|Alternative Funding Network|
Challenges to P2P and Crowdfunding in 2014 - Insight from Andy Davis
The founders of the UK’s Crowdfunding and P2P companies should be feeling pretty good - things have gone about as well as anyone could have expected over the past year. The challenges of scaling up businesses like these are significant. In lending markets liquidity and borrowing demand must be kept in rough balance at all times and achieving this when they are showing sustained annualised growth rates of 100%-200% must count as a major success. There have been no unpleasant blow-ups to undermine the movement’s reputation, just the emergence of routine defaults that are only to be expected in any lending business. The movement’s expansion points to a further striking fact. Large numbers of people, both lenders and borrowers, have proved remarkably comfortable with the idea of using online services to lend or borrow large sums of money without much (if any) contact with the people behind the platforms. The growth of this kind of trust in new online financial brands represents a powerful shift in consumer behaviour. We’ve already witnessed the transformation of markets such as simple insurance products by online intermediaries, and this is now spreading to saving and borrowing with similar potential consequences.
Of course, a lot of attention over the past year has focused on the official standing of Crowdfunding and P2P. This issue has now clearly been decided in the movement’s favour. Much discussion and lobbying has resulted in a fundamentally benign regulatory settlement that will allow growth and experimentation to proceed. And the announcement in the Budget that P2P loans and debt securities are in line for inclusion in the New ISA marks a watershed moment. What was, 12 months ago, an unregulated niche product treated by many investment professionals as a passing curiosity is today officially endorsed as suitable to sit alongside investment funds and bank accounts within the UK’s favourite tax shelter. The implications for retail financial advisers could be significant if they are to keep up with where their clients are heading.
So the challenges that face the major Crowdfunding and P2P platforms today are “nice problems to have”. But they are challenges nonetheless. ISA inclusion is potentially transformational for these companies and can be expected to bring vastly more money their way. In 2012-13, £16.4bn flowed into Stocks & Shares ISAs – capturing even 1% of this would vastly accelerate the growth of the P2P industry.
Is it ready? One of the biggest advantages the movement has over its more traditional rivals is its ability to use new, purpose-built technology platforms that do not suffer the legacy issues that periodically cripple the banks. The efficiency gains that online technology permit have enabled investors to build diversified holdings of P2P and Crowdfunding assets, be they loan parts or equity investments, quickly, cheaply and at small overall portfolio sizes. These are among the most important gains that the movement offers to individual users. But will even these purpose-built platforms be able to cope with a big influx of new lenders, emboldened by the official seal of approval that ISA inclusion confers? The technological challenge that a leap into the investment mainstream implies will be among the biggest that the industry will face in the coming years.
Heavy investment in infrastructure will be required. Another major challenge that this transformation brings with it will be the need to find good homes for all that new money. As the pool of lenders starts to expand faster, so must the pool of borrowers and the ticklish problem here will be to originate sufficient lending opportunities of the right quality without venturing too far along the “risk curve” into lower quality credits or equity propositions that can be expected to produce higher rates of loss.
Finally, there’s the question of secondary markets. These are essential if P2P assets are to be eligible for ISA inclusion because the conditions states that retail investors must be able to access their money within a relatively short period if their needs and circumstances change. But the risks here are obvious and cannot be made to go away – the underlying P2P assets are relatively illiquid and so people can only get their money out if others are willing to step in as buyers. This is essentially the same problem that faces the promoters of property funds and at some point it will become a live issue for the P2P industry. ISA inclusion is an undoubted boon for the movement, but it probably brings that moment closer.
Crowdfunding and P2P are in the midst of a giddying burst of growth that looks like it could even accelerate. Whatever happens, however, the challenges remain the same – balancing two sides of a rapidly growing market – but they now exist on a much bigger scale.