One of the most significant changes in the European finance market over the last year has been the advance of new market entrants in the form of direct lending and marketplace lending platforms. The size and sophistication of these marketplace platforms is now beginning to have a significant impact on the workings of the European financial markets.
What is marketplace lending?
It is hard to find a strict definition for marketplace, lending given the wide variety of entrants and financing techniques involved. The principal characteristics of new marketplace lenders, however, would include operating from a lending platform outside a traditional bank lender; applying technology to leverage and optimise the lending platform and user experience; and connecting borrowers and lenders through the platform rather than applying funding arising from a wider deposit based relationship.
A wide range of marketplace lending products
Marketplace lending is available to address most forms of traditional bank funding products. Over recent months products have included virtual credit cards, consumer loans, student lending products, SME lending, residential property and commercial property mortgage lending. It is likely that the volume of lending in these product sectors as well as further and additional product sectors will significantly increase over the coming months, as financing becomes more readily available to support the marketplace lending sector.
As discussed in the ‘Marketplace Lending’ panel at the 2016 Global ABS Conference, it is likely that these products will further be supplemented with secondary market trading platforms capable of trading individual or pools of marketplace lending credit product, generating further liquidity and reducing individual platform risk.
How are marketplace lending platforms funding themselves?
Whilst marketplace lending often includes peer-to-peer type structures, the increase in demand for credit through these marketplace platforms requires larger pools of available capital. Funding will now often be in the form of institutional finance rather than individual investors on a traditional peer-to-peer basis.
Following the initial incorporation and start-up funding for a new marketplace lending business, there will be a need to establish funding lines which can accommodate growth of the ongoing lending activities of the platform. Because the start-up lender will not have an established track record, deposit base or asset pools, we are typically seeing funding of the structure follow the format of a warehouse securitisation structure. Origination of new assets will be funded through drawings on a note issuance facility backed by security over the new assets. Each of the new assets will be subject to eligibility criteria determined by reference to the nature of the underlying asset. In order to provide an efficient financing structure the assets will typically be held through an SPV with origination and servicing provided by the marketplace lender. In order to cover expected losses on the asset pool, the senior facility will be subject to the lending platform maintaining sufficient subordinated capital in the form of equity, or a combination of equity and subordinated debt.
Whilst the funding may be structured through a revolving loan or note programme, the tranching of the debt will typically result in the platform satisfying the criteria of a securitisation for the purposes of the EU Capital Requirements Regulation, with the attendant requirements to hold risk retention and provide appropriate reporting and disclosures.
With online platforms often providing greater data transparency and analytical attributes relative to traditional credit providers, the reporting and disclosure requirements will generally be less of an issue, although unique proprietary characteristics of data analysis and credit scoring may be issues that the developers of the platform are less willing to provide.
Why are marketplace lenders achieving success in a difficult financial market?
Marketplace lenders provide a new and often fresh approach to customer service, meeting the needs of consumers for online access and rapid turnaround in the credit approval process. New online lenders are looking to deliver credit decisions in hours, rather than the days or weeks usually required by traditional lenders. The new platforms also take away the need for time-consuming physical meetings and travel, providing consumers with direct access and contact through their home computer or workplace.
Whilst concerns remain over the capitalision and resilience of online and marketplace lenders in a severe credit downturn, and traditional human risks such as fraud or bad behaviour will continue, the fresh approach provided by these online platforms is finding investment backing and customer appeal. With leaner business structures and no legacy of expensive historic liabilities for regulatory claims or expensive property or technology infrastructure, these new platform models are an exciting area in the development of the European finance sector. Whilst regulators remain cautious of the new business model, they do bring a new competition element to a staid market and subject to managing their risk profiles adequately appears to be the direction of future travel, either together with traditional finance providers or in direct competition with existing financial institutions.