[Editor’s note: No jokes today – yes the Warren Buffett piece yesterday was an April Fools Joke. Today, we bring you a guest post from Samuel Hu, an attorney with Chapman & Cutler LLP, who has done a great deal of analysis of the legal framework within which the p2p lending companies operate. He has produced a detailed report on this topic and provides a brief commentary about it here.]
First, I want to thank Peter for the opportunity to post a brief summary of the work we’ve been doing with respect to legal issues affecting p2p lending. As the title of the post suggests, I have recently co-authored an article (download it here) that was based on our experience advising operators and prospective operators of p2p lending platforms as well as institutional investors in p2p loans.
The article we put together covers four general topics: i) securities laws; ii) laws affecting lenders; iii) borrower protection laws; and iv) bankruptcy considerations.
However, instead of summarizing the paper I thought I’d take this opportunity to throw out a few thoughts that came up while researching the paper and I hope to generate some discussion on where the p2p lending industry may be headed.
As most of you know, shortly after p2p lending industry was launched, the SEC determined that a company that sells loan notes through an internet platform, in combination with that company’s undertaking to service the loans and perform certain other services entails the issuance of a “security”. As such, both Prosper and Lending Club have spent significant time and money to file a registration statement with the SEC and have undertaken ongoing filing requirements in order to continue issuing p2p loans. And without their leadership in the area, most of us would not have the opportunity to earn the returns we have been provided by investing in p2p loans.
Having said that, we note in the article that if p2p loans are sold only to ‘accredited investors’, a p2p lending company could by-pass the SEC registration requirement as well as the state regulations that currently prevent people located in certain states from being a lender on Prosper or LendingClub.
Question No. 1
Given the lower barrier to entry, why are there not more p2p sites focused solely on institutional/accredited investors (especially as compared to the proliferation of equity crowd funding sites)?
In the article, we also outline an argument (albeit tenuous) that under certain circumstances (and if certain laws are passed), the SEC may require a p2p company to retain a portion of the risk of each loan that it originates (the so-called “risk-retention rule”). These proposed rules are meant to address one of the perceived causes of the great recession – namely, the originate-to-distribute model of mortgage origination. According to proponents of the risk-retention rules, because mortgage originators did not have any “skin in the game”, they were not adequately incentivized to follow prudent underwriting standards.
Question No. 2
Whether or not there is a legal requirement to do so, would the p2p lending industry benefit from a requirement that a p2p company retain a small percentage of each loan it originates (keeping in mind that the return to lenders will likely need to be lower in order to compensate the p2p companies accordingly)?
The final part of the article discusses the risk of buying p2p loans associated with an insolvency of the p2p company. We also discuss some of the ways that a p2p company can isolate lenders from this bankruptcy risk. One method is the use of a bankruptcy-remote vehicle to hold the loans on behalf of the lenders. For those of you with a structured-finance or securitization background, you will recognize that this construct is widely use for financing a wide variety of assets including mortgages, car loans and credit card receivables.
Question No. 3
What are the next asset classes (beyond consumer loans) to be financed by p2p ‘technology’? Residential mortgages? Commercial mortgages? Accounts receivables? Others?
I hope this post generates some discussion and I would enjoy speaking with anyone regarding the comments above or the contents of our article. Please feel free to e-mail me at samuelhu@chapman.com if you have any questions or just leave a comment below.
