In an interesting and unusual development, the Treasury Department has issued a notice seeking public input on the online marketplace lending business for small businesses and consumers (“Notice”), setting forth 14 questions for comment. Treasury indicates that it is interested in the potential for marketplace lending to expand access to credit to historically underserved market segments. Of particular note, Treasury looks for input on how the financial regulatory framework should evolve to support the safe growth of the industry. Treasury also invites market participants to provide input that would help it to become better informed on the impact of online marketplace lending on the broader economy. The deadline for filing comments is September 30, 2015.
Structure of the Marketplace Lending Sector
The Notice describes the recent growth of the both the small business and consumer lending components of the marketplace lending sector. It notes that the sector began as peer-to-peer lending which allowed investors to provide financing to individual borrowers. It has now expanded as venture capital funds, hedge funds and banking entities have begun to participate in the sector.
The Notice explains that marketplace lenders provide loans through an online method rather than physical locations, generally using automated underwriting models. It describes three models used in the sector:
- Balance sheet lenders that retain credit risk in their own portfolios and are generally funded by private funds;
- Online platforms (formerly referred to as “peer-to-peer”) that, through the sale of securities such as member-dependent notes, obtain the financing to enable investors to fund borrowers and as a result of the contingent nature of the payment obligation on the securities do not retain credit risk on the loans; and
- Bank-affiliated online lenders that are funded by banks that originate loans and directly assume the credit risk.
The Notice indicates that many marketplace lenders have pursued a model in which they partner with banks. Under these arrangements, a bank acts as the lender to borrowers that apply through an online platform. The loans are then purchased by another party, which could be an investor in a transaction facilitated by a marketplace lender – or by the marketplace lender itself – which funds the loan purchase by note sales.
The legal implications of a bank origination model in the consumer sector are currently the focus of industry concern as a result of a ruling by the U.S. Court of Appeals for the Second Circuit which found that usury preemption available to a national bank did not transfer to a purchaser of a loan originated by the bank. For further information, please refer to DechertOnPoint, Second Circuit Denies Request for Rehearing in Madden v. Midland Funding Case.
Risk Retention Considerations
As discussed above, Treasury asks interested parties to respond to 14 separate questions. One question related to risk retention can be expected to receive particular attention and comment from market participants.
Just as other markets begin to grapple with the implications of the final risk retention rule adopted in October 2014, Treasury asks the extent to which marketplace lenders should be required to have “skin in the game” (i.e., whether marketplace lending should be subject to risk retention, perhaps even in the non-securitization context). Market participants are currently contemplating whether “skin in the game” requirements would have the effect of aligning investor interests with platform or lender interests – and, if so, whether any such alignment or realignment is necessary considering the business model. To date, one of the strengths of marketplace lending has been the ability of marketplace lenders to remain adaptive and provide access to capital for underserved markets. We believe the implications of applying risk retention to online marketplace lenders will be of significant concern to market participants and anticipate significant response to this particular question.
In entering into the marketplace lending area, Treasury does not suggest that the sector has any financial stability implications. Nor does it suggest that there are indications of problematic practices in the sector.
Treasury notes that, in some instances, marketplace lenders are subject to regulation by the Consumer Financial Protection Bureau, the Federal Trade Commission or other federal agencies. Such federal regulation would generally be focused on consumer rather than small business lending.
Questions in the Notice suggest that Treasury may follow-up on the Notice with recommendations for regulatory or legislative initiatives in regard to the marketplace lending area. Such initiatives could affect the interests of marketplace lenders, their investors, banks and borrowers.
Interested parties should consider providing Treasury with the benefit of their perspectives on marketplace lending practices and issues as it begins to evaluate what, if any, actions the Federal government should take in this area.