DBS

18 “Alternative finance is now a £10 billion industry – not exactly niche. Since it has caught the attention of forward thinking financial advisers, many of whom are investors in Crowd Bonds themselves, that growth looks set not just to continue, but to accelerate.” – Julia Groves, Downing LLP DIFFERENCE BETWEEN CROWDFUNDED DBS AND P2P LOANS CROWDFUNDED DBS OTHER TYPES OF P2P LOANS APPROPRIATENESS Platforms are required to carry out appropriateness tests that non-advised investors must complete. If the investor fails this test, they can’t invest. There is no requirement for the platform to assess an investor’s understanding of risk or whether a particular loan is appropriate for a particular lender. INVESTOR CATEGORISATION The platform must categorise investors as ‘advised’, ‘sophisticated‘, ‘high net worth individuals’ or ‘restricted’ (in which case they shouldn’t invest more than 10% of their net investable assets). There is no need for the platform to check a lender’s wealth or experience and there is no restriction on how much they can invest. DUE DILIGENCE The larger investment amount required by single issuers allows platforms to carry out more thorough due diligence, providing investors with much more detail on the investment. The smaller size of loans makes it difficult for the platform to plough resources into due diligence from a commercial perspective. Investors won’t get as much background on the borrowers and rely on platforms to assess risk. DIVERSIFICATION In 2015 the average single-asset crowdfunded DBS fund raise was £880,000. The larger fundraise allows for more thorough due diligence but offers less diversification. The average P2P loan in 2015 was £76,280. The smaller raise allows for increased diversification but restricts thorough due diligence. PROVISION FUNDS VS. SECURITY Since platforms are required to treat investors as their clients, necessitating ongoing monitoring of the investment, some take the role of security trustee, with the right to step in and take control of the asset to repay capital in the event that the borrower defaults on a bond. Other platforms appoint an independent entity to undertake this role. Some P2P platforms set aside a percentage of the total amount of loans outstanding to pay back lenders if there is an occasional bad debt. But capital is still at risk – if bad debt rates go up there may not be enough in the provision fund to pay all the lenders back in full. TRANSFERABILITY Crowdfunded DBS aren’t listed but can be transferred between investors through a secondary market. In general investors should expect to hold their investments to term. Loan parts are redeemed rather than transferred. P2P platforms tend to have more developed secondary markets, making them arguably more liquid than investment-based crowdfunding but less liquid than shares. REGULATION Shares and bonds have always been regulated so only fully-authorised platforms with permission to ‘arrange deals’ for retail investors can offer investment-based crowdfunding. All loan-based platforms that held a consumer credit licence were given interim permission while the FCA reviewed their application for full permissions. This process is well underway but some of the biggest platforms are not yet authorised. FINANCIAL SERVICES COMPENSATION SCHEME (FSCS) FSCS Investment Protection Scheme provides up to £50,000 of compensation where the platform is unable or unlikely to honour legally enforceable obligations against it. But, investors can’t claim just because a DBS fails. FSCS Deposit Protection Scheme applies, (up to £85,000) where client money has been deposited by the platform with an authorized banking entity in a segregated account, if that banking entity fails. Investors are not protected by the FSCS Investment Protection Scheme. The FSCS Deposit Protection Scheme applies (up to £85,000, where client money has been deposited by the platform with an appropriately authorised banking entity in a segregated account, if that banking entity fails. IFISA PERMISSIBLE? Crowdfunded DBS Peer to Peer and Peer to Business CORPORATE BONDS CHARACTERISTICS TYPOLOGIES MATURITY SHORT TERM MEDIUM TERM LONG TERM COUPON RATE FIXED RATE FLOATING RATE ZERO COUPON CREDIT QUALITY INVESTMENT GRADE NON-INVESTMENT GRADE (HIGH YIELD OR ESPECULATIVE) PRIORITY CLAIM SENIOR DEBT SUBORDINATED DEBT COLLATERAL SECURED DEBT UNSECURED DEBT <3 YEARS 4-10 YEARS >10 YEARS SOURCE: NEW APPROACHES TO SME AND ENTREPRENEURSHIP FINANCING: BROADENING THE RANGE OF INSTRUMENTS, OECD 2015 “The regulatory framework is a key enabler for the development of instruments that imply a greater risk for investors than traditional debt finance. However, designing and implementing effective regulation, which balances financial stability, investors’ protection and the opening of new financing channels for SMEs, represents a challenge for policy makers and regulatory authorities. This is especially the case in light of the rapid evolution in the market, resulting from technological changes as well as the engineering of products that, in a low interest environment, respond to the appetite for high yields by financiers.” — OECD 2015