PlatformApr 28 2017

Six things to know about P2P

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Six things to know about P2P

Arguably, peer-to-peer lending (P2P) is the fastest growing retail investment product of the past 10 years.

Using technology to revolutionise SME and consumer lending has produced an incredibly efficient way of connecting investors with borrowers.

Traditional financial intermediaries have looked on as they face innovative, nimble-footed competition.

P2P has now evolved and is taking its place as an asset class with much to offer investors, not least in a world of low returns and a consequent search for yield.

It has reached a stage of maturity where it can be fully assessed using in-depth analytics and can, with the right approach, form a stable portion of an investor’s portfolio (the size of capital allocated depending, however, on the risk profile of the investor).

What do these advisers need to do to make themselves comfortable with P2P investment?

IFAs were initially cautious about P2P lending. While their clients’ anxieties related to returns, IFAs had to grapple with tougher regulation, post RDR, and consequent increases in the compliance burden.

Although the appeal of P2P is clear, without an in-depth knowledge of the asset class it understandable that the regulatory risk of advising has, to date, been too high.

Therefore, when IFAs were allowed for the first time to recommend P2P investment to their clients on 6 April last year, the initial response was muted.

Much has changed since then, with some IFAs embracing P2P lending enthusiastically and recommending it to those clients for whom they deem it to be suitable.

By contrast, some of the more conservative IFAs show no sign of steering their clients towards P2P platforms any time soon.

But what of those in the middle, the broad group of IFAs who have thought about P2P investment, who are interested – even intrigued – by the asset class but have yet to become involved?

What do these advisers need to do to make themselves comfortable with P2P investment?

Here are six considerations that may help them towards that end:

1.     The key factor when looking at P2P is the performance of the platform concerned - and the yardstick here is actual historical default rates and subsequently net returns.

Actual default rates should be considered with the amount of loans still in circulation for a given time period. Loan terms can run for up to five years and if they are still being repaid, they are still at risk of default.

2.     Put bluntly, how much has the platform in question lent? This is important for three reasons.

  • One, the more lending that has been undertaken, the better the platform is likely to be in terms of its credit processes.
  • Two, if a platform operates a secondary market and the major platforms do, the more the platform lends, the more active this market is and the greater the chance of investors getting their money back.
  • Three, financial stability. A platform without scale is less financially stable and could become insolvent.

A caveat to that last point is that a P2P loan contract is not with the platform itself but with the borrower, and the platform’s insolvency does not affect that.

The Financial Conduct Authority insists platforms have a framework in place to ensure these contracts are fulfilled regardless of the fate of the platform.

3.     Talk of the FCA leads to the vital issue of regulation in general, both of the platforms and of the IFAs. With regard to the former, most have only interim authorisation, which means they cannot offer the innovative finance Isa (IFISA), the P2P version of the ever-popular tax-advantaged Isa.

In relation to IFA regulation, the big questions around P2P investment are compliance questions. How risky is a specific P2P investment and how does that marry up with a particular client’s stated appetite for risk?

In the early days of P2P in the UK, the information needed to make such judgments was only provided by the P2P platforms themselves. That is no longer the case – high-quality, independent data and research are available.

4.     Advisers will need to decide whether to actively or passively manage a P2P account. Passive P2P investing provides automatic diversification, where investors capital is split across a large number of borrowers, automatically.

Although it is possible to find Alpha by actively selecting borrowers on certain platforms this process is far more involved. It is also possible to access P2P loans through several investment trusts and/ or non-listed investment vehicles, such as Crowd Bonds.

Each IFA needs to consider the mechanics, the nuts and bolts, of how they intend to invest client money in P2P lending.

An individual retail investor simply goes to the platform in question and makes the investment. For IFAs, there are two methods for servicing clients interested in the asset class.

One – which currently seems the preferred option – is to give advice, charge a fee for that advice and let the client invest directly.

The other is to use the currently small but growing number of platforms that have been built out to facilitate IFA involvement, with adviser portals, client accounts and the ability for the IFA to report regularly back to the client. 

5.     As with most types of investment, diversification is the key to mitigating risk in P2P lending. Lending to a large number of borrowers spreads the risk and leaves investors less exposed to the potential default of one or two sizeable counter-parties.

Different P2P platforms offer different, diversification methods. Zopa, for example, splits investors capital into a minimum of £10 chucks and allocates to borrowers accordingly. This creates significant diversification at relatively low investment amounts.  

6.     Finally, IFAs need to bear in mind that P2P lending is not covered by the Financial Services Compensation Scheme. In light of this, what sort of security is available for your client? First, a substantial proportion of P2P lending relates to property, thus the assets in question underpin the loans.

Beyond this, many platforms offer limited compensation cover through so-called provision funds. But remember that these funds are paid for by the borrowers, meaning they have less money available to pay interest to investors.

In other words, provision funds may flatten the returns from the platform concerned.

IFAs, and their clients, are increasingly attracted to P2P lending as a financial opportunity. With the right approach, both can feel confident investing in this innovative, fascinating and potentially rewarding asset class.

Iain Niblock, chief executive of Orca