A 3D look at UK Altfi Lending: Government, Associations and Businesses

By Efi Pylarinou

Like or not, we live in economies that can only operate efficiently if the Trio – Government, Not-for-profit trade associations, Private businesses – work together. Any block in the flow between these constituents will impair economic growth and social impact that are the essential benefits of healthy private businesses.

In 2014 in the UK, over £1.2billion of funds were channeled through the online lending platforms to UK consumers and businesses. The final projections for 2015 are pointing to close to double the 2014 amounts! A couple of dozens of platforms are operating with various niche positioning in the origination space.

Back in 2011 (Fintech wasn’t yet in the Oxford dictionary) Zopa, FundingCircle, and RateSetter formed a self-regulatory body for the sector to promote high standards of conduct and consumer protection, the Peer-to-Peer Finance Association (P2PFA). This association has contributed a lot in representing the space. They are pushing for best operating practices and have a rigorous membership procedure that has resulted in only 9 member platforms: FundingCircle, Landbay, Lendingworks, LendInvest, Madiston Lendloaninvest, MarketInvoice, RateSetter, ThinCats and Zopa. They have promoted awareness and contributed to legislative and regulatory practices in the space that are in alignment with fairness. They are proponents of transparency on the P2P platforms, so that loan data is public. They promote practices that are alignment with fairness for the consumers and are supportive of the honest representation of the risks of these investments.

The consumer borrower in the UK is protected by the Consumer credit act. The lender is protected by regulation, since P2P lending is a regulated activity in the UK (April 2014). Most of the P2P lending in the UK is consumer-lending (5-7k), areas that the banks don’t compete. At the same time, one has to be aware that alternative lending has served mostly the higher end of the credit rating spectrum (i.e. prime borrowers). Small businesses are also starting to use the online altfi platforms because they either have no assets for the collateral requirements of financial institutions or they like the convenience of online transacting instead of in person and at a branch.

In 2012, the investment arm of the British Business Bank started investing in 2012 in startups and scale-ups of the P2P lending sector and has already reached £80mil. They have financed SMEs by funding them via platforms like Funding Circle.

The European Investment Bank (non-profit bank, owned by member states of the EU,) announced at the end of September, that it is preparing to lend £100m to UK small businesses through the peer-to-peer lender Funding Circle, in a move it hopes to replicate in other countries. The EIB is also looking at investing through peer-to-peer in the Netherlands, where platforms include Geldvoorelkaar and Lendahand.

With a 3yr old self-regulatory body and £180mil of government investment, should the UK P2P origination market considered “a Mature space-market-asset class”? Should we await a survival test through one big systematic risk event (e.g. black swan interest rate event leading to increase of probabilities of default) and also, the creation of guarantees for certain origination subsectors from agencies?

Am I looking for the birth of some Fannie Mae or Freddie Mac in the Altfi UK market? Yes, looking towards that direction; the only glimpse that I have seen is the emergence of guarantees by the EIF (European Investment fund which is a quasi public entity focused on supporting the funding of SMEs – entrepreneurship and innovation) who have actually supported one marketplace Ezbob.com with micro-credit guarantees. There have not been any other meaningful Programs of guarantees for consumer loans or mortgage lending for the Alternative financing sector, yet. I foresee that this will come along in 2016 and will coincide with a richer offering of investments structures that indirectly or directly invest in Altfi loans.

Am I looking for the birth of some form of Collateralized Loan Obligations (CLOs) from the Altfi origination space? To be coined as C.Altfi.Os, maybe? Yes, looking towards that direction. Despite the fact that currently, in the UK institutions are not allowed to cherry pick loans from the altfi platforms; I am still a big believer in the creativity coming out of Wall Street and their ability to financially engineer new structures.

Altfi loans are offering excessive risk-adjusted returns

In the US the value in this “space-market-asset class” is already been taken advantage of and we are seeing an increased amount of institutional money investing in these loans and thus, the space has been re-named to P2P marketplace.

In the UK, GLI Finance has already created the first UK closed-end fund investing in international SMB loans from P2P platforms. It may not be my fantasy C.Altfi.O or asset-backed structure, because it is not a pure loan fund since it takes also equity stakes in the originating platforms. However, it is an investment structure which wraps value from the Altfi space for investors.

Funding Circle announced in late August the launch of Funding Circle SME Income Fund. They aim to raise £150 million (led by Goldman Sachs) and targeting 8-9% returns per year, with a dividend yield of 6-7%. The SME Income Fund will probably be listed on the LSE and will be the first marketplace lender to run its own fund (more details on Altfi, Funding Circle sheds light on Fund).

Heading towards the end of 2015, the UK P2P lending space evolves with the launch of these funds that are complementing the self-regulatory body and the growing government investment. Geoff Miller, the CEO of GLI Finance, who has worked with governments and public bodies on developing ways to fund SMEs, has addressed also the role of the government in AltFi from a broader economic perspective.

I discussed last week with Samantha Ridler, who manages the P2P Finance Association, about the evolution of the space and it became clear that the main factors resulting in the boom in the P2P lending space in the UK, which remains largely retail, are:

  • A society with high internet penetration and high volumes of online transactions
  • A society with decent contract law, so that confidence is high in legally binding contracts
  • Consumer and business credit data that are readily available, are facilitating the assessment of risk for lenders
  • The UK regulator has offered clarity to the ecosystem as to how the P2P lending space is characterized and what are the requirements for obtaining approval
  • Two legislations are in the pipelines that are supportive of further growth in the space:
    • “SME referrals”: banks refer the SMEs they refuse to finance to Altfi platforms
    • P2P lending will qualify as a tax-free investment (expected in Spring 2016)

Am I looking at Spring 2016, as the tipping point that will bread a new asset class? Is the imminent legislation

P2P lending becomes a tax-free investment in the UK

the birth of a new asset class for investors? James Levy, an international investment advisor, has written and spoken extensively on this issue. The main points to consider are summarized in his article “Is Marketplace Lending Really a New Asset Class? (And Why This Matters)

In conclusion, the UK P2P loans offer high risk-adjusted returns. The financial metrics can confirm that. Most importantly, the legal and regulatory environment is conducive to them becoming a traditional investment vehicle in investors’ portfolios. The self-regulatory body and all private sector stakeholders are aligning their interests. 2016 will be a year of innovation in creating investable structures from the UK P2P lending space.

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