The United Kingdom’s alternative finance market has developed and flourished within a regulatory environment that has been relatively light touch and, thus, conducive to innovative SME lending, Newly announced regulations are likely to change the dynamic of the platform lending market while highlighting a potentially enhanced role for sophisticated investors.
In the wake of the great financial crisis, peer-to-peer (P2P) lending and equity crowdfunding emerged to fill a gap in the corporate funding market. The fact that they were able to do so was in part down to the willingness of the financial authorities to forego the temptation to regulate too tightly. And that was probably a sensible thing. It allowed new sources of funding to emerge from the corporate finance industry. Equally important, perhaps, it created opportunities for investors.
Things are changing, however. The Alternative Finance market is now relatively mature – and arguably no longer “alternative“ – so it is natural that regulators should look at lessons learned over the past few years and take appropriate action to create protections. And this month, the Financial Conduct Authority’s Director of Strategy, Christopher Woolard announced a package of measures aimed particularly at the P2P finance market.
At least one of the proposals – a 10% limit on any P2P investments that retail investors can hold in their portfolios – was controversial. But it was perhaps not surprising. The FCA has published its plan hard on the heels of the collapse of property lending platform, Lendy. To the regulator, this demonstrated the need to prevent ordinary investors – perhaps, lacking in experience – from exposure to too much risk.
In addition, the FCA has signaled new rules to tighten the governance policies and procedures of P2P platforms, with a particular emphasis on risk assessment and management. Under the new regime, platforms will be required to ask their investors about their knowledge and experience and there will be a minimum level of information that will have to be provided by the site operators. In the event of a platform failing, new rules on winding down the business will come into play.
Impact on SME Lending
So what will all this mean for marketplace lending? Will the rules nip a young industry in the bud, or will tighter regulation allow P2P lending to expand further, given that new investors may be encouraged by the added protections?
Certainly, the FCA sees this as a positive move for the industry. As Director of Strategy, Christopher Woolard put it: “These changes are about enhancing protection for investors while allowing them to take up innovative opportunities.”
We won’t know if that will indeed prove to be the case until the months that follow the December 9, 2019 deadline for implementing the new rules, but there could be some effect on SME lending.
On the face of it, the10% of portfolio restriction may mean smaller amounts of capital allocated by some investors, although the impact on the total amount available could well be only marginal. However, new credit assessment standards could have also impact on the availability of loans to certain companies or businesses in specific situations. Equally, it could have an effect on the lending criteria of platforms as they seek to match their risk/return models to the expectations of their communities of lenders.
None of this represents a revolution, given that many leading P2P platforms have governance policies in place that already align with the incoming rule. But one byproduct might the emergence of more niche lenders – catering for specific industries or situations – providing an alternative to more generalist platforms. The Route’s experience also suggests an enhanced role for sophisticated investors.
Niche platforms may be supported by retail investors who are willing to consider exposure to specialist lending opportunities in return for higher return potential. There is, however, a case for attracting more “sophisticated” investors to the market lending space.
This is something that The Route – Finance has already done. The Route’s Private Debt Platform differs from standard P2P sites in that the investment community is much smaller and is comprised of High Net Worth and sophisticated investors, alongside institutions and family offices. Sophisticated investors often have an appetite for special situations investing. Equally, the Route’s experience indicates they are also attracted to property ventures. The common factor is the potential for superior returns.
It’s important to stress that these sophisticated investors are not seeking “higher risk” scenarios – in fact, what they want are solid, viable proposals. Crucially, however, they have the experience to identify and assess opportunities that might not appeal to retail investors. And their presence as investors is increasing the capital available to SMEs.
Regulation should create a better P2P marketplace by addressing the worries of retail investors. At the same time, The Route expects to see increasing numbers of sophisticated investors adding platform lending to their portfolios.
To find out more about The Route – Finance’s Private Debt Platform, call 020 3141 9040