With the Scottish referendum several weeks away, we look at how independence could affect peer-to-peer lending between Scotland and the rest of the United Kingdom.
The vast majority of UK peer-to-peer companies are based in England, with one company - Funding Empire - based in Wales. As yet there is no major peer-to-peer lending organisation based in Scotland. Today Scottish borrowers can use peer-to-peer lending sites such as Zopa, RateSetter and Funding Circle to both lend and borrow. If Scotland were to separate from the rest of the UK, would this situation continue? Existing Scottish borrowers would still be required to repay their current loans in Sterling, and existing lenders would receive interest and capital in Sterling. However, would peer-to-peer companies allow Scottish individuals to continue to use peer-to-peer services based in the remaining UK? Would UK lenders continue to fund loans for individuals that are now outside the UK?
Bondora currently facilitate loans between UK lenders (as well as other European lenders) and European borrowers, so cross border lending does exist, but the lender assumes the currency exchange rate risk. An independent Scotland is unlikely to be able to formally use the Pound, but any Scottish currency is likely to be pegged to Sterling, so any currency exchange risk is likely to be small but probably not zero. If UK-Scottish peer-to-peer lending were to continue the costs for Scottish borrowers are likely to be higher.
Given the regulatory requirements, would UK peer-to-peer companies also want to adhere to a Scottish FCA equivalent as well as the current UK FCA? As Scotland is significantly smaller, by population, than the UK it is likely not all peer-to-peer companies would adopt Scottish regulations given the incremental costs.
It is likely we won't know exactly what will happen, but it is our belief that peer-to-peer lending in Scotland would be reduced by independence, which would be a setback to everyone in England, Wales, Scotland and Northern Ireland.
Peer-to-peer lending does involve taking some risk, and they are not currently covered by the FSCS (Financial Services Compensation Scheme). The value of a lender's loan book will vary and can fall as well as rise, with the possibility of a complete loss.
What are these risks and how can lenders mitigate them?
Borrower does not repay
This is perhaps the most likely risk, and perhaps "risk" is actually the wrong word as it is almost a certainty. In this category most borrowers will be unable to repay, but there will be some who are unwilling to repay, and possibility some that are fraudulanty, but ultimately the outcome is the same. The peer-to-peer platform may take the borrower to court and have a CCJ placed - or worse, but if the borrower can't replay then the lender will be left out of pocket.
Lenders can mitigate this by spreading their funds as thinly as possible. We would recommend no more than 0.5% of the total fund exposed to any one borrower. Some peer-to-peer platforms, such as RateSetter, operate a provision fund that will step in and repay the outstanding capital, and these funds are paid for by the platform charging the borrowers more than platforms that don't operate such a scheme. Other platforms, such as Wellesley & Co, have loans secured on assets, so if the borrower is unable to replay the asset can be sold and the funds used to repay lenders.
Platform goes out of business
In the years since Zopa launched there have been several peer-to-peer companies that have ceased trading or gone out of business. Some business fail because they are unable to manage the supply and demand between lenders and borrowers. A company where bad debts start to rise and lenders loose confidence and start withdrawing funds is likely to fail unless they can quickly turn the situation around. Despite FCA regulation there is the possibility that a platform may be affected by fraud.
Most of these companies have run down lenders loan books in a controlled manner, but others have simply gone offline and lenders have been left out of pocket. The FCA regulations required peer-to-peer companies to have a contingency fund which would pay for the administration of loans after a company ceased trading, but there is no guarantee that this would be sufficient to run down a 5 year loan book and chase late payments.
This is perhaps the hardest risk to quantify, but lenders can mitigate this by speading their funds between providers. Lenders should also look for companies that are members of professional bodies, particually the P2P Finance Association.
After some discussions with the kind people at Zopa, the P2P money website has arranged a special £60 cashback (by way of Amazon gift vouchers) to new lenders who sign up through the P2P money website and subsequently lend £2000 or more. This offer is scheduled to last until mid 2015, so there is sufficient time to take advantage of it.
Terms and conditions apply.
One of our readers has decided to take the plunge into the wonderful world of peer-to-peer lending, and in the process published their experiences to date. With their kind permission, we have shared some of Paul's comments so far.
Zopa review by Paul Manwaring:
2 months have passed since we opened our Zopa account and I am pleased to say we have lent out 100% of our £1000 fund.
I haven’t had any problems using Zopa and so far I really like the hands-off automated approach to their system. Below are screenshots from my second month, you can see I gained £3.01 interest from borrowers. I had more fees deducted this month probably because a lot of my loans loans had been accepted.
The first few months are always a bit slower to get the ball rolling because it takes time for your bids to be accepted and then once they have been accepted you have to wait the repayment period (usually 30 days) to see any interest. After 2-3 months you should see your entire fund pot spread out into accepted loans. I’m expecting slightly higher interest next month because of this (fingers crossed) but so far it looks promising to keep on target with the 5.1% rate promise.
Funding Circle review by Paul Manwaring:
2 months have passed since we opened our Funding Circle account and I am pleased to say we have lent out 100% of our £500 fund. My account does show that some money is waiting to be lent out but that is because I have received repayments and the bidding cycle repeats itself continuously reinvesting my money.
I haven’t had any problems using Funding Circle and so far I really like the hands-off automated approach to their system. Below are screenshots from my second month, you can see I gained £3.56 interest from borrowers. I had more fees deducted this month probably because a lot of my loans loans had been accepted.
The first few months are always a bit slower to get the ball rolling because it takes time for your bids to be accepted and then once they have been accepted you have to wait the repayment period (usually 30 days) to see any interest. After 2-3 months you should see your entire fund pot spread out into accepted loans. I’m expecting slightly higher interest next month because of this (fingers crossed) but so far my returns look good.
Seeing as our results with Funding Circle have been very good I have added another £500 into the investment fund so as to level the playing field with Zopa.
You can read more of Paul's experiences on the Internet Marketing Hustle blog.
I was recently asked the following questions:
What happened to investors/lenders money when companies listed as ceased trading or suspended or went off line?
Do you think there may come a time soon when lenders money is covered by compensation scheme?
Firstly peer-to-peer lending, in virtually all cases, is a contract between a borrower and one or more lenders, which is managed by an intermediary (a peer-to-peer company). Unlent funds are segregated in a client account, separate from that of the peer-to-peer company. If the intermediary peer-to-peer company were to cease trading the contract is still valid and enforceable, but the difficulty that may occur is that in most cases, the lenders' and borrowers' identities are hidden from each other.
The FCA regulations required peer-to-peer companies to have a contingency fund which would pay for the administration of these loans after a company ceased trading, but there is no guarantee that this would be sufficient to run down a 5 year loan book and chase late payments. In the case of the collapse of Quakle, lenders were left out of pocket, but other companies did, and in most cases, still are performing a controlled return of lenders' funds when they are repaid from borrowers.
In the previous FCA consultation process I did argue for lenders funds to be covered by the FSCS in the unlikely event of a peer-to-peer company failing and where any contingency funds were insufficient for a controlled winding down. Unfortunately I believe the industry argued against this as they believed the costs for this would be prohibitive. I also suggested the members of the P2P Finance Association, who account for a very large percentage of the peer-to-peer loans arranged within the UK, should operate their own contingency scheme, in effect sharing the costs of one of the companies taking on the failed company's loan book.
Following the recent suspension of trading in Be The Lender, it is too early yet to ascertain what the impact to lenders will be, but I'm sure the FCA will be monitoring the situation, as will we.