The European alternative finance sector grew by 92 per cent to €5.4bn (£4.5bn) in 2015, according to Judge Business School’s latest report on the subject, Sustaining Momentum. Excluding the UK, that’s 10 per cent slower than in 2014, but shows, say the report’s authors, expansion across almost all alternative finance models.
This slowing growth rate is a reminder that there’s more work for the industry – it needs to make the shift from startups to a sustainable market for funding. The report surveys platforms, rather than investors, but provides plenty of material investors will find useful. Here are four key takeaways:
1. Investor concerns and growth
In order to make the transition described, platforms will need to look at the risks hampering growth. According to the report, lender concern over riskier borrowers, business failure rates, fraudulent activity and platform collapse because of malpractice are salient factors.
“It’s no longer about chasing growth rates; it’s about the sustainability of your business model,” says Bryan Zhang, one of the report’s directors. “How can you improve fundamental practices – underwriting, credit risk management? How do you fend off pressure from new platforms and incumbents like banks?” With 42 per cent of platforms indicating a “notable increase” in default rates, whether an investor can continue to trust your service will be an increasing focus.
2. The rise of auto-bid
The trust question is only being compounded by developing technology. The first platform models enabled investors to select opportunities individually. As the industry developed, several platforms started offering an auto-bid function. This saw investors deciding on their lending preferences, with algorithms then allocating their funds across a (usually much larger) range of investments.
In 2015, 82 per cent of P2P consumer lending platforms said retail investors were making use of auto-select options. In the UK, for instance, Zopa and RateSetter offer 100 per cent auto-selection. The average P2P consumer loan was approximately €5,997 in 2015, with 113 lenders per loan (so an average of €50 each). Auto-bid technology means it’s not unusual to see lenders per loan in the double digits, as platforms try to diversify a lender’s portfolio.
“It’s far too early to say whether this model is sustainable. The question for investors is ‘do you get leftover loans?’. We can only track the performance of the asset and compare it to manual selection, so it’s not yet possible to say whether an investor is getting an optimal allocation,” says Zhang.
And the rise of auto-bidding poses challenges for platforms: if they’re responsible for selection on behalf of the investor, due diligence and credit assessment become increasingly important.
The report points out that this will be particularly vital for those dealing with secured loans, who will need to either “create their own in-house underwriting facilities or seek external underwriting partners to adequately assess the security on offer.”
3. The crowded-out retail investor
Institutionalisation is accelerating across Europe. Twenty six per cent of P2P consumer lending and 24 per cent of P2P business lending was funded by institutions like pension funds, mutual funds, asset managers and banks in 2015. Even in equity crowdfunding, 8 per cent of investment was funded by VCs, angels, family offices and funds.
Yet this is not perceived by the industry as a threat to the retail investor. Indeed, 47 per cent of platforms viewed the “potential crowding-out of retail investors” as “very low risk” or “low risk”.
“Crowding out is not a primary concern for now,” says Zhang. That’s because, even in this low-rate environment, the cost of acquiring capital is still quite high for platforms – because they have to return some of their margin to lenders. “That means having a balanced pool of investors, and having the same rules for all of them. Provided institutions aren’t cherry-picking loans, they can spread risk, and investors have access to a greater deal flow.”
4. A cross-border future
Another future development to look out for is a rise in cross-border transactions. Levels are currently low – probably because of poor regulatory harmonisation. But the report notes that internationalisation, at company level, increased in 2015, with a few high-profile firms expanding organically or through M&A. In the UK, for instance, equity crowdfunder Seedrs is already passporting, meaning that a UK investor has access to deals in, say, Hungary.
“A lot of platforms are using passporting facilities, but it’s unclear what will happen in the long term. The Capital Markets Union is still under development, and the challenge for the Commission will be ensuring the same standards,” says Zhang. Despite currently low volumes, this might give an indication of the market in the future – the opportunity to invest in a particular industry, or thematically.