Lenders Provide Clarity Around Institutional “Cherry Picking” Ban

By Ryan Weeks on 26th May 2015

P2P/Marketplace Lending

A reported P2PFA ban on institutional "cherry picking" has sparked a response from the industry's biggest players. 

Lenders Provide Clarity Around Institutional “Cherry Picking” Ban

The FT reported over the bank holiday weekend that the P2PFA had taken steps to ensure that peer-to-peer lending in the UK remains a retail-oriented industry, by banning the practice of institutional cherry picking. "Cherry picking" refers to a process in which sophisticated institutional investment vehicles use algorithms to rapidly scan loan portfolios for the optimal blend of risk and yield, scooping up the loans that match their criteria within minutes. This practice leaves the often time-strapped, resource-poor retail lender at a marked disadvantage, and is prevalent in the US market. 

But the notion of a so-called "ban" on institutional cherry picking among UK P2P platforms has been contested by representatives of both Funding Circle and Zopa. The reason for their challenge is that neither believe that "cherry picking", as it is defined above, currently exists within the UK market – certainly not amongst members of the P2PFA. Both Zopa and Funding Circle play host to institutional funds, but both assert that no cherry picking currently takes place upon their platforms. 

These industry representatives have suggested that the FT story has been drawn from a recent P2PFA meeting, at which the continued inflows of institutional capital was in reality but a small aspect of a far broader discussion around refreshing the principles of the organisation. The group reaffirmed that all platforms must remain fair in their treatment of private investors, and that the acceptance of institutional money must not come at the detriment of the retail lender. A "ban" on the cherry picking of P2P loans may well work its way into the P2PFA rulebook, but we will await a formal announcement on that front. Having listened to the platforms themselves, such a development ought not to be newsworthy – given the general absence of cherry picking in the UK market to date. 

P2P lenders from all over the world have been courting, and have been courted by, a large variety of yield-hungry institutional investors. The most prominent examples of these entities are the dedicated alternative lending funds – P2PGI and Victory Park Capital. Such has been the interest in this sector that the largest US platforms are now typically 80% funded by institutional capital.

Up to now, however, the UK market has remained largely true to its “peer-to-peer” roots, and the P2PFA would like to keep it that way. 

Whole loan purchasing is the standard method of access to P2P for institutional vehicles. AltFi Data has long been tracking institutional lending volumes on the Funding Circle platform by analysing whole loan sale volumes.

When the Liberum AltFi Returns Index launched, Zopa and RateSetter joined Funding Circle in publishing their full loan books for the world to see. AltFi Data has since conducted an analysis of institutional lending volumes for both consumer lenders, by scrutinising provision fund coverage levels. Institutional investment vehicles are the only parties capable of forgoing the coverage of the provision fund on Zopa and RateSetter. AltFi Data has therefore been able to ascertain minimum institutional lending volumes for each platform. This analysis was referenced in the FT’s coverage of the P2PFA's cherry picking ban.

The results suggested that institutional loan purchasing is becoming increasingly important for Zopa. The same can be said for Funding Circle. RateSetter appears to be sourcing ~95% of its capital from retail investors, for the time being.

Zopa and Funding Circle use technology to randomly designate loans for institutional or retail investment. But the institutions may be selective within the pool of loans that has been assigned to them, and it’s fair to wonder what becomes of the loans that aren’t funded. Are they simply re-inserted into the retail pool?

Funding Circle has confirmed that such a process exists, but assured the FT that the quality of its credit assessments are such that none of the approved loans in circulation should be considered untouchable. Indeed, a Funding Circle representative told us that loans may also be passed in the opposite direction – from retail pool to institutional pool. 

Christine Farnish, the independent Chair of the P2PFA, explained the evolution of the trade body’s rules:

“Our members are very clear that they don’t want to discriminate between retail and institutional investors.”

“Institutions must be offered the same service as ordinary people.”

Any move to curtail cherry picking has likely been dreamt up as a pre-emptive response to a marked uptick in institutional funding commitments since the outset of 2015. P2PGI, which has been buying loans since 2014, raised a further £250m of firepower in January via a C Share issue. Victory Park Capital’s Specialty Lending Investments floated on the LSE in March, raising £200m. Landbay secured a £250m wholesale funding line in late April. Every one of these developments has channeled institutional money into various member platforms of the P2PFA.

The P2PFA has also indicated that its Directors are to be given greater powers to expel companies that do not comply with its “regulation plus” requirements. The organisation’s Directors are Ms. Farnish and Tony Boorman – who joined the P2PFA in November last year.

This is one part of a broad post-regulation revamp of the group’s operating principles. Renewed emphasis will be placed on transparency requirements, as well as on rules for handling credit risk. “Peer review” of fellow members will also be encouraged. Ms. Farnish warned:

“If there is a bad apple, they wouldn’t stay in the P2PFA.”

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Companies in this Article:

Funding Circle
Brismo
RateSetter
Landbay
Zopa
Victory Park Capital
Liberum
Circle

People in this Article: