How P-to-P loans evolved into different animals in the US and UK

The United States has the dollar, while Great Britain has the pound. We have a president, and they have a queen.

Now add one more item to the list of differences between the two closely linked nations: the US has loans in the market, a fast-growing sector dominated by institutional investors, while the UK is out of it. largely held to the peer-to-peer lending model, in which retail investors provide industry capital.

The loan between individuals was born ten years ago in London, and the concept quickly crossed the Atlantic. In the much larger U.S. market, the P-to-P industry has grown faster, but it has also evolved into a way for large financial institutions, including banks and hedge funds, to investing in loans while allowing online platforms such as Lending Club to handle the complicated underwriting details.

Meanwhile, in the UK, the P-to-P industry has remained closer to its roots, as a vehicle for individuals to earn a more modest return on their savings.

[Coming this November: Marketplace Lending + Investing. Hear how participants in this fast-growth niche are using data and technology to propel lending into the 21st century.]

Observers from both countries attribute the divergent trajectories to a mix of regulatory and cultural factors. At the same time, they predict that institutional investors will become a bigger factor in the UK, while US retail investors will soon find new ways to invest in market loans. The changes underway underscore the rapid evolution of a nascent industry that is full of experimentation.

“The two markets seem to have moved in different directions,” said Jahan Sharifi, a lawyer at Richards Kibbe & Orbe LLP, which represents hedge fund investors.

But he added: “The markets could turn around very quickly.”

UK’s conservative path

Peer-to-peer lending platforms in Britain have long marketed themselves to consumers as an alternative to depositing cash at the bank, as opposed to a riskier investment vehicle.

“The main idea is to give a low and stable return to retail investors,” said Mike Baliman, who hosts a UK fintech podcast.

Zopa, the London-based company that invented peer-to-peer lending in 2005, is reporting annualized returns of 5.0%, which is at the lower end of returns reported by US markets. “No bailout needed,” says Zopa’s website, in an appeal to savers who have been put off by banks’ role in the financial crisis.

“I would say the vast majority of Britons tend to want to put their money somewhere for a few years and let it accumulate,” said Mat Gazeley, a Zopa spokesman.

One of the main competitors in the UK, RateSetter, advertises pre-tax returns of up to 6.4% with little risk for the investor. “£649,873,514 lent out and not a penny lost,” the company’s website says.

Zopa and RateSetter keep reserves that are used to compensate consumers who invest in loans that go bad. These money pools work much like privately funded deposit insurance and make UK loans look more like a savings product than their American cousins.

Lower yields on UK loans have made them less attractive to institutional investors. At the same time, the UK government has taken steps that have strengthened the retail market, for example by drafting regulations specifically designed for peer-to-peer lending.

The UK government is also making it easier for consumers to invest their retirement savings in P-to-P loans. After August 5, changes to the country’s rules for individual savings accounts, which are similar to individual retirement accounts in the United States, will mean ordinary people will be able to hold some or all of their savings in P-to-P lending platforms.

“In the UK, it’s just easier to do retail capital formation,” said Sam Hodges, managing director of Funding Circle USA, the San Francisco-based arm of a peer-to-peer lender. based in London.

“The UK in terms of regulation … is moving a little faster than the US,” said Scott Talbott, senior vice president of government relations at the Electronic Transactions Association in Washington, noting that Britain is a smaller market with a flatter regulatory structure.

Admittedly, institutional investors are entering the British market. For example, British bank Metro Bank, founded by Vernon Hill, the former managing director of Commerce Bancorp in New Jersey, recently announced a partnership that will allow it to lend through the Zopa platform.

But for the most part, UK banks have been slower to adopt online lending platforms than their US counterparts.

A London-based startup, investUp, recently decided to abandon plans to partner with banks and resell their loans to the crowd. Company executives said UK banks are too risk-averse to buy into the idea and are waiting to see if P-to-P lenders will survive the next downturn.

US pushes for higher yield

A turning point in the evolution of the US market came in 2008, when Lending Club and its biggest rival, Prosper Marketplace, were temporarily forced, for regulatory reasons, to scale back their operations.

At the time, the two P-to-P firms realized that the US government was going to classify their investor notes as securities and therefore they would have to register with the Securities and Exchange Commission.

Eventually, Lending Club and Prosper began filing daily prospectuses with the SEC, which allowed them to sell to retail investors. But this process is expensive and new competitors have chosen not to follow this example.

“It’s capital-intensive. It’s people-intensive. It’s a lot of work,” said Ron Suber, president of Prosper.

Accredited individual investors, who typically have a high income, a net worth of at least $1 million, or both, can invest in the loans offered on various competing platforms. But middle-class investors in the United States currently don’t have many P-to-P options, unlike their British counterparts.

Meanwhile, Lending Club, Prosper and other US platforms have turned to institutional money to fuel their rapid growth. Prosper issued $205 million in loans in December, up from $60 million a year earlier.

“Today, Prosper is roughly one-third retail and two-thirds institutional,” Suber noted. “I would just say institutional demand has been higher than retail demand at this point.”

Lending Club declined to provide a breakdown of its lending volume by type of investor. But the San Francisco-based firm issued more than $4 billion in loans last year, with around 60% of those loans going to riskier borrowers and generating returns of 8.5% or more. .

Industry observers have pointed to several factors that have accelerated the rise of institutional investors in the United States. This list includes the fact that there is simply a lot more institutional wealth to invest in this country than there is in Britain, and the emergence of new technologies and corporate support that have allowed investors US institutions to place large sums more easily on online platforms.

Right now, there still seems to be room for growth among hedge funds and other investment firms. A recent survey of over 300 US institutional investors found that 29% of respondents currently have investments in the sector, while 85% of respondents expressed an interest in making such an investment.

The survey results were published in a report by Richards Kibbe & Orbe and a student-led project at the Wharton School of Business at the University of Pennsylvania. “We believe that the high level of interest in any form of loan investment in the market indicates the potential for strong and continued growth,” the report said.

Changing winds

Still, observers have warned that in both countries the mix between retail and institutional investors could change quickly.

In the United States, online markets try not to alienate retail investors, who sometimes complain that large institutional investors snap up the most attractive loans before individuals have a chance to review them.

“I think the pendulum will swing back and you’ll see even more retailer participation,” said Prosper Marketplace’s Suber.

US platforms might be wise to prepare for a scenario in which hedge funds, which can be fickle investors, quickly exit the sector. Rising interest rates could make other asset classes more attractive. Higher credit losses, if they materialize, could also trigger an exodus.

At the same time, a new way for US individuals to invest in market loans is on the horizon. During the third quarter of this year, two P-to-P funds for retail investors will open, according to Suber.

These funds should give individual investors in the United States access to a wide range of loans in the market from different online platforms. “This will allow individual investors to invest,” said Peter Renton, publisher of Lend Academy, a website that covers market lending.

Renton argued that the individual loan assessment process, which is how the P-to-P industry began, is time-consuming and not something that appeals to a wide range of people.

“People aren’t interested in managing their own money. People want someone else with experience to do it for them,” he said.

Recent trends in the UK point in the opposite direction. UK lending platforms have recently become more interested in attracting institutional funds as a way to fuel faster growth.

Some UK companies have seen the success of Lending Club’s IPO – the US company has a market capitalization of almost $7 billion – and may be hoping to emulate it.

“What has taken off recently is the realization that an IPO is possible for first-timers,” said Baliman, who hosts the London Fintech Podcast. “The main name of the game right now is growth, asset growth.”

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