loans can be sold at a premium or discount are at risk of falling into the taxman’s definition of a trading

activity, rather than an investment. On the whole, the practice is compliant with current regulations and can be a good way of boosting

liquidity in a less-thanliquid market. However, from HMRC’s perspective, the tax paid on a profitable trade would be different to the tax paid

on the earnings from an investment. There could be a big difference between a capital gains tax bill or an income tax bill. The industry differs >> 4

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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 Anna Brunetti Chief Reporter anna@p2pfinancenews.co.uk +44 (0) 7546 995334 Marc Shoffman Senior Reporter marc@p2pfinancenews.co.uk PRODUCTION Karen Whitaker Art Director Zac Thorne Logo design COMMERCIAL Amy St Louis Director of Sales and Marketing amy@p2pfinancenews.co.uk 07399 414 336 SUBSCRIPTIONS AND DISTRIBUTION info@p2pfinancenews.co.uk Find our website at www.p2pfinancenews.co.uk Printed by The Manson Group ©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.

HAT is a peer-to-peer lender? With many of the largest platforms still awaiting authorisation from the Financial Conduct Authority, that is clearly a difficult question to answer. P2P grandfather Zopa finally gained approval in May after an arduous 18-month application process, sending shockwaves through an industry that was expecting a triple-whammy of approvals. Funding Circle and RateSetter were still awaiting the regulatory green light as of 19 May, showing that no one has a crystal ball that can accurately predict the FCA’s next move. What’s interesting about Zopa’s authorisation is that the platform has flagged its intentions to launch a bank. While everyone has been worrying about fitting in with the regulator’s strict definition of P2P, Zopa has been transparent about the next stage of its evolution. As our front page story shows, the future landscape of P2P is far from certain and it seems likely that some platforms will expand into other segments. But Zopa’s approval suggests this could be a help to regulators, rather than a hindrance.

SUZIE NEUWIRTH EDITOR-IN-CHIEF

NEWS

cont. from page 1 don’t really care where the money comes from," he said. Such blunt statements run counter to the current perception of balance sheet lending as a hurdle to gaining regulatory authorisation, but Davis and Faulkner seem to agree that this is not the case. "Evidence so far is that mixed structures with a direct lending arm and a P2P lending platform have obtained authorisation very quickly," said Davis. The Financial Conduct Authority does not specifically outlaw direct lenders creating a P2P offshoot, as long as they set up separate

structures, guarantee a degree of risk sharing and most importantly, a high level of transparency, he said. "What is absolutely critical is that any changes to the risks that this brings are explained clearly to investors," said Faulkner. So in the next phase of the P2P market's coming of age, hybrid lending and consolidation could become the norm for most players. But for the largest platforms, which have reached an impressive level of scale in a relatively short time period, it is a different story.

Zopa – which is planning to launch a separate banking arm – is seen as an exception to the rule, with insiders predicting that most of the largest firms will stick to their core P2P lending activities. RateSetter does not think that it is necessary for platforms to shift into hybrid models. "We are of the view that our own model is scalable and sustainable," a spokesperson said, citing the fact that the platform was profitable in the financial years ended 2014 and 2015. Funding Circle has indicated that it is not

interested in launching a bank. "It is clear that the ones that manage to gain scale [as straightforward P2P platforms] then become perfectly profitable, and that's where the leaders are going," said Faulkner. Despite industry forecasts, smaller players are not necessarily convinced. “I think the argument about hybrid models is complete rubbish,” said Lee Birkett, founder and chief executive of Cheshire-based lender JustUs. “There’s no such thing as a hybrid model. You’re either a bank or a P2P platform.”

expressed concerns that HMRC guidelines on investing versus trading are unclear, making it harder to assess which camp a sale falls into. The taxman’s definition depends on a wide variety of factors, which centre around the intention of the widely as to whether it individual. Its guidelines say enables loans to be sold that you are most probably at varying prices or just trading if you want to make at par. Platforms such as FundingSecure and Ablrate a profit or you have bought goods to sell them on. allow loan parts to be sold But you are probably not at both a premium or a discount, and Assetz Capital regarded as trading if you only sell things to cover allows discounts but not your costs or you only premiums, while Landbay, make sales occasionally. Proplend and Lendy only Peer2Peer Finance News sell loans at par. understands that from A number of platforms HMRC’s perspective, most allowing premium and individuals selling P2P discount prices have

loans on the secondary market are not trading but investing and that there would have to be sufficient evidence of trading to displace that investment presumption. “Rather than just having a load of loans for sale at par, people can create their own bids more like a stock market ," said David Bradley Ward, chief executive of Ablrate. “There are instances where the credit profile of a loan might change. If you’re only selling at par, how would you compensate the person who took the risk in the first place?” Stuart Law, chief executive of Assetz Capital,

agrees with the idea of discounts but said he is “uncomfortable with premiums”. “Does the new buyer know that they’re buying at a premium? There is the credit risk that investors don’t realise they’re taking, or the risk that we’re not trading customers fairly,” he said. Ultimately, P2P lending is not necessarily the right choice for investors who want fast, flexible access to their money. “At Proplend, loans are just sold at face value on the secondary market as I want people to feel committed to the loan maturity,” said Brian Bartaby, chief executive of the property lender.

cont. from bottom story page 1

NEWS

UK Bond Network may offer P2P securitised loans to retail investors UK BOND Network (UKBN) may become the first platform to offer securitised peer-to-peer loans to UK retail investors through its Innovative Finance ISA. The P2P bond auction firm is hoping to extend the next tranche from a Sancus BMS securitisation it participated in to all its investors, by adding it to the tax-free wrapper it launched in March. The firm helped

alternative lender Sancus BMS structure a £14.45m securitisation of a variety of its assets including P2P loans at the end of April. £11.45m of senior notes were up for sale to high-net-worth individuals and small family offices, offering returns of seven per cent. "Due to restrictions on how we were able to distribute the offering, it was available to professional investors only,

and we took a relatively passive involvement at this stage," UKBN’s chief executive Chris Maule (pictured) told Peer2Peer Finance News. "If Sancus [BMS] were to tweak and evolve its offering, taking steps to enable us to introduce the product to retail investors, it could be very much a possibility.” John Davey, director and co-founder at Sancus BMS, said that while the

specialist finance provider hadn't reached a decision on whether to structure its next batch of securitised bonds as a retail offering, the move could represent a realistic possibility.

Peer-to-peer community forums: Friend or foe? INDUSTRY opinion is split on the benefits of company-specific forums, with some insiders questioning their viability once a platform reaches a certain scale. As Peer2Peer Finance News exclusively reported, Funding Circle closed its forum on 2 May, in the wake of a thread on defaulting property loans that attracted more than 1,300 replies and 59,000 views. The business lender suggested that its investors share their views on the P2P Independent Forum (P2PIF) instead – an impartial, sector-wide online forum that allows

individuals to post comments on any lender. Regardless of platform-specific issues, the closure provokes the question of whether forums are a good idea for P2P firms in general. “It’s really a commercial decision,” said Neil Faulkner of P2P research firm 4th Way. “It’s a great way to attract an audience but if a platform gets to a certain scale it isn’t worth moderating it. It’s good for investors but there aren’t enough benefits for larger platforms.” Ablrate, an assetbacked lender that has channelled just over £20m to businesses

to date, has an internal comments section on its website. Chief executive David Bradley-Ward said that the platform builds a lot of functionality based on its feedback, but questioned whether it would be practical in the future. “There comes a point where it will become more difficult to monitor and manage all the comments that are being made,” he said. Like many platforms, Lendy does not have its own forum but responds to investors on the P2PIF. “Any form of social media has its own risks,” said a spokesperson. “I think it’s important to be as

open and transparent as possible.” Stuart Law, chief executive of Assetz Capital, said the firm was considering launching its own forum, as “the P2PIF is a very good place but it’s not known by everybody”. He eschewed the argument that forums do not work for platforms of substantial scale. “I have a very strong opinion on this,” he said. “If a platform doesn’t have time to respond to their investors, then its days are numbered. “It’s so wrong on so many levels. That sort of behaviour is why people are walking away from banks!”

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NEWS

Banks boost digital capabilities with new fintech hubs BARCLAYS opened the largest co-working fintech space in Europe last month, underlining an increasing trend of banks moving into technology. Rise London is based in Shoreditch and encompasses 30,000 square feet of office space over seven floors. It will support more than 40 fintech companies, including those in the current cohort of the Barclays Accelerator scheme for emerging startups.

“How do we maintain our success in the face of new technology, and how do we have the mindset to defend what is so critical to the institution?” said Barclays Group chief executive Jes Staley. “One of the responses of the bank is Rise, and that says that we’re not afraid of new technology, we embrace it.” The move is being echoed by other mainstream lenders. For now there is not

much evidence of a threat to P2P innovation from banks’ fintech hubs, as most seem to focus on other types of financial technology such as contactless payments. HSBC has seven innovation labs globally in London, Hong Kong, Singapore, Sydney, India, Israel and China, focusing on blockchain, artificial intelligence, data analytics and cyber security. Similarly, Royal Bank of Scotland opened a specialist

fintech hub in May at its Edinburgh headquarters, the largest in Scotland, giving start-ups access to the bank’s staff and technology partners to help grow their ideas and businesses. It is not just the biggest lenders moving into fintech. Clydesdale and Yorkshire Bank has partnered with Market Gravity to design, implement and launch an experiential banking innovation lab called Studio B in London.

Lenders slow to develop apps APPS may be seen by some as a vital tool for any fintech business but peer-to-peer lenders have largely avoided this area so far. Of the biggest UK P2P players, only Funding Circle has an app for investors, while Zopa has one in development. Instead, others such as RateSetter, MarketInvoice and Landbay have focused on the overall web, desktop and mobile user experience. Julian Cork, chief operating officer at buy-tolet lender Landbay, said the platform had considered making an app but decided against it. “As a technology-driven business we considered building a mobile app but in the end we chose to

go for a fully responsive web app so our investors can access our platform in the same way across all devices,” he told Peer2Peer Finance News. “In addition, our user testing has shown that investors tend to prefer desktop for making financial transactions and indeed 87 per cent of our investment so far in 2017 has come via desktop. “With an average account size of £8,000 and investment products that do not require investors to pick or bid on individual loans, or log in to monitor the secondary market, I don’t expect this to change in the near future.” New Peer-to-Peer Finance Association

(P2PFA) member Folk2Folk has also stayed away from apps because of limited interest from its user base. “Most of our customers are over 60 so I think an app would be a stretch too far at the moment,” a spokesperson said. “We are focused on improving our online portal for customers to ensure they have a great experience when investing and looking at their portfolio of loans. “The websites tend to be built to be mobile ready so the same experience is had across desktop, mobile or tablet.” Outside of the P2PFA, P2P pawnbroker Collateral

is working on an app, while LendingCrowd and Crowd2Fund both have apps, with five and fourand-a-half star ratings respectively on the Apple Store. They have had relatively few reviews though, with just five for LendingCrowd and 12 for Crowd2Fund. In comparison, Funding Circle’s app has three stars out of five from 118 ratings.

NEWS

Ireland's Flender plans double UK and IFISA launch PEER-TO-PEER lending platform Flender is planning to synchronise its foray into the UK market with the launch of an Innovative Finance ISA (FISA) within the next couple of months. The platform gained full authorisation from the Financial Conduct Authority at the beginning of May and recently soft-launched in Ireland, attracting £4m in demand over five weeks. The business and consumer lender is now looking to build up enough volume to launch a tax-free wrapper at the same time as it kicks off its UK operations.

The return on its IFISA investments would mirror the current average yield rate of between eight per cent and 14 per cent, the firm's co-founder and chief executive Kristjan Koik told Peer2Peer Finance News, although the nature of Flender's business means that rates on the platform can vary widely and start from as low as zero per cent. The company was set up to enable individuals and small business owners to launch fundraising campaigns targeting their circle of acquaintances and to allow both sides to choose

their own interest rates. Koik said he expects that the balance between its consumer and business borrowers in the UK will be "very much in line with current P2P statistics in the country, where the former stands at slightly below 50 per cent," and he hopes to quickly scale up lending thanks to the larger scale of the British market. P2P firms raised £11m of funds in Ireland over 2016, which compares with about £1bn of investment channelled in the UK in first quarter of 2017 alone. The expansion could allow the platform to

shift from retail, high-net worth and small family office lenders to institutional investors within six months, Koik said. "We are focusing on building up a good track record to bring results to the table for larger investors," he said. Mainstream banks as well as challenger lenders such as Metro Bank could be a strong match for the platform, which offers a more secured type of lending compared with other P2P firms, including director guarantees on business loans, Koik said.

REGULATION UPDATE

City watchdog gives Zopa the green light THE BIG REGULATORY news last month was Zopa’s long-awaited authorisation from the Financial Conduct Authority (FCA) on 11 May. The world’s oldest peer-topeer lender had undergone a rigorous 18-month approval process since applying to the City regulator and can now apply to HMRC for ISA manager status to offer the Innovative Finance ISA (IFISA). Last month also saw a number of P2P lenders throw their weight behind

the UK Fintech Financial Crime Exchange (FFE), which aims to bring together fintech companies to help them detect and counter money laundering, terrorist financing, bribery and corruption, tax evasion and market manipulation. MarketInvoice, Landbay and RateSetter are among the 17 members of the project, which was set up by security think-tank RUSI and financial crime risk

management consultancy FINTRAIL. Last but not least, the FCA has entered into a co-operation agreement with the Securities and Futures Commission in Hong Kong to boost collaboration on fintech innovation. Under the agreement, the two regulators will share information and refer innovative businesses to each other that would like to operate in the other jurisdiction.

NEWS

Lenders are moving towards niche assets PEER-TO-PEER lending is moving towards more niche assets with platforms now offering loans secured on items such as fine wine or classic cars. Platforms such as HNW Lending, Collateral and FundingSecure act as P2P pawnbrokers so there is no credit checking but loans are based on the provider’s own due diligence and the value of the underlying asset. For example, HNW Lending provides personal loans ranging between £30,000 and £3m, backed by valuable assets such as real estate, cars, pensions and fine wine. Investors can get returns of up to 15 per cent and HNW Lending also provides an Innovative Finance ISA (IFISA). HNW Lending says it

has provided more than £1m in loans against classic cars and there has just been one default, which meant a borrower had to sell his 1980s Porsche. This does raise the question of why someone who can afford a classic car or collect wine would need a P2P loan, but Ben Shaw, founder of HNW Lending, explained it is about speed. “Some people just need to raise a bit of extra cash in a hurry, such as to pay a bill or to buy a new property or to help out their business, then will refinance more cheaply or pay it off,” he said. Another IFISA provider, FundingSecure, works in a similar fashion, with rates of around 12 per cent.

These rates are higher than what many of the traditional P2P platforms offer. For example, Zopa’s highest rate is currently 6.1 per cent while Landbay, which provides buy-to-let loans secured on property, has a rate of 3.75 per cent. However, niche assets can be more risky in the event of a defaulting loan. “Typically, we see P2P investors lending across platforms where loans are secured on property or are

unsecured,” said Jordan Stodart of Orca. “More niche assets that secure loans are harder to value and potentially more difficult to liquidate. “Investing in P2P requires significant research and due diligence. To introduce a new, unknown element – namely the type of security – might overcomplicate the process, particularly for the less-seasoned investor.”

KPMG’s new debt advisory service could refer SMEs to P2P KPMG has set up a new small- and medium-sized enterprise (SME) debt advisory service, to help smaller businesses obtain finance from sources including peer-to-peer lenders. Enterprise Financing launched last month and is focused on businesses trying to raise between £2m and £10m. “KPMG has always

had a lot of SME clients especially in the regions,” Steve Elisgood, who leads Enterprise Financing in the UK, told Peer2Peer Finance News. “There is a changing debt landscape out there, with a wide variety of providers ranging from banks, to challenger banks, to P2P lenders. It’s quite difficult to navigate as an SME.”

Elisgood said that KPMG would obviously still consider high street banks when recommending finance to SMEs but explained that the firm would take into account all sources of credit before deciding what was appropriate. “I definitely think there’s a place for P2P in the market,” he said. “However, it’s likely P2P

will fall outside of the remit in the majority of cases due to the size of the loans, as P2P is at the lower end. “But I don’t see any reason we wouldn’t recommend P2P if it were appropriate for the client. “There’s definitely a large source of funds out there. We need to find the best lender with a competitive price.”

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COMMENT & ANALYSIS

Payments are pivotal

Myles Stephenson, chief executive of business payment solutions provider Modulr, explains why investing in new payments technology is essential for the growth of P2P…

F YOU LOOK AT THE growth rates, the future looks bright for peer-to-peer finance providers. The sector, which was practically non-existent in 2010, was worth £2.5bn in 2016, with a 40 per cent year-on-year increase from 2015-16. The four leading P2P platforms saw double-digit growth last year, while the P2P lending sector as a whole has become one of the leading categories amongst the alternative finance sectors. This rapid growth has not gone unnoticed by regulators and competitors alike and there are challenges that need to be addressed if the sector is to sustain its impressive growth rate. The first of these challenges is security and fraud management. It’s an inevitable and growing threat casting a potential shadow over the booming sector. More than 50 per cent of platforms surveyed by the Cambridge Institute of Alternative Finance saw breaches and malpractice as a threat to the industry at large. Platforms have a clear responsibility to minimise the chances of first-party, fundraiser and borrower marketplace fraud. Effective protection of client funds, know your customer (KYC) and anti-money laundering processes will be key. Competition is also beginning to mount beyond other platforms and non-bank lenders. Both Barclays and NatWest have recognised the challenge and are fighting back with automated lending platforms for small- and medium-sized enterprises.

The response for P2P lenders is to continue to strive for even better ways to serve customers. While a key part of this will be offering innovative products carefully tailored to the needs of specific customer segments, delighting and engaging services are also critical. Building trust and satisfaction will mean rapid customer onboarding, self-service portals for status checking, instant access to customer information so queries and problems can be resolved quickly, proactive communications for repayment reminders and receipts and rapid transaction times. Implementing these growth strategies will mean streamlining core competencies to improve the customer offering. Payments is one of

Complex payments “flows are at the heart

of what alternative finance providers do

”

these critical competencies. Complex payments flows are at the heart of what alternative finance providers do. As platforms evolve with more intricate product offerings, the levels of payments complexity are only likely to increase, along with the likelihood of unnecessary overheads and risk of errors. Fortunately, the stars are aligning in the payments industry with regulatory changes (including PSD2

and the open banking initiative), a well-funded fintech sector and subsequent developments in new technologies. A new generation of service providers now offer more effective means of processing inand-out payments with simplified reconciliation and dedicated payment accounts that allow a different way to deal with client money segregation. These new technologies facilitate instant payment account creation, highly flexible and immediate payment initiation and ongoing ledger reconciliation. The physical separation of payment accounts is essential, ensuring protection of client funds, transparency in reporting and a simpler approach to compliance. Once initial KYC checks are completed, multiple accounts can be opened instantly, making customer onboarding quick and clean. As P2P lenders emerge into their next growth stages, there will be an intense need to support an increasingly complex product set, at scale, while maintaining customer trust and satisfaction, meeting compliance requirements and ensuring platform flexibility and security. These demanding times have created a catalyst for change. Effective payments will form the new tipping point, adding that competitive injection upon which P2P platforms can build a bright future.

INVESTOR PROFILE

Spread your bets Matthew Dodd is currently applying for jobs in the venture capital sector and moved to London at the start of the year. He has been building up his investment portfolio in recent months and tells Peer2Peer Finance News why peer-to-peer lending will remain a significant part of his strategy…

N SOME WAYS, MATTHEW DODD is not your typical peer-topeer investor. Many of the industry’s earliest adopters were nearing retirement age, attracted to the higher yields that P2P could offer as a means of boosting their pension pots. But Dodd, a millennial, already invests in a handful of P2P platforms and has even been entrusted to allocate his family’s money into the sector. “My first experience of P2P was actually straight after I graduated from university in 2013,” he tells Peer2Peer Finance News. “I had an internship at an investment bank and there was someone there was that was quite interested in the P2P space and who invested in ThinCats’ platform. “I didn’t know anything about it at that stage, but he explained that there were some good opportunities.”

His first equity investment was in Royal Mail’s initial public offering in October 2013. The hugely oversubscribed sale saw shares rise 38 per cent in their first day of conditional dealings on the London Stock Exchange. “It did quite well and got me interested in investing my capital,” he comments. But Dodd did not get properly involved in investing – in any shape or form – until he had his first full-time job at Oxford University Endowment Management (OUEM), which manages the £2bn of Oxford funds on behalf of 28 collegiate university investors. “We were investing across all types of asset classes and geographies, with the biggest allocation towards public equities,” he says. “We also had private equity, venture capital, credit and property. “So I got a good education in finance there

for two-and-a-half years and learnt a lot about the space.” Armed with his new knowledge, when Dodd had more money to invest he looked toward P2P amongst other opportunities. “I put it passively into equities and into P2P lenders such as Funding Circle and Zopa,” he says. “I didn’t have that much time to keep going through platforms like ThinCats and do the due diligence on the opportunities that were coming up, so I went for a more passive approach. “I left OEUM last August and invested both my money and my family’s money. My parents had retired, so they had a bit of

money, but they didn’t have a background in finance. “They were looking to get higher yields than they had previously been able to get, but obviously, with interest rates now, they were struggling to earn money.” Dodd has just under 50 per cent of his portfolio in public equities, around 30 per cent in credit – “which is basically P2P” – and around 13 per cent in what he calls venture, which includes earlystage investment and cryptocurrencies. He is not afraid of taking some risks with his portfolio, but feels that diversification gives him more stability. His best returns so far have come from what he sees

INVESTOR PROFILE

as the riskiest part of his portfolio, namely cryptocurrencies. He has enjoyed bumper returns on his Ethereum and Bitcoin investments, but he accepts that these are early-stage technologies that “could go to zero”. “I’ve made some money and trimmed the position now to rebalance my portfolio, but they’ve been very successful recently,” he explains. “Obviously you’re not going to see returns like that in P2P but you’re not going to get the high volatility either.” When it comes to P2P platforms, Dodd looks for brand visibility and longevity, as well as a proven track record.

He invests predominantly in Funding Circle and Zopa. He has dipped into ThinCats and has put £1,000 into RateSetter to take advantage of its £100 cashback scheme, which has now ended. He also has some money with Lendy, formerly known as Saving Stream. Like all of his investments, diversity is key when it comes to P2P, Dodd explains. “I consider the return you’re getting and the risk you have to take for that return,” he asserts. “Each platform has a slightly different way of going about that, so I think diversity is obviously very important in the sector.” P2P investments do not tend to be the most liquid

The way I see it, you’re “ essentially buying insurance by having a provision fund ” of assets, so Dodd finds the secondary markets offered by platforms to be useful if he wishes to sell a loan part before the maturity date. “It can be helpful because that can reduce your risk, as obviously defaults tend to occur later in the life cycle of the loan,” he explains. When it comes to active versus passive investment,

Dodd is only prepared to spend time researching specific opportunities if he thinks he can add value, particularly as P2P does not make up the majority of his portfolio. “How much better am I at picking good loans over bad loans? I feel I might have a bit of an edge in the property space,” he says. “That’s why on Lendy I look at all the

INVESTOR PROFILE

opportunities carefully. Also, they’re slightly higher-risk investments. When they’re higher risk, you have more to gain by being active. If they’re quite low-risk investments with better credit grades, it can be more difficult to discern which are good and bad investments, especially after they’ve passed the criteria of whichever platform they’re on. “So I take a kind of semi-active approach, where most of it is passive, as I think that’s a good way to get exposure, but on certain platforms, I’m a bit more active.” odd is not overly enthused by provision funds and says he would opt for a higher yield if he had a choice. “The way I see it, you’re essentially buying insurance by having a provision fund,” he says. “You’re going to get a lower return, on average. If you can ride the volatility and take the losses, you are going to generate a better yield. “If I were recommending it to someone, it would depend on their appetite for risk. Because I have quite a diversified portfolio overall, I’m happy to take more risk.” Despite his confident approach to risk, Dodd

prefers to opt for secured loans. He argues that security can be a good cushion against defaults, even if you can only recover a proportion of the initial investment. However, he highlights the fact that the value and type of security need to be taken into account. “I think you always have to discount your security; you can’t take it at face value,” he asserts. “You have to expect that you’ll get less than whatever the security’s valued at, just because of the costs of recovering the security and any possible change to its value. “For example, if it’s property, property prices might fall and you might not be able to generate a sale. Or things like personal guarantees often don’t hold up in court.” Dodd has not taken up an Innovative Finance ISA (IFISA) yet, although he uses a tax-free wrapper for his stocks and shares. However, he would use an IFISA when one of the platforms he currently invests through launches the product. “I think it’s actually more attractive to protect the income from P2P because a lot of the gains from stocks and shares will come from capital appreciation and you have allowances for that,”

Unless a downturn were “particularly bad and that’s

obviously very hard to predict, I think P2P would still offer a decent reward-to-risk ratio

”

INVESTOR PROFILE

probably eek out another couple of per cent from it if I shopped around a little bit, whereas other parts of my portfolio, like the cryptocurrency investments, have the potential to generate much greater returns. For example, my holding in Ethereum which appreciated over 400 per cent over a couple of months. “If you get those kinds of bets right, it far outweighs seeking out a small amount of extra return from P2P. However, in order to be comfortable to take those types of risks, I need to have a decent part of my portfolio generating a consistent return.” odd, like many industry onlookers, notes the fact that P2P has not yet been through a financial crisis. He sees a downturn in the economy as the real test for the industry, to see how it weathers a real uptick in default rates. “Equities would probably get harder hit, but again, diversity among sectors, borrowers and types of risk is important,” he says. “Unless a downturn were particularly bad and that’s obviously very hard to predict, I think P2P would still offer a decent reward-to-risk ratio.” Despite his predilection

D he says. “Also, capital gains tax is lower than my income tax would be. The P2P income would be taxed at income tax levels, so it would be more beneficial to shield that from a tax perspective rather than to shield stocks. So it’s definitely something I’m looking into.” Looking forward, Dodd is planning to maintain P2P as a sizeable part of his portfolio, although he reiterates his diversity-is-

best strategy. “I’m fairly comfortable with what I have presently,” he comments. “I need to do some more research into the platforms as I’m sure there are some more interesting opportunities out there, but it has been, and will continue to be, just a staple in my portfolio that continues to generate some pretty attractive returns. “It’s not a priority for that reason, as I could

for P2P, Dodd admits that he would be a less enthusiastic investor if interest rates weren’t so low. The Bank of England lowered the base rate to 0.25 per cent last summer in the wake of the Brexit vote, which contributed to the influx of retail investors who flooded towards the P2P sector in search of yield. “If interest rates were five per cent and you were getting six per cent from P2P, I’d probably take the money that’s backed by the government in terms of losses,” he affirms. “But when it’s near to zero per cent, that’s a significant amount of return you’re losing.” For now, the cost of borrowing is set to stay low so Dodd’s P2P loans won’t be going anywhere. He sees himself as a long-term investor. “I think about liquidity on a holistic basis in my portfolio,” he says. “I try to be quite a long-term investor, but liquidity can dry up if times turn sour and that is something we need to be cautious about. “While liquidity is good, I’m happy to hold all of my loans until maturity and hopefully still have a positive yield, even in a crunch.”

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Blurred lines

High-profile bank partnerships have brought peer-topeer platforms to the masses. But are the lines being blurred between alternative and traditional lending?

HEN PEERTO-PEER PLATFORMS burst on the scene, they were seen as the antidote to traditional banking structures. It’s no coincidence that the P2P sector started to take off in the aftermath of the global banking crisis - their early success was largely down to the fact that they offered finance when high street banks stopped lending. By cutting out the

middleman, P2P platforms could connect lenders and borrowers directly with each other, reducing fees and increasing returns for investors. But fast forward a few years, and the UK’s oldest P2P platform – Zopa – is announcing plans to launch its own digital bank, while there has been a slew of high-profile partnerships between P2P platforms and retail banks.

Where once P2P lenders were the plucky outsiders, now they are joining forces with the establishment, sparking speculation that we may soon see a flurry of dealmaking activity, as banks and P2P platforms move closer together. “The lines are getting very blurred,” says Katrin Herrling, chief executive and co-founder of alternative finance

aggregator Funding Xchange. "If you look at alternative funders in SME lending, we see the likes of Funding Circle and MarketInvoice continuing to open up some white water to their nearest competitors – however, these guys are concerned about sustaining their growth. Unless a player really drives scale or owns an attractive niche, their model isn’t going to work. For the bigger platforms to scale, they will have to work more and more with banks who still own most of the customer relationships.” This is already starting to happen. A number of high-profile partnerships have sprung up between the likes of Zopa and Metro Bank, and Funding Circle and Santander. Meanwhile, the government’s bank referral scheme means that nine UK high-street lenders are bound to refer all their rejected business borrowers towards three alternative finance aggregators (Funding Xchange, Funding Options and Bizfitech), which refer them to P2P platforms and other alternative lenders. However, six months into the project, uptake seems to have been quite limited. While the government won’t release the funding figures, the Treasury has

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asked Professor Russel Griggs to conduct an independent review into the scheme to make sure that banks are cooperating. This comes amid concerns that the banks are not referring as many clients as they should be, or that front line staff have not been adequately trained to deal with fintech questions. However, others have claimed that the nature of the rejected referrals means that they simply end up being rejected by the P2P lenders as well. “The misnomer that’s been around for years is that P2P lenders will take on any loan,” says Sarah Walker, UK lead of alternative finance at KPMG. “The ones that I would see as credible are the ones that don’t operate in that way – they still want prime customers. What may be going on is that the referrals aren’t the prime customers and therefore the P2P lenders wouldn’t want to lend to them anyway.” Speaking on condition of anonymity, one lender told Peer2Peer Finance News that the referral scheme has actually held things back for some P2P lenders. Before the scheme was officially introduced in November 2016, a number of platforms were already in talks about creating partnerships with UK banks. In fact, two of

We think “ there is a space

for P2P lenders in the market alongside more traditional lending organisations

”

the most high-profile P2Pbank partnerships – Metro Bank and Zopa, and Santander and Funding Circle – predate the bank referral scheme by more than 18 months. By forcing these partnerships to take place under the strict conditions of a government-mandated scheme, platforms are missing the chance to negotiate their own terms. Rather than beginning a partnership on an equal footing, they are being forced to settle for the least attractive loan referrals as chosen by the banks themselves. This is a big contrast to the win-win deal which has been set in place between MarketInvoice and Portugal’s Banco BNI Europa, where the bank simply promises longterm funding through the platform, gaining access

to favourable interest rates in return. “I think that what the UK is doing with the referral scheme is very brave,” says Herrling. “The government is trying to solve a real problem by encouraging fintechs and banks to work together. "As part of this approach, the government is mandating a specific solution – the mandatory bank referral process. One potential risk of this approach is that innovation gets stifled." Unless uptake increases dramatically, the bank referral scheme stands to benefit the institutions more than the platforms. It gives banks access to services that they would not otherwise be able to provide, allowing them to offer large volumes of SME loans indirectly

through their association with the P2P lenders. This makes the banks appear innovative, and can help them to retain customers who are already showing a willingness to search elsewhere for funding. “They want to be signed up to the scheme but the practicalities are not really happening,” says Walker. “It’s good for banks to put money on these platforms as it makes them look good because they say they can’t help but they can refer you to someone else. I think they’re more interested in the image than what they’re really doing.” Retail banks will always be stymied by regulation such as capital adequacy rules, which means that they aren’t able to compete with the higher-risk, higher-return model of

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deposits protected by the Financial Services Compensation Scheme, to lend off its balance sheet, to engage in maturity transformation and to offer more complex products such as overdraft facilities, which would be very attractive to Zopa’s existing borrower base. If it works, Zopa could become the most successful P2P brand of all time, inspiring other platforms to follow its lead. n the meantime, UK banks are keen to find other ways to take advantage of P2P’s unique benefits. “The banks are not interested in the balance sheet of these lenders, but they want the technology,” says Herrling. “You will start to see partnerships where the banks are buying platforms just for the technology. “In the US, 50 per cent of lending is done by nonbanks simply because they can do some of the stuff that banks can’t. There’s a huge role for professional lenders to play.” Over the past few years there has been muted speculation around M&A activity in the P2P sector. After all, banks have something that P2P platforms want (scale), while the platforms have something that the banks

alternative finance. This is where P2P lenders have the edge. Without the worry of these regulations, they can move a lot faster and prioritise innovation. For this reason, Zopa’s decision to launch a bank has raised a few eyebrows. Zopa announced its intentions to apply for a banking licence in November 2016 and chief executive Jaidev Janardana has been very vocal

about his plans to create a new kind of banking experience which draws on the innovation and agility of P2P lending. “We’re uniquely placed to make the next generation bank a leader in consumer finance combining our customercentric culture, agile technology and data excellence with a track record of loan origination and risk management,”

Janardana said in an open letter to customers earlier this year. “No other provider has this combination of attributes.” The likes of Metro Bank and Triodos have proven that there is an appetite for challenger banks among consumers and Zopa’s existing reputation will help to secure its place as a “next generation bank”. Becoming a bank will enable Zopa to offer

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would like (technology). However, the dearth of deals suggests that lenders and banks are destined to complement each other, not compete in the same space. “We think there is a space for P2P lenders in the market alongside more traditional lending organisations,” says a Metro Bank spokesperson. “And we believe they offer a valuable alternative to the high street for borrowers and lenders in the right circumstances.” “Do I think P2P lenders are a threat to banks? Not really,” says KPMG’s Walker. “These lenders are providing alternative products and solutions in a space that banks aren’t really looking at. “I don’t think that banks will buy P2P lenders.” It is worth noting that the partnerships which currently exist between P2P platforms and banks are either driven by money or by government intervention. Despite the similarities in their business models, these are two very different sectors, with different skills, challenges and goals. There is no doubt that both sides stand to benefit from the right partnership, just as long as they are each able to play to their strengths.

THREE GAME-CHANGING P2P PARTNERSHIPS SANTANDER AND FUNDING CIRCLE When this partnership was announced in 2014, it was the first of its kind. High street bank Santander UK promised to help thousands of small businesses access alternative finance by referring them towards P2P giant Funding Circle. “Santander’s partnership with Funding Circle is a good example of how traditional and alternative finance can work together to help the nation’s SMEs prosper,” said Santander UK’s chief executive Ana Botin at the time. Since then, Santander has announced similar partnerships with US online lender Kabbage and equity crowdfunding platform Crowd Funder. The bank was also one of the first big names to sign up to the UK’s bank referral scheme. METRO BANK AND ZOPA In May 2015, Metro Bank revealed plans to lend millions of pounds every month directly to UK customers through Zopa, in the first ever P2P-bank partnership for the retail market. However, Metro Bank chief executive Craig Donaldson recently said that while the relationship remains very beneficial, it is not lending in any considerable scale through Zopa at present. It is steering clear of unsecured consumer finance as it sees it as highly uneconomical in the current climate. BANCO BNI EUROPA AND MARKETINVOICE Earlier this year, MarketInvoice announced that it had received a £45m commitment from Portugal’s online bank Banco BNI Europa, cementing a partnership which has been two years in the making. Last year, BNI made a test investment of £28.3m in the platform, although the two companies have been working together since 2015. “Banco BNI Europa has shown foresight in adopting a digital strategy and executing it by working with the European peer-to-peer industry,” said MarketInvoice chief Anil Stocker. “There are strong synergies between us as a fintech platform and BNI as a digital-only bank. “I’m sure we’ll see many more examples of this type of collaboration in the coming months.”

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This time, it’s personal Consumer lending is the essence of peer-to-peer finance, but low interest rates and warnings of a debt bubble have taken the gloss off the sector. Can personal loan-focused platforms continue to thrive in the current climate?

N THE PEER-TOPEER INDUSTRY, BUSINESS lending is what everyone seems to be talking about these days. Platforms offering finance to small- and mediumsized enterprises (SMEs) and property developers, such as MarketInvoice, Lendy and Assetz Capital, are enjoying some of the highest growth rates at present. Even RateSetter,

which had mainly focused on consumer finance, recently revealed plans to ramp up its business lending. SME finance has acquired a new shine in the Brexit era, as businesses across the country seem strongly determined to turn uncertainty into an opportunity for growth. And P2P firms look

increasingly eager to volunteer as the supporters of these ordinary SME heroes, stepping in to fill the funding gap created by traditional lenders that are once again in the process of retrenching and tightening their lending. Measured against this promising SME bonanza, the consumer space could seem less attractive.

To use the unforgiving words of Metro Bank's chief executive Craig Donaldson: “At rates of 2.7 per cent to 2.8 per cent, unsecured consumer lending just doesn’t any make economic sense for us”. The boss of the challenger bank revealed that the firm, which had partnered with P2P consumer champion Zopa in 2015 to increase its lending in that space, is now steering well clear of unsecured consumer finance. "We are just not willing to lend at those rates,” he explains. “The risk/return

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Any sector which has achieved “ long-run profitability…is susceptible to new entrants and disruption ” dynamic is just not right at the moment.” A 90 per cent loan-tovalue secured mortgage produces a higher yield and requires less capital, he points out. It appears that the days when everyone wanted a slice of the consumer cake are now over, dissolved in time by protracted ultralow interest rates and renewed cautiousness. "With consumer loans available for 2.8 per cent on comparison websites and mortgages available for only around one per cent, competition is harsh and profitability is decimated," says Kevin Allen, chief risk officer of The Money Platform and a veteran P2P investor. Allen, who was RateSetter's first chief risk officer, recollects that one of his first P2P investments was lending to a consumer who wanted to consolidate existing debts. “My share was £20 at an annual percentage rate of 8.3 per cent,” he says. "Those were fun days; on some of the P2P platforms you got to see a picture

of the borrower and a description of what they wanted the money for. But those days are gone." Now, consumer lenders Zopa and RateSetter return around three to four per cent to investors, which is dwarfed by the seven to 10 per cent returns typically yielded from SME lending and around 12 per cent on most property platforms. Data from the Peer-toPeer Finance Association shows that in less than a year, its members have reduced their new lending volumes to individuals against businesses by about 18 per cent, going from a 6.2 to 10 ratio in the second quarter of 2016 to a 5.1 to 10 ratio in the first quarter this year. And if this weren’t enough to strike a tough blow to the appeal of consumer debt, recent data and warnings by policymakers have added to its reputational decline. In March, the Bank of England's Financial Policy Committee stepped up warnings about households' overindebtedness against a

backdrop of stagnant wages and rising inflation, as consumer borrowing returned to historical highs. Interest-free offers on credit cards and an increase in loan limits are contributing to the fastest rate of expansion in consumer credit since 2005, the committee warned, announcing it would increase its scrutiny in that space. his compounded a parallel review by the Financial Conduct Authority (FCA) on creditworthiness assessments used in the consumer credit market, and a separate investigation by the Prudential Regulation Authority into new lending across credit cards, personal loans and car dealership finance. While these headlines could sound like bells of doom for consumer borrowing, to more attentive eyes and ears they could conceal precious opportunities. It would not necessarily be wise to turn away from what has been the bread

and butter of the P2P industry to chase newer and easier sources of profit. "When there's a squeeze on one sector, naturally people start taking more risks and going into unchartered territories that generate volumes rather than being sustainable, but it is not all as risk free as it looks," warns Abhai Rajguru, co-founder and chief financial officer of online consumer lender Nava. Despite the concerns of regulators and policymakers, there are still opportunities for P2P consumer lenders. Bank of England data shows that banks and building societies charged an average interest rate of 6.9 per cent on new personal loans at the end of 2016. THis is "vastly at odds with the rate prominently advertised on their websites, which is currently standing at almost half that level, at 3.5 per cent [on average]," according to Rajguru. Such a discrepancy could benefit the P2P sector, which prides itself on its unparalleled

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Competition is harsh and “profitability is decimated” transparency. And with banks sometimes offering higher interest rates than their websites suggest, a P2P consumer loan could be more competitive on price as well. Furthermore, Anthony Parry, senior vice president at Moody’s, says that while rising household indebtedness in the UK has received a lot of attention recently, P2P firms fall outside the category of lenders that have prompted regulatory scepticism. "Clearly, P2P lending remains a relatively small part of the overall consumer loan market in the UK so is not itself fuelling this growth," he comments. Michael Todt, spokesperson at consumer finance platform Lending Works, affirms that P2P players have so far not contributed to unsustainable levels of household debt. "Any evidence of a credit bubble is not a reflection on consumer P2P lending," he says. "Our rigorous underwriting standards and affordability checks and our ongoing vigilance

with respect to arrears and defaults, coupled with the fact that our credit models are stress tested against data from recessions in 2009 and 2011, leave us confident that our customers will fare well throughout the cycle.” The UK’s oldest P2P lender Zopa, which launched in 2005, proudly proclaims that it has survived through a downturn in the credit cycle. Allen points out that the platform managed to protect 100 per cent of its lenders' capital through the crisis, although it should be noted that Zopa was in its nascence at the

time with a comparatively diminutive loan book. Despite the challenges, P2P platforms are now presented with a golden chance to offer consumers a better and fairer service than both high-street banks and expensive payday lenders. There is a potential borrower pool of about one quarter of the country's adult population, or 14 million people, that are "imperfect borrowers" in the eyes of the traditional banks and building societies, points out Rajguru. And according to data collected by Nava, one third of households are shunning the possibility of applying for credit as they see it as a perilous path following the financial crisis. But Parry says that

borrowers are not currently facing any particular risks. "For the wider market we believe consumers will continue to be able to service their unsecured debt levels," he explains. "Most importantly, due to the ongoing low interest-rate environment, but also [because] regulators have taken positive steps to address overall consumer debt levels ahead of any issues emerging." Increased regulatory scrutiny and requirements may actually help catalyse the innovation that the P2P consumer market needs to prosper, Allen suggests. "Regulatory requirements to perform enhanced credit assessment will not necessarily mean more ‘no’s or slower

IMPERFECT BORROWERS: AN UNTAPPED MARKET By age and socioeconomic group

Source: YouGov, Cebr analysis

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application processing, but will quicken innovation, as well as potentially improve the quality of credit decisions,” he says. Rajguru thinks that platforms should focus on boosting their ability to price risk correctly, which would then allow them to make their way into new consumer credit niches that could prove highly successful. "There is a case for a more sophisticated and intelligent analytics approach to loan applications, that looks beyond credit scores and considers the specifics of the individuals involved," he comments. Current issues in the consumer credit space could thus become a bridge to better business practice, innovation and expansion into new subsegments and areas of unrealised growth, rather than lead to an inescapable and infertile crisis. "Consumer lending is a huge market," says a spokesperson at RateSetter, "and although P2P lenders such as ours have grown, there is clearly still more opportunity in the market." More opportunity to disrupt and innovate a poorly-serviced market, for which P2P players would once again have to thank traditional lenders.

P2P CREDIT CARDS: PIPE DREAM OR IMMINENT REALITY? P2P lenders could soon tap into the credit card space, several sources have said. Stephen Findlay, chief executive of P2P investment specialist Bond Mason, thinks that the segment would represent a very natural progression of P2P consumer finance. "Within consumer lending, there's a lot of potential to develop a credit card type of finance over the next three to five years," he explains. Credit cards have proved to be a very profitable market for banks and other providers over many years and through different credit cycles. "Any sector which has achieved long-run profitability in this way is susceptible to new entrants and disruption,” he adds. "So I can see credit card consumer lending will start to emerge [in the P2P space].” The FCA recently proposed new rules on repayments and debt servicing to help 3.3 million customers who are currently struggling with credit card debt. Abhai Rajguru, co-founder and chief financial officer of online consumer lender Nava, agreed that while it would be logistically challenging to initiate such a business line in P2P terms, there is a clear opportunity in that market.