DBS

17 If the issuer defaults on its crowdfunded bonds, loan notes, or debentures, the holder with no security only has a general claim on the company’s asset and cash flow. This is unless it is ranked as senior debt, ahead of all obligations of the borrower (senior debt) 10 . DISTINCTIONS For clarity, it’s worth noting that crowdfunded bonds, loan notes and debentures are distinct from other types of bonds: Sovereign bonds, or gilts, issued by governments and corporate bonds issued by large, listed corporations are the least risky types of bonds available. This is because of the robustness of the entities which are issuing them, that are given ratings by agencies such as Standard and Poor ’s to help investors determine the level of risk they are taking on. These bonds are covered by a large analyst community and there is a very large secondary market where they are bought and sold. This market has been open to large institutional investors for years, but recently has been opened up to individual retail investors. Closer to crowdfunded bonds in risk profile are retail bonds. They provide a direct route to corporate debt opportunities for individual investors, without the requirement for hundreds of thousands of pounds minimum investment that corporate bonds historically demanded. Like a crowdfunded bond, they may require a minimum investment as low as £100, but the key difference is that they are listed on the London Stock Exchange’s Order Book for Retail Bonds (ORB) 11 . The ORB offers bond investments in smaller unit sizes – although the range of issue sizes from £25 million to more than £300 million 12 is significantly higher than standard crowdfunded bond raises, which generally don’t exceed €5 million as per the current EU regulation. Another loan mechanism which is facilitated by online platforms is peer to peer lending. Like the majority of the DBS market, the platformmatches individual (corporate and personal) borrowers with multiple lenders through online platforms which are not traditional financial services institutions. However, with crowdfunded DBS, investors are purchasing a security rather than making a loan. They can be longer in term than P2P loans – the average term is 3 to 7 years, but some have terms reaching over 20 and even 30 years. In its Policy Statement PS14/14 back in 2014, the Financial Conduct Authority defined DBS as having a higher risk profile than P2P loans, stating the key distinctions as below ( the italic text in brackets is our comment ): Companies issuing unlisted debt securities are free to set the terms of the securities they issue to suit themselves. In contrast, a company or individual borrowing money under a P2P loan agreement facilitated through a loan-based crowdfunding platform usually does so under terms which they do not control. (Although, where a crowd bond or debenture issuer enters a reverse auction, which is one method for deciding the interest rates investors receive in the crowdfunded DBS market, the same could be said of them. Also, some terms of crowdfunded bonds, loan notes and debentures with IFISA eligibility cannot simply be decided by the platform – they must be transferable.) Individuals investing in the peer to peer loan market can usually lower their overall risks by diversifying their investments more easily than investors in securities can. (As more crowdfunded bonds and debentures are offered on the market, the potential for diversification grows, and as aggregators provide services to make investments in multiple DBS easier from a due diligence and administration perspective, the validity of this argument is reducing.) The longer-term, illiquid unlisted debt securities offered by companies carry more risk of capital loss for investors than short-term P2P agreements. (Many crowdfunded bond and loan note investments now have terms of just 1, 2 or 3 years and those DBS with longer terms tend to be backed by assured government subsidies). Although some are more established, many of the companies offering unlisted equity or debt securities are early-stage companies and (this is also the case with loan based crowdfunding) research indicates that around 50% to 70% of early-stage businesses fail. (But, many of the companies that issue unlisted, crowdfunded DBS have sufficient assets to provide security in the event of failure). In contrast, P2P loan agreements often involve lending to individuals rather than companies, are usually re-paid over 3 to 5 years, and currently have low default rates. 13 (There are plenty of DBS products on offer for this short term and some with terms as short as a year, lowering the risk profile.) When you take into account the above bulleted text, we think that the argument that DBS are more risky than P2P loans is less and less accurate. Moreover, DBS tend to be larger than loans – 11 x the average P2P loans to business (P2B) loan size in 2015 (£880,000 vs £76,000) and now more likely to be in the £2 million to £4 million range – which should allow the platform to carry out much more in-depth due diligence, because there are funds available to pay for it and the size of the bond justifies it 14 . It also means that the investee firm is generally much larger and established, lowering the risk profile. In addition, some P2P platforms are still not FCA authorised. The main remaining differentiator noted by the FCA is that there is much less consolidated data on the performance of DBS. “Crowdfunded DBS, with a cheaper cost of capital than more traditional corporate bonds, have also given smaller, dynamic companies a route to this method of raising funds.”