"To peer, or not to peer?"
When we set up PrimaDollar in 2015, we had to decide how to fund the business. We provide trade finance to emerging market manufacturing companies who have mid-cap or large-cap customers in OECD countries. This is a credit arbitrage that is hard to access, but very rewarding. There are, basically, two ways to proceed: the old-fashioned balance sheet route (borrow the money and lend it ourselves), or should we use peer-to-peer technology, call ourselves a "platform", and sell the receivables that we generate to the marketplace?
Without doubt, peer-to-peer would have been an easier route. However, we have gone the old way - balance sheet. Here we explain why, and it might not be for the reason that you imagine.
Peer-to-peer funding has many attractions. Listing some of them here, it is clear to see why this route has taken off among many of the new non-bank lenders:
- Peer-to-peer gets you the ability to raise funds from a zero base.
- Other people (participants who are providing the funds to your platform) are taking the risk.
- In the UK, it usually means you can raise equity capital from business angels and crowd-funders more easily, since "platforms" are generally considered to be sexy, and investments can be eligible for the tax shelter of the Enterprise Investment Scheme.
On the other hand, we can see issues with peer-to-peer:
- If you do originate bad credits, the participants in your platform will walk away. So there is no real risk transfer. If you get it wrong, you are just as dead as if you lent the money yourself.
- The main bulk of the revenue generated goes to your participants. All you have is your "platform fee" to live on. So break-even is often at quite a big volume of business.
- Regulators have the sector on their radar screen. The line between taking deposits (and therefore being a bank) and selling fractional interests in a loan book is a legal sleight of hand. The substance of the arrangements looks remarkably similar.
Although everyone's attention has been diverted to the idea that being a "platform" is sexy, we could not see the attractions of the platform model from a shareholder point of view. If we still have all the risk of the credit performance, shouldn't we also retain the upside, especially if this substantially postpones the date when we can bring the business to break even? If we can originate business at above market rates, surely that premium return should flow to our shareholders. Moreover, the threat of regulation (now slowly arriving) suggests that the legal form of the platform model is not going to fool the regulators for long.
But the really troubling problem is one of guilt-by-association. This is actually why we avoided peer-to-peer and went the conventional balance sheet route. One brush will tar everyone. It will only take one dodgy bunch operating a peer-to-peer pyramid scheme and the entire sector will shake down in no time. Moreover, many peer-to-peer platforms are operating a maturity-transformation model - which means lending long. If there is a rush to get the money out, it may well not be available. It's no surprise that Zopa has announced plans to get a banking licence and likely other larger platforms who can afford it will follow in time. Whilst we may be sceptical about the report, Chinese regulators are apparently warning that 90 per cent of peer-to-peer platforms could fail in 2017 (SCMP Feb 17th) as regulators respond to the failure of Ezubao in 2015.
"To peer or not to Peer?" Not to peer looks like the sensible answer.
If you would like to comment, please do. If you would like to discuss any of the issues raised, please get in touch with us (Contact us), or see our website more generally for an understanding of our business www.primadollar.com.
A next article in this series will look at the Fintech lending space where, as with peer-to-peer, our views also seem divert from the mainstream.