After over a decade of strong growth, the alternative finance industry ran into some real difficulties in 2019. Although the majority of investors would have continued to see inflation beating returns, there were some high-profile market failures. These were followed by specific regulations for both P2P and unlisted bonds (aka debt-based securities), which in turn were followed by even more players leaving the market.
2019 started with mini-bond provider London Capital & Finance entering administration after it was caught falsely advertising its bonds as IF ISA compatible. Four months later, this was followed by P2P platform Lendy collapsing. In this case, the platform was struggling with late payments – at the time of going into administration, 35 of its 54 live loans were either insolvent or in administration,
The two collapses left savers millions of pounds out of pocket, and led to enquiries into both industries, as well as criticism of the Financial Conduct Authority (FCA) for its perceived inactivity in the build up to the failures.
In October another P2P platform – FundingSecure went into administration – with £80m from 3,500 invested in 486 loans.
In the second half of the year, a number of high-profile bond issuers failed or were called into question. These included bonds issued by a firm run by Grand Designs presenter Kevin McCloud and the so called ‘burrito’ Bonds from Mexican food restaurant Chilangos. Although these bonds were not IF ISA eligible, their high-profile nature still tarnished the reputation of unlisted bonds in general.
The response from the regulator was somewhat predictable. In June, it published new regulations for the P2P sector. These rules included the creation of the ‘restricted investor’ class (those not considered high-net worth, sophisticated or taking financial advice, whose investment amount is restricted to 10% of their investable assets), as well as an appropriateness test that investors need to take before being allowed to invest in P2P.
These rules came into force at the start of December. In some respects, they were similar to those already existing in the securities market, and in many ways the regulations brought P2P rules in line with debt based securities.
This was not for long, as in November the FCA announced a temporary ban on the promotion of speculative mini-bonds to retail customers. This came into force at the start of 2020, and means bond issuers and financial advisers can not market these bonds to a consumer until they were satisfied the potential client was high net worth or sophisticated.
Looking to the future
Despite these regulatory moves, alternative finance providers have reasons to be optimistic for 2020.
Despite the 2019 election out of the way and the Brexit Bill passed, there is still huge uncertainty in the market (not least caused by the legal deadline the Johnson government has passed for a trade deal with the EU and Trump’s unpredictable foreign policy). In the face of such uncertainty, the fixed rate returns offered by Alt Fi could prove a tempting option.
Similarly, as Britain leaves the EU, alternative finance could help pick up the slack caused by any reduction in traditional EU funding, in the same way it did for SMEs when traditional banking began to lend less following the credit crunch.
It’s role in replacing banks as a source of credit for SMEs could even be enhanced thanks to the government’s support for the new round of Basel standards, which is likely to cause even more restrictions on SME traditional funding routes.
The regulations themselves should also result in a healthier industry. The P2P regulations, for example, provide some minimum standards around underwriting, more disclosure requirements and a published plan of what happens if the platform fails. Even if the regulation leads to some consolidation (so far two platforms have closed their offering to retail investors), it should result in a more transparent, investor friendly industry.
The mini-bond regulation has the potential to be more damaging, however even here, there are still legitimate routes for unlisted bond issuers to access the retail investor market.
Advisers, with their databases of pre-classified of high net worth and sophisticated clients, could provide one option for platforms and issuers.
Beyond this, bond issuers could legitimately side step the temporary ban and find routes to retail investors potentially through discretionary fund managers in combination with IFAs or overseas listing in an appropriate territory. Either way, the involvement of additional authorised entities or reporting and disclosure obligations are likely to be required. This is an unlikely path for those unscrupulous issuers the FCA is seeking to target, but could be a useful option for those operators with genuine products, regard for the law and the interests of their investors.