THE IFA AND P2P LENDING - EXECUTIVE SUMMARY
P2P lending was established to cut out the middleman. Peculiarly, IFAs, 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 IFAs as an important channel when sourcing loan capital.
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. 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. The market also 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.
But the P2P story is not all positive. Some outside of the sector are circumspect of its potential. 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”. Additionally, all but a few platforms are making losses, some substantial. Larger platforms typically cite their investments in ‘scaling up’ as the reason and are confident of future profits. It is however a common view that number of platforms currently in the market is not sustainable.
A number of platforms are making moves to court the IFA and see them as an important channel for sourcing loan capital. Octopus Choice see IFAs as their most important distribution channel. “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 IFA portal. Funding Circle havn’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 Ceri 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 markets … that’s one of our main tasks over the next few years, to ingratiate ourselves more and more to that audience.”
How should IFAs 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.
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. Alignment of interests with retail investors could be an influencing factor for the IFA and 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 IFAs 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 IFAs to play a bigger role. The report considers some of the issues.
P2P lending was established to cut out the middleman. Peculiarly, IFAs, 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 IFAs as an important channel when sourcing loan capital.
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. 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. The market also 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.
But the P2P story is not all positive. Some outside of the sector are circumspect of its potential. 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”. Additionally, all but a few platforms are making losses, some substantial. Larger platforms typically cite their investments in ‘scaling up’ as the reason and are confident of future profits. It is however a common view that number of platforms currently in the market is not sustainable.
A number of platforms are making moves to court the IFA and see them as an important channel for sourcing loan capital. Octopus Choice see IFAs as their most important distribution channel. “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 IFA portal. Funding Circle havn’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 Ceri 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 markets … that’s one of our main tasks over the next few years, to ingratiate ourselves more and more to that audience.”
How should IFAs 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.
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. Alignment of interests with retail investors could be an influencing factor for the IFA and 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 IFAs 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 IFAs to play a bigger role. The report considers some of the issues.