The squall before the storm

The TrustBuddy debacle has the makings of a cracking business scandal. Buccaneering Vikings, suggested operational fraud, suspensions, payday lending – it’s all there. And unfortunately the timing of this prominent alternative finance failure is unfortunate to say the least, coming just a few days after Trillion Fund’s pivot away from lending. Over in the rewards based crowdfunding space there’s also been some rumbles with some investors beginning to ask awkward questions about various start ups. Take SKARP Razor for example which has been suspended by Kickstarter after crowdfunding 4 million USD. Kickstarter said that not only was there no product (no surprise here) but they also doubted that a working prototype existed. You can see more at https://www.kickstarter.com/projects/skarp/the-skarp-laser-razor-21st-century-shaving. And how did SKARP respond to this put down? By moving the campaign over to Indiegogo. Not a great move! In a much more mundane way l

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But make no mistake about this confluence of unrelated events – they collectively represent a blank cheque for the alternative finance doom-mongers to hit back. We’ve already seen the beginnings of a media backlash with journos asking whether investors truly understand the risks – and whether too much money has perhaps been raised by funds active in this space. TrustBuddy is the icing on the cake and I’d expect an avalanche of negative press in the next few months.

The whole industry now needs to be on the front foot. The trade associations need to be out there earning their bacon day in, day out – arguing their corner. The major platforms need to be fighting back with really honest language about risks and rewards while the big funds need to be reassuring institutional investors that this is a space to take seriously. Now is not the time to stay low and not put your head above the parapet. And that’s doubly true for those platforms looking to raise money for funds on the stock market – the TrustBuddy debacle is terrible timing for the likes of Funding Circle and LendInvest, both apparently looking to raise a big chunk of change on the LSE.

What should their message be? I’d first start with the facts. TrustBuddy had a very different model and wasn’t British. It was effectively payday lending using tech to leverage a pan European business. That’s very different from the big mainstream UK platforms.

Next up the big platforms all seem to be in ruddy health – the day that the TrustBuddy story broke, LendInvest announced some cracking revenue and profits numbers underlining why so many investors want to put money to work in this sector.

Also the industry needs to constantly bang the drum that investing in alternative finance is not SAVING. It is risky and it is investing. It is not a home for widows’ and orphans’ money. That doesn’t mean that it’s only for spivs and speculators. Just that like anything alternative within investment this should be a home for only a small percentage of your total portfolio. And to help spread this message platforms and trade bodies should be on the phone to the likes of Hargreaves Lansdown, encouraging them to say why they think the sector is so interesting that they’re also planning their own offering. Get the message out.

But in dealing with the impending firestorm, the industry also needs to do a bit of soul searching – asking awkward questions. And I’d also put my hands up here and admit that I was personally surprised by the TrustBuddy story. In various financial organs I’d written that its model seemed interesting and the shares compelling. Luckily I sold out my shares in TrustBuddy way back at the end of last year – after a run in with the regulators in Denmark – but I’m still at a loss to explain what went wrong.

One question remains at the forefront of my own mind – how the hell did a platform involved in an incredibly high margin business (lend out for hundreds of per cent but give investors 12$) manage to lose money so spectacularly? Is the hard truth that lending to deeply subprime consumers is simply a mug’s game? Frankly, if neither Wonga in the UK nor TrustBuddy in Europe can make a brilliant robust business franchise out of lending to poorer customers, what hope has anyone else?

We also need to be having an open discussion within the European space about regulatory arbitrage i.e. choosing the most lenient regulator. With regard to TrustBuddy, it is interesting that the Danish FSA closed TrustBuddy down in the summer of 2014 because the Danish FSA said that their business model would require a bank license, and since they hadn’t applied for one they were closed down. However, in Sweden the local FSA didn’t actively regulate TrustBuddy, they were just registered with the FSA – like all other Swedish peer-2-peer platforms. Unlike Denmark, where the FSA actively regulates and oversees the local platforms. It’s interesting (and a bit surprising) that the Swedes have had a much more “laissez-faire” approach than the Danes to regulating the platforms.

Next up the alternative finance space needs to think long and hard about public markets and IPOs. Being brutally honest it now seems that TrustBuddy was too immature to list on the stockmarket, and corporate governance was seemingly very weak. If this is the case, how on earth can we expect many of the other European platforms to list? What rules and corporate governance needs to be in place first? Should businesses be at least three to five years old before listing?

But perhaps the biggest lesson of all is an old one – follow the money. If one reads local Nordic coverage of the TrustBuddy affair (you can see an excellent summary at this local website http://digital.di.se/artikel/miljonbedrageriet-i-trustbuddy-sa-har-gick-det-till) you’ll guess that we might be dealing with something approaching a Bernie Madoff-like pyramid investing scheme, with inflows shuffled around to satisfy liquidity concerns. I have no inside knowledge of what was going on but it all sounds depressingly familiar – who was keeping a watchful on customer client accounts and liquidity flows? It’s the question every financial journalist will now focus on as well as every institutional investor. The industry needs to be absolutely transparent and completely watertight on client money if we’re not to have any more future TrustBuddy-like affairs.

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