P2P lending was established to cut out the middleman. Peculiarly, IFAs and financial planners, seen by some as the archetypal middlemen, are facing pressures to get more involved. Clients see attractive returns and credible incentives such as the Innovative Finance ISA. Platforms are starting to see advisers and planners as an important channel when sourcing loan capital. Paul Bryant, founder of Canbry Research, an investment research consultancy with a specialisation in fintech, presents some insights into the state of the sector and the challenges which advisers and planners face.
A peer-to-peer (or P2P) platform facilitates direct loans between borrowers and investors. Borrowers are typically consumers or small businesses that are underserved by banks. Lenders are mostly retail investors seeking higher returns.
Dizzying growth post financial crisis
P2P platforms in the UK originated £4 billion of new loans in 2016. The sector is almost 20 times larger than it was just four years ago. It has attracted 100 new entrants since the financial crisis with around 80 still in the market.
There are good reasons for the growth. Interest rates are far higher than banks, there is strong demand for annuity income and the asset class offers portfolio diversification. Government is sympathetic to an industry that can boost SME access to finance whilst introducing minimal systemic risk. John Mould, CEO of ThinCats, a platform operating since 2011, sees growth continuing. “Put all of this together and in five to ten years time we are going to see more and more direct lending. Fact!”
The market has scope to grow far bigger. P2P is a tiny share of a £400 billion plus market of consumer, SME, buy-to-let and property development loans.
Richard Wazacz of Octopus Choice, the P2P spin-off of Octopus Investments, sees significant potential. “We’re in the adopter phase at the moment, but we’re hopeful that within the next few years it will become more mainstream,” he says. “I have hopes that this could become a tens if not hundreds of billions of pounds asset class.”
Not all positive
Some outside of the sector are more circumspect. In their 2016 report “Marketplace lending | A temporary phenomenon?” Deloitte suggested that the market is “unlikely to pose a threat to banks in the mass market. In the medium term, however, MPLs (P2P lenders) are likely to find a series of profitable niches to exploit”.
All but a few P2P platforms are making losses, some substantial. In their most recent accounts filed with Companies House, the ‘big 3’, Funding Circle (UK), Zopa and RateSetter recorded losses of £18 million, £9 million £4 million respectively. Even some smaller lenders are making multi-million pound losses. Larger platforms typically cite their investments in ‘scaling up’ as the reason. Ceri Williams, Head of Investor Operations at RateSetter says: “We have taken investment from the likes of Artemis and Woodford who have a reputation for delivering back on investment. I think it is a ringing endorsement of the sector that these people still provide more investment into P2P platforms such as ours.”
It is however a common view that there are too many platforms. David De Koning, Director of Group Communications at Funding Circle stresses the importance of scale. “Platforms are effectively creating stock exchanges … it is likely there will only be a handful of winners over the long term. We think you are going to have 2 or 3 main platforms that account for the vast majority of lending.”
Mould of ThinCats is more blunt. “Most P2P platforms do not have a sustainable business model and will not last the next 18 months. We are likely to end up with a few big ones, a mid tier segment and the rest will collapse and disappear.”
Growing recognition of the importance of professional advisers
Some platforms such as Octopus Choice see advisers and planners as their most important distribution channel. As they comment: “One of the reasons we built Octopus Choice was that we felt that this was an asset class that would serve advisers well in helping their clients.”
RateSetter has set up a dedicated adviser portal. Funding Circle hasn’t yet but it is clearly on the radar. “IFAs are trusted advisers to thousands and thousands of individual investors … the industry has been maturing over the last few years and it does feel right that it is at about this stage (of industry development) for the wider IFA sector to take more interest.”
Developing the channel is not straightforward. According to Williams of RateSetter: “One of the key issues to drive lending volumes through IFAs is overcoming the challenge of getting P2P investments onto some of the mainstream investment platforms more commonly used by the IFA … that’s one of our main tasks over the next few years, to ingratiate ourselves more and more to that audience.”
To advise or not to advise?
How should advisers react? Wait until the market matures and winners emerge? Wait until loan books have been tested in an economic downturn? This may not necessarily be in the best interest of clients. The answer must lie in conducting robust due diligence.
Platform and product due diligence is required
There are efforts to assist. Octopus published a guide for financial advisers in association with the Personal Finance Society. “What we believe is that IFAs, with a bit of due diligence and care, can very much choose platforms that meet their goals and at the same time not take unnecessary risk.”
Track record is obviously preferable but only one platform, Zopa, has actually been tested through a recession. A deeper look into underwriting practices will be necessary. Some platforms have commissioned due diligence reports from 3rd party agencies to assist but this practice is not widespread.
The strength of a platform’s balance sheet is critical given that most are making losses.
Regulatory status and the transparency of lending statistics should also be near the top of any due diligence checklist. De Koning has strong views. “Those that don’t get regulated will either change their business model or exit the market,” he says. “FCA authorisation is something that will be a clear recognition of those platforms that are here for the long term. In terms of disclosure of performance data, platforms that are doing this are confident in their business model, platforms that aren’t doing this, investors should be asking some tough questions of them.”
Alignment of interests with retail investors could also be an influencing factor for the adviser (Octopus Choice takes a 5% first loss position on all loans). The benefits of features such as RateSetter’s provision fund to cover defaults should also be considered.
Many in the industry stress the necessity of platforms offering diversification across a portfolio of loans. Although advisers s will need to choose between consumer, SME, property and even invoice financing loans, an obvious risk reduction strategy is to select “bond like” products containing a portfolio of loans as opposed to having to cherry pick individual loans.
The immediate way forward for IFAs is not obvious. There are clear product attractions and portfolio benefits from this emerging asset class. But there are also risks and practical difficulties. What is obvious is that both clients and platforms will be pressing advisers and planners to play a bigger role.
About Paul Bryant
Paul is the founder of Canbry Research, offering investment research and strategy consulting services in the insurance, insurtech and fintech sectors.
Paul has extensive investment and M&A experience in financial services. He has worked as a Senior Dealmaker for a multinational insurance group, sourcing and evaluating strategic investments. He co-founded, built and exited a successful insurance underwriting agency and has been a consultant with McKinsey and Company.
Get in touch:
Web: www.CanbryResearch.com
Twitter: @CanbryResearch
LinkedIn: www.linkedin.com/in/paul-bryant-canbry
