[Editor’s note: This is a guest post from Andy Whelan, Chief Executive of GLI Finance. GLI Finance is a Platinum sponsor at LendIt USA 2016, which will take place on April 11-12, 2016, in San Francisco. Andy will be speaking on multiple topics at LendIt including publicly traded closed end funds, investing in an SMB platform and transitional capital for early stage companies.]
Since the economic crisis, the alternative finance train has gathered speed as traditional banking lenders have become less willing and less able to lend to SMEs. Recent research from Cambridge University’s Centre for Alternative Finance and NESTA showed that the alternative finance sector grew £3.2 billion in the UK alone in 2015, while research from Morgan Stanley recently estimated that the global P2P market, just one segment of alternative finance, could be worth up to $450 billion by 2020. There are now hundreds of online alternative finance platforms across the globe facilitating millions of dollars’ worth of transactions every day for individuals and small businesses alike.
It is the continuing rapid growth of the industry that is beginning to attract institutional investors. According to the Cambridge / NESTA report there was a significant increase in the involvement of institutional investors in the alternative industry last year – 45% of all platforms reported some level of institutional involvement. Global banking powerhouses like Goldman Sachs and Société Générale have gradually woken up to the huge potential of the alternative finance sector and are increasingly keen to get in on the action. They have realised that not only can you take equity positions in a rapidly growing industry but also provide finance for platforms to lend to SMEs and consumers.
However, the alternative finance train is in danger of slowing if potential institutional investors are put off by the perception that the industry lacks a fully developed regulatory framework. One issue to hit the headlines last year was that of co-mingling – essentially the combining of investors’ monies with that of the alternative finance platform itself. TrustBuddy, the world’s first listed peer to peer lender, was forced to suspend operations and report itself to police after discovering “serious misconduct” including misuse of client money. Investors’ monies were not protected, therefore when TrustBuddy failed, its investors’ money was completely wiped out. A 2015 U.S. survey of marketplace lending by RK&O and Wharton FinTech found that 85% of institutional investors are interested in allocating capital to alternative finance in the future so it is crucial that the industry ensures that it minimises the risk of another TrustBuddy scandal and provide transparency around how capital is being managed and deployed.
So what can alternative finance companies do to protect investors, minimise risk and build greater trust? First and foremost, it is crucial that they are as transparent as possible as to how investors’ money is protected – this is the most effective way to build trust within the investor community. At GLI Finance, our investee platforms clearly state on their websites how they segregate investor funds from those used to provide working capital, in accordance with FCA guidelines.
Secondly, it is also vital that an appropriate regulatory framework is implemented. While a company Code of Conduct can sometimes be enough to convince investors to trust a company with their money, if things get serious, such as was the case with the TrustBuddy saga, only a real regulator will be able to enforce the rules. Regulation should not be seen as a knee-jerk reaction to isolated failures but rather as a result of the collective responsibility the industry now has to the businesses it serves. The public has to be confident that someone is keeping a close eye on the industry, protecting standards, investors and SMEs. One just needs to take a look at the reputational damage the financial crisis had on the banking industry to realise how crucial it is to have appropriate regulation and standards in place.
The alternative finance industry has, of course, not reached the size of the big bank sector – and are not going to any time soon – however the industry is certainly established enough to suffer permanent damage from another scandal, which could potentially stifle further investment in the sector. There is also a danger that some in the alternative finance sector will be concerned that the involvement of institutional investors and adhering to a set of rules goes against the disruptive ideals of alternative finance platforms. However the industry should welcome greater institutional involvement, after all, it will ultimately help get more money to SMEs who are currently being starved of the resources they need to grow.
The alternative industry has the potential to undergo phenomenal growth in the coming years and institutional investment will be critical if it is to do so. Therefore it is crucial that the industry is able to convince investors that it is being run in a professional and responsible way and that their money is protected.
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