“Risk Debt” In P2P - Overview

By Mike Baliman on 5th May 2015

In my last article “Risk in Equity Crowdfunding – Oh Dear What Can The Matter Be?” I took time out from having to use the brain too much to shoot some fish in a barrel.  As Mythbusters proved if you don’t hit the fish it dies from the shockwave.

“Risk Debt” In P2P - Overview

Mind you as my Cassandra like warnings about investors being set up to be legged-over proved only too timely (inter alia “A Bitter Taste for Camden Town Brewery Crowdfunders?”) it was perhaps less like shooting fish in a barrel than seeing investors shot in a barrel.

The issues I highlighted in that article (principally “Second class equity”, Due-Diligence, Pricing) are good examples of Risk Debt in Equity Crowdfunding.

In this article we turn our attention back to Risk Debt in P2P (online, non-bank lending/borrowing).

Tech Debt

Wiki defines Tech Debt as:

“Technical debt is a recent metaphor referring to the eventual consequences of poor system design, software architecture or software development within a codebase.

 

The debt can be thought of as work that needs to be done before a particular job can be considered complete or proper. If the debt is not repaid, then it will keep on accumulating interest, making it hard to implement changes later on.

 

Unaddressed technical debt increases software entropy.”

 

This is of course a very common phenomenon in the startup world – you start with string and sellotape and gradually upgrade to more robust and solid.  Hopefully ahead of the whole thing collapsing around your ears.

P2P Is #NewFS

P2P has sprung from all sorts of interesting (and successful) heritages. It is this fresh and fascinating mix of consultants, marketing folks, customer insight folks, tech folks, that has spawned the creativity.  And has driven many from startup well into scaleup territory and IPOs looming just over the horizon for a few.  It’s great.

However P2P tends to be very light on folks with deep FS experience (outside the obvious “must have” departments of credit and compliance). 

As P2P grows it is becoming less “tech” and more “Fin”. But to date it has been light on “Fin” folks (probably usefully in terms of doing things completely differently).  However I feel at the stage it is at this is a major weakness.

P2P-FX-B2B is a very different animal (due to greater interaction with #oldFS in the execution of its business (it long ago gave up being “pure” P2P)).  In “LFP024 – Lessons from my 25yrs in Fintech, #oldFS, #newFS and VC with Nigel Verdon”, I discussed the issues of the need for deep “Fin” background with a man who was a star of #oldFS as it evolved into Fintech and who also founded and is chairman of Currency Cloud (which has now done over $10bn of business).  In discussing Fintech with Nigel it was very apparent that at the deepest level a long background gives you reflexes that you just wouldn’t have otherwise (audit, independent pricing, risk etc etc).  This needs to permeate the whole firm.

Geoff Miller CEO of GLI Finance is perhaps a man who sits on more P2P boards than perhaps anyone else in the western world. At the recent AltFi European Summit he said that one of the key needs for the industry he saw was for greater finance experience at an operating Board level.

He also gave a fascinating and realpolitik presentation (rare in a world of “hype it up”). Eg:

  • "untested in a downturn" [MB: Zopa apart]
  • “learning to underwrite as they go along”
  • “some shockingly naive CEOs out there”
  • “pricing at times remarkable, possibly incredible”
  • “investors right to be worried”

So plenty of engineering to be done still.

What Is “Risk Debt”?

There are two reasons “tech debt” often ends up working out ok in many cases. 

Firstly every firm knows they need a CTO.

Secondly VCs know of the phenomenon and are sure to address.

However as Fintech is so young next to no P2Ps have a CRO (yet).  As Fintech VC-ing is so young next to no VCs have the practical experience of seeing their investments sink below the waterline due to the lack of a CRO.

No CRO means no-one to pull all the risks into one place.  Means no-one to leap up and down and get the required budget to fix all the leaks, cracks, and ensure that the firm as a whole is tightening all the loose nuts and bolts.

Hence I feel there is a lot of Risk Debt in P2P right now.

After writing “Deja-Vu All Over Again” in which I wrote:

 

Major/serious AltFin players need a CRO who pulls together all of the sources of uncertainty into one locus on the organogram.

 

…the general reply to this was “we have a credit risk guy” or a “compliance” guy.  Well I hope you do dudes!

One or two wondered what “other risks” there are beyond credit and compliance.

Well all the other business risks - operational, reputational, performance, strategy, business model, audit, growth (too fast/too slow), disaster recovery, fraud, cyber-crime, etc etc etc and all those items that fall between these “square floor tiles on an uneven floor”. 

Rather that picking some chapter headings in the 21stC manual of risk management in the companion article “Risk Debt” In P2P – Examples” I pick a few examples of Risk Debt right now.

The aim in that article isn’t to write an encyclopaedia but to give a feel that, whilst the best firms are very good and have impressively come a long way baby, there is still work to be done. 

Especially as they have come a long way very fast without the deep FS background and reflexes that a CRO brings.

So for this big picture article I’ll keep my conclusion simple

Personally I think the fact that there isn’t one person whose dedicated job it is to cover the whole boundary of risk is the biggest risk in P2P by far.

As a result of this the industry has incurred a lot of Risk Debt.

Firms that aspire to be big solid, robust players in the new FS landscape need to “pay down” this Risk Debt as a (the?) major business priority.

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