FRAMING THE FUTURE OF ALTERNATIVE FINANCE
THE GLOBAL REGULATORY FORUM 2015
WEDNESDAY 4TH NOVEMBER 2015 | ORGANIZATION OF AMERICAN STATES, WASHINGTON DC
WELCOME TO OUR REVIEW OF THE GLOBAL REGULATORY FORUM ON ALTERNATIVE FINANCE 2015
- David Stevenson suggested that we are at a tipping point where alternative finance, which include P2P lending and crowdfunding, is becoming mainstream. But this presents real challenges for regulators and policymakers, particularly relating to how they manage risk.
Fintech: Building a 21st Century Policy Framework - Daniel Gorfine, OnDeck
- Daniel Gorfine (OnDeck) talks about some characteristics of the alternative finance space and about different approaches to regulation in the US.
- One of the key theme in the industry is disintermediation, since fintech platforms frequently bypass traditional intermediaries; another one is convergence that is raising important questions and challenges for regulators; globality stands out as well: technology permits platforms to reach millions of people in a short period of time; last but not least democratization of finance, since more investment opportunities are available for a wider group of investors in the market.
- Given the above characteristics, we need a powerful regulatory framework that fit in every situation it might occur. The majority of experts claim that there are two kinds of regulatory model: rules based or principle based. For Daniel this is a too simplistic view. According to him, first we need a regulatory framework that permits the spreading of the benefits of this phenomenon, and then a more detail one that prevent people to behave badly.
- Management innovation practices have developed substantially in recent years in response to rapid technological advancements; the same cannot be said for the US law making process.
Challenges and Opportunities of Policy in the Age of Digital Finance
- Seth Wheeler (Guest Scholar – Brookings) explains challenges and opportunities for policy makers in the age of digital finance. Should fintech be considered as an evolution or revolution? According to Seth, alternative finance ought to be considered a revolution, as well as a discontinuity in the path of innovation – with technology as its main driver.
- Policymakers should care about integrity, protection of investors and consumers, cyber security, competitiveness issues and risk management. In the US, there are a plenty of regulators and all of them they should cooperate in order to regulate this space.
- Regulators must recognize not only the risks, but also the upside that the alternative finance industry offers. Thus, they should regulate the space, being neither too strict nor to loose. Policymakers must be humble: humility is essential, since they don’t know deeply how the industry works.
Introduction to US/Americas Alternative Finance industry
- Richard Swart (Director of Research - University of California, Berkeley) introduces the US alternative finance industry, focusing on crowdfunding. There are many kinds of crowdfunding, such as donation-based crowdfunding, word of mouth marketing, reward-based crowdfunding and the like.
- Richard claims that there is a high correlation between the state of development of societies and crowdfunding. In particular, crowdfunding techniques and businesses adapt in relation to each country’s culture.
- Looking at Australian data, 83% of crowdfunding investors are parents or friends of entrepreneurs. Among those who have ever contributed to a crowdfunding campaign, Kickstarter was used 56% of the time, tied up with gofundme (54%). Other sites had been used by 24% or fewer respondents.
Introduction to UK Alternative Finance industry
- Rupert Taylor from AltFi Data sheds light upon the space from a quantitative perspective. His findings focus on the difference between the US and the UK markets. The US market is four times bigger than the UK one and it is mainly centred on consumer lending, whereas the UK has a more diverse borrower basis. However, the UK market is bigger on a relative basis. In terms of lenders, the institutional share of the UK market is approximately 42%, while in US is 89%.
- Interest rates net of defaults, fees and the like are higher in the US market rather than in UK: 8.57% vs. 5.45%, but at the cost of higher volatility. However, this gap is definitely shrinking.
- The UK market is dominated by three platforms – Zopa, Funding Circle and RateSetter – and their share is approximately 67% of the whole market. In the US, there are only two platforms that have the same share: Lending Club and Prosper. A critical trend has been highlighted: the bigger players are becoming even bigger.
- Trust is central in financial services. The key ingredients that develop trust are regulation, governance and transparency/disclosure. The industry best practices are different for platforms and asset managers. For the former, best practices are loan book publication and peer review of returns; for the latter the main one is benchmarking to allow investors to make informed decisions on expected returns.
Introduction to European Alternative Finance industry
- Paul Poltner, (Managing Director, Finance and Business Development, Conda) introduces the European alternative finance industry. The European space is different from the US and even from the UK one.
- The total transaction volume of the online European alternative finance market was €2,957 million in 2014; 144% was the growth rate of the online European alternative finance market compared with 2013; € 620 million was the total transaction volume of the online European alternative finance market excluding the UK, in 2014; € 201 million was the early-stage, growth and working capital funding provided to European start-ups and SMEs through alternative finance platforms.
- On European level there is just a rough regulatory framework: implementation and interpretation lie in the hands of the single countries. There are three levels that need to be considered: company, investor and platforms; each level ought to be regulated in different ways.
- One of the main challenges is to cope with differences of European countries. European countries have different rules, different languages, different levels of consumer information and thus a cross-boarder prospectus is very expensive (EUR 100.000+).
- The MiFiD 2 (2014), the directive on markets in financial instruments repealing Directive 2004/39/EC, is the main regulatory text that should be taken in consideration.
The State of Play in US Alternative Finance – Panel
- Joseph Brady (Executive Director, NASAA), Monique Rollins (Deputy Assistant Secretary for the Office of Capital Markets), Melissa Koide (Deputy Assistant Secretary, The Treasury), Candace Klein (Chief Strategy Office, Dealstruck) and Stefanie Schmidt (VP of Legal and Compliance, DemystData) discuss about the state of play in the US alternative finance space.
- Melissa claims that US regulators are adopting the Request For Information (RFI) to understand and better regulate the industry.
- Monique Rollins explains the Title II and Title III of the Jobs Act. The new Title III permits individual investors, over a 12-month period, to invest in the aggregate across all crowdfunding offerings up to different limits, depending on their annual income or net worth.
- Joseph Brady explains that NASAA’s mission is to protect Main Street investors from fraud. He says that two important factors in regulating this new space are responsible capital formation and investor protection.
- Stefanie Schmidt claims that regulation is essential, but it should not be a blocker to innovation, but help innovation to develop responsibly.
- All panellists agree about the fact that 2016 will be a watershed year: the new Jobs Act will be operating, there will be a shift towards retail equity crowdfunding and the Congress’s interest in the P2P market will extremely increase.
Introduction to China’s peer-to-peer lending and alternative finance
- Xin Zhou (CCUAIF - Deputy Secretary in Chief) introduces an analysis of China’s P2P lending and crowdfunding space. The alternative finance industry in China is booming for several reasons: special political environment, good economic trend (i.e.: interest rate cuts, increasing average income, businesses transformation), Chinese culture and tradition, popularity of mobile technology and smartphone (e-commerce).
- At the moment, there are 3251 P2P lenders in China, whereas last year they were only 200. The curve seems to be still going up very quickly. In 2016, the industry will be worth $2 trillion, whereas in 2020 Xin announces the astonishing figure of $20 trillion.
- Looking at the regulating guidelines for the China’s P2P lending platforms, it is clear that governments at all level should actively encouraged innovation in e-finance platforms. Moreover, the guidelines also urged government red tape to be cut and related fiscal and taxation factors to be improved to ward off potential risks for the industry’s development.
AltFi and Cyber Threats - Why should you care?
- Mark James from consulting firm PWC suggested that regulators and policymakers need to think about the data implications of financial disruptors.
- Looking at the recent UK hacking example he suggested that every business was vulnerable
- Platforms need to think beyond just hacking considering how vulnerable they are to disgruntled employees.
- Platforms need to robustly test their preparation on a regular basis to cyber related criminal activity.
The UK experience, navigating through disruptive change – Panel
- Paul Massey (CrowdCube General counsel), Rhydian Lewis (RateSetter Founder and CEO), Louise Beaumont (Head of Public Affairs and Marketing, GLI Finance) Eddie George (CEO and Founder, NewFinance) discuss the UK alternative finance market.
- Eddie claims that UK is really good in fintech for several reasons. The first one was the GFC that helped platform to raise and build the space. Another essential factor is the strong presence of the Government that is really involved and engaged, since the high growth potential of the space has been recognized. Moreover, regulating the space in the UK is easier than in US, as the US is formed by 52 states, the UK it is just a single state.
- Rydian explains that attracting customers from banks to platforms is the key to fast growth. RateSetter is the first platform in UK to pool risk and to base its business on .
- Paul agrees upon the importance of trust and confidence and he says that it mainly comes from the climate of the economy and from how regulators act in the space.
- Louise explains that before the advent of P2P lenders, the lending industry was dominated by the oligopoly of banks that controlled more than 80% of lending to SMEs. Unlocking finance was possible with neutral platforms with no interest of any sort.
- All panellists agreed upon the fact that awareness of the sector is still fairly low and one of the best ways to boost it is increasing the consumer literacy.
Alternative Finance Revolution and Counter Revolution
- Rhydian Lewis (CEO and Co-Founder, Ratesetter) explains the history of the alternative finance space in four different stages, making comparisons with the French Revolution. The four stages are: the monarchy, the revolution, the restoration and the republic.
- The era of monarchy is equivalent to the period dominated by banks with the banks disregarding the interests of their clients – “let them eat biscuits!”
- After the Global Financial Crisis, the crowd took matters into its own hands and revolutionized the entire system that was too complex and expensive. The world entered a new period of enlightenment and new clarity, characterized by fairer exchanges and closer relationships with customers.
- After every revolution, the established institutions, such as banks and regulators seek o restore the ancient regime. The industry might be at this stage. However, Rhydian thinks that a restoration of the old establishment is not possible: rules of the games are changed and a new set of principles has taken root.
- The republic is the last step and it is where the industry is heading to, namely a fair and stable environment in which prices are decided by supply and demand dynamics and not by superior entities. The world is evolving towards a new and more efficient financial system.
The US Experience – Building a Sustainable Equity Crowdfunding Sector in the US
- John Berlau (Senior Fellow, Competitive Enterprise Institute), DJ Paul (Board Adviser, SIFRA), Sara Hanks (CEO/Founder CrowdCheck), Richard Swart (Director of Research, University of California, Berkeley), Christine Kymm (Chief Economist and Director, Office of Economic Research), Anya Coverman (Deputy Director of Policy, NASAA) and Chance Barnett (CEO, CrowdFunder) discuss the challenges inherent in building a sustainable equity crowdfunding sector in the US.
- In the US, crowdfunding is seen as an American tradition. The US crowdfunding market is highly segmented and in order to regulate the sector, regulators have to be cognisant of the role of crowdfunding for small businesses.
- The US crowdfunding market reports a lack of sensible data that are critical to the process of regularization of the space. In the UK, the situation is different. Indeed, the UK market seems to be more transparent, as Ruper Taylor from AltFi Data reported.
Formative Framework Focus: The Future of Emerging Markets.
- Kristine Pontoppidan explains some trends in the EU alternative finance market: many companies set up in UK since it is really easy to set a business there; Denmark is behind with equity crowdfunding, but it will catch up soon; talking about Trustbuddy, she argued that it was reputed illegal in Denmark since they were operating like a bank, but in reality it was a P2P platform.
- Which countries are taking regulation seriously? Jason Wiens says that it depends. However, the European regulation is highly fragmented and each European country seems to apply its own law. UK and Germany are example of good regulation in Europe.
- All the panellists agree that the regulatory framework in EU must converge to a unique model like in US. However, in US the task is easier since they are a single country (even if formed by 52 states), with only one culture and one language, whereas in EU there are many different countries and therefore many languages.
Real Estate Crowdfunding in Colombia
- Rodrigo Nino (CEO/Founder, Prodigy Network) explains how Prodigy Network works and which the social impact of crowdfunding is.
- Crowdfunding is the evidence that the crowd has power to make a change in the established world of banks. Moreover, it gathers people together and permits to finance things useful to the whole community, and not only to few people.
- Rodrigo reports some example of buildings in Bogota (Colombia), financed by equity crowdfunding. Also new projects in New York were discussed, with a total transaction volume of over $1 billion
Cross-Border Data Transfer Issues
- Stefanie Schmidt (VP of Legal Compliance, Demyst Data) explains why access to data is so important in the alternative finance industry.
- She reports the lack of global data protection laws and in some part of the world people do not have access to data at all. For instance, 68% of Indonesian platform have no access to data due to low credit bureau coverage and poor data quality.
- She concluded claiming that the needs of 21st century require better system of data protection and better rules that govern data transfers. It has to be considered as a Government-to-Government issue and a Safe Harbor 2.0 would be just the beginning of a new era.
The Rise of Alternative Finance since the 2008 crisis
- Richard Nash (Global Head of Government Relations, Paypal) explains how the alternative finance space has evolved since the 2008 crisis. Before 2008, small businesses experienced a lot of difficulties in accessing credit solutions. After the crisis, the so-called global credit gap – credit solutions to SMEs not provided by traditional systems - amounted to $2 trillion. Nowadays, the fintech revolution is trying to fill that gap, leveraging the power of technology. The gap between missed lending from banks and current loan originations from platforms is still huge, so platforms have to understand what regulators want in order to keep operating.
- Paypal Working Capital is the new tool designed by Paypal that aims to fill the gap of lending to SMEs. Paypal’s goal is to solve the information asymmetry problem that characterized the industry at the moment. This product is based on flexibility: when businesses are doing well they repay higher chucks of debt, whereas when they are doing poorly they repay smaller amounts. The only cost of this service is an up front set up fee.
- Since inception, Paypal Working Capital has originated $1.2 billion of loans. Usman reports the successful example of Emily, single mother-of-two that used this service to hire a business consultant to build her new website.
Taking a concept to Innovation – Developing next generation Financing
- David Stevenson (Executive Director, AltFi), Richard Swart (Director of Research, University of California, Berkeley), Brian Knight (Associate Director, Financial Policy, Centre for Financial Markets) and Kyle Clark (Co-Founder, DesignBook) have a final discussion about how to develop the next generation of alternative finance actors.
- According to David, the world of extremely high returns from investing in housing, must finish. Fintech is leading the transformation to a fairer and more efficient financial system. However, investors need to understand that P2P loans are a risky asset class and if they want to have good returns they need to buy volatility. Free lunches in finance continue to be impossible, apart from the traditional diversification.
- All the panellists agree with David and Eddie adds that apart from regulation, technology represents the successful feature of the space.
- David argues that Regulation does not mean protection and investor protection is guaranteed not by rules, but mainly by transparency: people have the right to know in real-time everything about platforms.
- Rich explains that crowdfunding is a useful and an extremely powerful tool but people have to understand how it works, before investing in platforms, as it is not guaranteed that it works. Everybody should be really cognisant of all possible threats and opportunities when building the next generation financing.
What could go Wrong? How to Prevent Over/Under Regulation
- Chris Tyrell (Ex- Wall Street), Sebastian Gomez Abero (Chief of the Office of Small Business Policy), Judith Shaw (Securities Administrator for the State of Maine Office of Securities, NASAA) and Doug Ellenoff (Partner, Ellenoff Grossman & Schole LLP) discuss about what could go wrong in the regulatory process.
- Chiris states that on the regulatory side there is a lot to do and one of the main things that could go wrong is that people could break the laws. In this case, confidence of the general public in the industry and industry’s reputation itself could be ruined and seriously damaged. Bad actors should be detected and stopped.
- The other panellists agree with Chris and consider Title II and Title III a fast track towards a better regulated environment. Countries at the beginning of the regulatory process ought to focus on two particular factors: capital formation and investor protection.
- Regulation seems to be the solution to misconducts and frauds, but the right balance between a fully regulated and an unregulated space should be reached as soon as possible. Law should not be a blocker to the fast development of the industry and its success should be always taken in account. The policymakers’ goal is to build an healthy and well-functioning environment.