Loanpad on the Future of P2P Lending

Loanpad’s Chief Executive Officer, Louis Schwartz, and Chief Operating Officer, Neil Maurice, give their views on recent events in the Peer-to-Peer industry and what it means for the future.

Industry

The P2P industry, like many others, has been hit by a number of corporate failures in recent times.

As an industry, our concern must be with investors who not only have their assets frozen but also may suffer losses on their investments through a combination of both loan impairments and professional fees. This is extremely unfortunate and, whilst all investors take risks, it raises many questions on operational controls, lending processes, due diligence and investor information disclosure.

Whilst a relative newcomer, we firmly believe that these corporate failures should not reflect on the wider industry. Loanpad, alongside our competitors, should focus on running our businesses in a stable manner, complying with all relevant regulation and guidance and putting the investor at the forefront and centre of any decision being taken.

We set out below a few of our thoughts on sustainability and navigating the P2P course.

Platform Risk

One of the biggest areas of risk that has come into very sharp focus in recent months is platform risk.

A fundamental principle of P2P lending is that investors should be exposed to borrowers’ credit risk (the risk of loans defaulting) but not materially to the credit risk of the platform. This is one of the things that differentiates P2P lending, where platforms simply act as an intermediary on behalf of the borrower and lender. Whilst at face value this is of course true, the recent administrations have quite clearly demonstrated that investors have been exposed to the good standing of the platform in ways other than borrowers’ credit risk.

So how are investors expected to be able to determine the level of platform risk when evaluating any platform?

The first thing many investors will look to is the size of the platform, with the supposition that bigger is safer. Whilst in many cases this would seem logical, in the world of P2P we remain unconvinced by this argument. This is primarily because no P2P platforms would appear to have reached profitability on a consistent basis, and some are still showing significant ongoing losses.

With the FCAs minimum regulatory capital requirements in place, losses can only be sustained via new equity being raised. However, the “golden years” of ever-increasing equity injections appear to be dwindling. Quite simply, platforms must now become self-sustainable to survive over the coming years and we envisage large-ranging changes to platforms’ business models.

So back to the question – how can investors reasonably evaluate “platform risk”? Sadly, with much difficulty and imprecision as most available information is historic.

However, the introduction of the new FCA rules in December 2019 will go some way to helping investors evaluate platform risk through clear disclosure on loans under management, fees and the rate of interest charged to borrowers. In addition, all platforms will need to adequately disclose their wind-down plans so investors can compare and contrast the approach platforms are taking to wind-down.

At Loanpad, despite being just 9 months post-launch, we anticipate reaching profitability and self-sustainability by 2020. This is as a result of our unmovable focus on sustainability ahead of exponential early growth.

Our focus is to steer the business to profitability whilst continuing to provide investors with (what we believe to be) the market-leading P2P product.

Revenue Models

One of the issues identified through the corporate failures to date is that many platforms generate a significant proportion of their income at the time of loan origination. Whilst perfectly acceptable to charge fees, this creates an inherent need to originate new loans to fund operating expenses which in turn relies on regular loan repayments and / or new investment.

At Loanpad, our income is generated from a Loans Under Management margin such that we earn income on a daily basis in the same way as when our investors do. This ensures that our income is stable irrespective of the level of new loans originated in any given period.

In the coming month and years, we envisage greater scrutiny on how platforms earn their revenues and the sustainability of the underlying business models.

Governance & Wind-Down Plans

Perhaps the most intriguing factor of these corporate failures is the role of governance and wind-down plans.

The overarching aim of a wind-down plan is such that the Board tracks and identifies when a wind-down should be triggered and then initiates the wind-down of the loanbook in an orderly fashion. Importantly, this must in good time before a business runs out of cash to operate.

Whilst each circumstance is different, we believe that strong corporate governance, a tight control on costs, clear and measurable indicators of the need to initiate a wind-down and full financial planning for the wind-down period are essential in any P2P platform.

In our opinion, the alternative to an orderly wind-down is falling into insolvency by way of administration or liquidation. This is the scenario that should be safeguarded against as otherwise the risk to overall recoveries and fees undoubtedly increase.  Whilst wind-down plans must consider their interaction with general and insolvency law, we believe that the initiation and completion of a successful wind-down plan should occur before any insolvency process is required.

FCA Recommendations Will Strengthen P2P Lending

The new FCA recommendations underline the importance of financial expertise in P2P lending, says Neil Maurice, chief finance and operations officer of Loanpad”

Proposals from the Financial Conduct Authority (FCA) will soon require all P2P platforms to introduce appropriateness tests and strengthen or reconfigure their wind-down plans.

As a chartered accountant, Neil Maurice understands this new regulatory universe better than most. Before becoming chief finance and operations officer at P2P platform Loanpad, he was a director at BDO and Duff & Phelps specialising in financial services.

“I spent a number of years undertaking some high-profile investigations on behalf of the FCA into specific areas such as client money, mis-selling, compliance, governance and systems and controls,” says Maurice. “What I learned was that a good financial services business focuses on three very fundamental items: policy, process and people. If you can get those three items right, then you should be a long way towards meeting regulatory expectations.”

Maurice joined Loanpad in January 2018, when the FCA was concluding its post-implementation review of the P2P and crowdfunding sector before its consultation on the proposed new rules in July 2018. “For me, joining Loanpad was about creating a simple and transparent platform that offers investors an innovative way to invest in P2P lending whilst being aware of and managing risk to the lowest extent possible,” he says.  “I think we’re now entering a period where everyone is realising that regulation is critical if not core to a P2P business.”

However, Maurice adds that P2P is unique in the sense that some people came into the sector with “little or no experience in being part of or running a regulated business.” This may cause problems for some platforms as compliance and regulation continue to take centre stage. So how does Maurice feel about the new FCA regulations?

“I believe very strongly that they already reflect what is good practice in any regulated firm, and certainly in the P2P lending market,” he says. “The FCA had a difficult job in trying to strike a balance between protecting consumers on the one hand whilst also allowing the P2P sector to thrive.

“I very much welcome the heightened focus on wind-down plans,” he adds. “As a sector we are trusted to hold and protect client money so we have to plan appropriately for the worst-case scenario. We have to be able to wind down a loan book in a calm and efficient manner.”

Maurice says that over the coming months, Loanpad will be reviewing the platform’s systems and processes to ensure that they meet regulatory expectations, and he is sure that other P2P lenders will be doing the same.

“If done properly, the implementation of these rules will allow investors to properly compare the risk levels for each P2P lending firm so they can choose the products that are appropriate for them,” says Maurice. “Our focus is on compliance and transparency with investors. We certainly want to feel that our investor base understands what they’re putting our money into.

“Ultimately, I think the new rules will be a positive for platforms as investors will understand the products offered and can adequately compare and contrast different platforms.”

Provision Funds vs ‘Skin in the Game’

Louis Schwartz, chief executive of Loanpad, explains why the provision fund model isn’t always the most effective way to protect retail investors…

DEFAULT RATES ARE beginning to loom large for the peer-to-peer lending community, as platforms start to see large tranches of loans reach maturity. As a result, the ways that platforms protect their investors from capital losses have been under scrutiny, with two methods proving to be the most popular: provision funds or ‘skin in the game’. For Louis Schwartz, chief executive of recently-launched P2P platform Loanpad, ‘skin in the game’ could be a more viable option.

“Provision funds can provide a somewhat false sense of security, or at least an unknowable level of security,” he says. “They are often funded by reducing lender returns, so basically these funds are built with money that may otherwise have been paid to investors, and the overall value of the provision fund represents a very nominal amount when compared to the total size of the loanbook – often just one or two per cent.

“If the rate of defaults is higher than that, the provision fund would essentially get wiped out. And then you have to make the decision, what investors are going to be covered, and at what point in time are they going to be covered? And can the platform even continue without the provision fund?”

Schwartz, unsurprisingly, is an advocate for the ‘skin in the game’ model, and Loanpad has devised a system whereby all of its retail investors will see a sizable part of any loan being funded by lending partners.

These carefully-selected lending partners invest at least 25 per cent alongside retail lenders on every single loan on the Loanpad platform on a first-loss basis. Schwartz says that this 25 per cent acts like a provision on each specific loan, as opposed to a provision fund that is aggregated across all loans.

“Provision funds can hide the level of risk when everything’s good and everyone’s getting their returns as expected, until a time when the provision fund may no longer be able to keep up,” says Schwartz.  “At that point, the underlying  loans and their risk profile would become more noticeable and relevant to investors, as will the duration of the underlying loans and thereby liquidity.

“We feel that the ‘skin in the game’ model provides a more sustainable and transparent approach to risk management.” The other undeniable benefit of the ‘skin in the game’ model is that retail investors have the peace of mind that comes with investing alongside established large-scale investors who have already done in-depth due diligence on each loan. This adds another layer of quality control, says Schwartz, and should help reassure retail investors.

However, communicating this message presents a challenge. Schwartz believes that more needs to be done to educate investors, as there is a huge difference between the two methods of mitigating risk.

He adds: “In the current environment and with Brexit uncertainty, investors should assess what they are investing in carefully, to ensure they fully understand the features, risks and benefits of each platform and its risk management methods.”

Written for a newcomer to P2P investing, Money Saving Expert Martin Lewis provides a useful overview of P2P investing, highlighting some of the risks, describing some of the larger platforms and acknowledging the vast number of alternative platforms on the market at the end of 2018.

https://www.moneysavingexpert.com/savings/peer-to-peer-lending/

Peer-to-Peer Lending Volumes November 2018

P2P Banking published its monthly round up of International P2P lending volumes. The table lists the loan originations of p2p lending marketplaces in November 2018.

https://www.p2p-banking.com/countries/germany-international-p2p-lending-volumes-november-2018/