Peer-to-peer (P2P) financing has been a hot topic on the lips of many investors over the past few years. One of the biggest names in the alternative lending sector, US firm Lending Club, has shown quite
remarkable growth in its fairly short life, but this week became embroiled in a scandal so disruptive, it saw the company’s CEO resign.
After all the buzz around P2P, is this “the beginning of the end” for this popular lending platform and the wider sector?
Eerie echo Lauren Silva Laughlin, writing for
Fortune, outlines the events that led to CEO Renaud Laplanche’s departure: “Cirrix [Capital] buys loans that Lending Club sells. To boost its returns, Cirrix borrows from other banks to buy some of these loans. This creates a virtuous cycle for Lending Club: the more money Cirrix borrows, the more loans it can buy, and the more fees Lending Club collects.”
35%
The amount by which Lending Club shares plummeted after its CEO and three senior managers resignedLaplanche did not disclose a personal interest in Cirrix Capital, "despite knowing that Lending Club was buying a 15% stake in the entity for $10m".
After an internal review that revealed violations of the company’s business practices, Laplanche and three other senior managers jumped ship, causing shares to plummet by 35%.
Laughlin explains that if Cirrix buys too many of Lending Club’s loans, which is possible with Lending Club as a partial investor, it could cause substantial conflicts.
She quotes Aswath Damodaran, Professor of Finance at the Stern School of Business at New York University: “If 80% of [Cirrix’s] portfolio is in Lending Club, it is very dangerous. You become almost a quasi-bank, and you need to worry about all the things that banks do.”
This is where Laughlin draws a comparison between Lending Club’s business and the activity that caused significant losses at Morgan Stanley. John Mack was at the helm at Morgan Stanley at the time. He resigned in 2011 and has sat on the board of Lending Club since 2012.
“John Mack’s history with bad loans doesn’t repeat, but does rhyme,” she says. “Like Lending Club, trading desks for a long time were just a conduit ... The trouble arose when the trading business got entangled with the lending one, and brokers like Morgan Stanley became banks as well.”
Fortune comment
Cross-Atlantic differencesReuters used the opportunity to explore how this blow up would have played out in the UK, which journalist Huw Jones points out has one of the biggest P2P sectors in Europe.
Citing industry and legal experts, Jones says: “Lending Club would be in breach of financial rules had it knowingly sold on loans in Britain that an investor did not want.”
He quotes Rhydian Lewis, Chief Executive of RateSetter, the second-largest UK platform. “The sector in the UK is more regulated and it has put quite a lot of emphasis on transparency, with all loan books published,” says Lewis.
What’s more, Lewis says: “The industry in the US has faced more pressure to grow and is skewed toward institutional investors and the wall of money they bring, rather than the small investor sums that UK platforms handle.”
Jones goes on to cite sector officials who implied the event would not prompt changes to regulation in the US: “The news pointed to an isolated matter involving an institutional customer rather than a systemic flaw affecting many small investors, which would trigger regulatory change.”
Reuters article
A smell-the-coffee momentSo, does all this spell the “beginning of the end” of P2P? asks
City AM.
According to Bill Blain, Strategist at stockbroker Mint Partners, it does. He describes the scandal as “a long-expected smell-the-coffee moment for the sector” and is unapologetic in his view of unsuspecting investors caught up in the scandal: “[They] convinced themselves that putting money into platforms was somehow akin to opening a bank account.”
Like
Fortune’s Laughlin, Blain makes a link with the financial crisis: “As collateralised loan obligations and credit default swaps proved eight years ago, and platforms are likely to show now, ‘diversified’ lending to corporates is lumpy risk.”
But Rupert Taylor, Chief Executive and Co-Founder of alternative finance news site AltFi, takes a contrasting view.
“The UK is blessed with industry-leading standards of transparency, but more can be done"Taylor’s chief point is that the scandal highlights how transparency is “critical to the model”, but that the failures at Lending Club do not “reveal a structural problem”.
This is because, says Taylor, they relate to disclosure – “a discipline that is central to what distinguishes P2P from conventional finance".
He believes P2P will continue to thrive, as long as “full and transparent disclosure” is at the core of the sector.
“The internet remains a superior conduit for [finance], given the associated reduction in cost and its convenience as a medium for sourcing data that can inform the pricing of risk.”
On how this all relates to the UK’s sector, Taylor says: “The UK is blessed with industry-leading standards of transparency.” Although, he adds: “More can be done … to ensure that buyers of loans are provided with sufficient information to allow for the enlightened appraisal of risk.”
City AM opinion
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