6 Alternative finance
Crowdfunding/peer-to-peer finance
252. While much of this report has focused on competition
in SME banking, not all competition in SME finance comes from
the banking sector itself. SMEs are able to obtain funding from
a variety of alternative sources. This includes both equity and
debt funding. In this report, the Committee has focused on a relatively
new form of disintermediated SME financing—crowdfunding
and peer to peer finance.
253. Crowdfunding, a term sometimes used interchangeably
with peer-to-peer finance, is a relatively new type of business
funding that has attracted broader attention in recent years.[470]
With regard to SME finance, crowdfunding/peer-to-peer finance
encompasses a variety of models where small individual lenders
directly fund businesses. Unlike saving through bank deposits,
the risk is borne directly by the investor.[471]
Crowdfunding/peer-to-peer lending can come in several different
forms, including:
· Peer-to-business lending, or loan-based
crowdfunding, is a form of debt-based funding where businesses
borrow small amounts of money from many small investors.[472]
· Equity or "investment-based"
crowdfunding is a form of equity based funding where "people
invest directly or indirectly in new or established businesses
by buying shares" or other securities.[473]
· Peer-to-peer invoice financing, a form
of asset-based finance where investors directly fund businesses
through purchasing their invoices.[474]
254. As discussed previously in this report, there
are few sources of official statistics on crowdfunding/peer-to-peer
finance. Those that do exist suggest that, while alternative lenders
appear to be small in comparison to established banks, they do
exhibit a high growth rate. The think-tank Nesta, in a 2013 report,
estimated that total finance raised by the sector—including
lending to individuals, businesses and charities—"more
than tripled from £309 million in 2011 to £939 million
in 2013".[475]
They also said that the "peer-to-business lending sector
is more than doubling each year and the UK is the undisputable
world leader of this alternative financing model".[476]
In January 2015, the Liberium AltFi Index, an industry dataset
on peer-to-peer and crowdfunding platforms, estimated that the
total lent by alternative finance platforms had exceeded £2.7
billion. Of this, peer-to-business lending accounted for just
over £1 billion, with an annual growth rate of approximately
200 per cent.[477]
ADVANTAGES OF CROWDFUNDING/PEER-TO-PEER
LENDING
255. Evidence to the Committee attributes the sector's
growth to new technology and reduced confidence in traditional
lenders following the financial crisis. Samir Desai, CEO and co-founder
of the alternative lender Funding Circle, told the Committee that
the "loss of trust and satisfaction with banks" was
helping to drive growth in the industry. He added that "the
costs of technology and being able to use technology have come
down dramatically"[478]
and that technology was beginning to disrupt status quo in the
financial services industry:
What we think is happening now—in the case
of Funding Circle and the same with MarketInvoice—is that
technology or the internet is starting to disrupt financial services.
We have seen that disruption in the book industry and music, and
what is happening now is that you have the digital equivalent
of lending—digital loan and digital invoice finance—starting
to take off. I personally think that is an unstoppable force.[479]
Anil Stocker, founder and CEO of alternative lender
MarketInvoice, agreed, saying that new alternative providers could
build business models which were leaner than traditional lenders:
We have better data now than ever before. We
have a chance to redefine completely how we think about these
products. We can introduce new products. We are not saddled by
branches, big bloated infrastructure, cost bases and people.[480]
256. Mr Stocker emphasised the speed, flexibility
and simplicity of crowdfunding/peer-to-peer finance, saying that:
When I look at the products that the banks have,
there are so many negative features about them. There is so much
lock-in. There are so many opaque things around the fees. Businesses
do not understand what they are going to get charged, how they
can exit and what collateral they have to give. Banks are constantly
changing the goalposts. Right now I think there is a huge opportunity
in the alternative finance market to make everything more transparent,
faster and easier […].[481]
257. With regard to the speed of funding, MarketInvoice's
written evidence said that initially it took 21 days to fulfil
an approved application for funds, which it stated was similar
to the level that "banks have been stuck at for 30+ years".
The firm said it had improved this, so that it could provide funding
"in a few hours". This reduction was attributed by MarketInvoice
to its "need to innovate" as a result of the "competitive
marketplace" in which it operated.[482]
Funding Circle also claimed to be "faster and more efficient
than a bank loan". It wrote that "on average it takes
12 days for a business to gain finance through Funding Circle,
compared to ~15-20 weeks with a bank".[483]
258. The New Economics Foundation (NEF), a think
tank, believed that part of the usefulness of crowdfunded loans
was due to the unsecured nature of the loans, which it said was
"particularly suitable for the SME sector where borrowers
often lack suitable collateral". It said that, as a result,
"borrowers who struggle to access bank finance, may be able
to get credit and at lower rates than other sources of non-bank
finance".[484]
Mr Desai highlighted the similarity that crowdfunded lending has
with sources of finance open to larger firms:
[…] if you look at big businesses, they
do not have to borrow from banks. They can go to bond markets
or equivalent syndicated loan markets and borrow the money directly
from big investors. Platforms like Funding Circle allow
smaller businesses to borrow directly from investors as well.
If you look at bond markets or syndicated loan markets, they can
be anywhere between 20% and 40% of finance markets, or even higher
in the US. There is precedent for this in larger business
finance.[485]
CROWDFUNDING AND COMPETITION
259. In written evidence, the British Bankers' Association
said that UK businesses had a "traditional overreliance"
on bank-sourced credit "with banks providing nearly 80 per
cent of all credit".[486]
RBS and HSBC said that crowdfunding and peer-to-peer finance were
leading to greater competition. HSBC wrote:
There has been a range of new entrants to the
market over the last five years. These entrants include challenger
banks, such as Aldermore Bank and Metro Bank, and a number of
new innovative funding sources for SME customers such as Funding
Circle. These new entrants are helping to drive competition in
the SME banking market and have increased their lending volumes
at a time when overall net lending in the market has declined.[487]
RBS wrote that it was "seeing increasing competition
from alternative sources of finance" and "though still
small in absolute terms, [this] has been showing extremely rapid
growth rates". RBS said that alternative lenders were, "in
some circumstances, better suited to the customer's needs than
a traditional bank product or service".[488]
Other organisations offered a similar view. The CBI wrote that
"increased competition in the banking sector coupled with
the impact of alternative finance providers indicates a positive
trajectory for the market".[489]
The ACCA wrote that "it would only take the alternative lenders
four years to rival today's banks for lending volumes if their
current growth rates are maintained".[490]
260. Crowdfunded finance is, however, still regarded
as niche by many businesses. The Institute of Chartered Accountants
of Scotland (ICAS) believed that "innovations such as the
emergence of retail bonds and crowdfunding remain, as yet, of
only marginal significance".[491]
The British Chambers of Commerce (BCC) said that feedback from
their members revealed a high degree of reliance on "traditional
debt finance." In a poll of their members, 49 per cent used
banks or building societies, 10 per cent used equity and 8 per
cent used "grants, venture capital, private equity, peer-to-peer
lending and angel finance combined". The BCC said that there
"remains little understanding of alternative finance options."[492]
261. In March 2014, the Government consulted on whether
and how it could "legislate to create a mandatory process,
whereby Small and Medium Sized Enterprises (SMEs) that have been
rejected for finance are linked up with other lending opportunities
from challenger banks and alternative finance providers".[493]
Awareness of alternative lenders was a particular problem cited
by witnesses to the Committee.[494]
Discussing the Government's consultation on this issue, Mr Stocker
said to the Committee:
There needs to be some way that we can either
build awareness at the point of application, or build awareness
alongside the banks and banking infrastructure. I think some things
are already being debated and discussed around referrals and ways
of signposting, just to build awareness, because I think that
with awareness you are going to have a lot more businesses finding
out about us, using us, and creating jobs.[495]
The Peer-to-Peer Finance Association wrote:
The P2PFA considers that any mechanism which
required banks to provide information to SME customers about alternate
sources of finance a helpful step in the right direction.[496]
262. As a result of its consultation, the Government
has proposed draft legislation on a requirement for banks to refer
SMEs rejected for finance to alternative lenders in the Small
Business, Enterprise and Employment Bill.[497]
It has also published, in draft, a statutory instrument to illustrate
its current intention as to the exercise of powers under clause
5 of Bill.[498]
RISKS OF CROWDFUNDING
263. Crowdfunding is currently regulated by the FCA.[499]
A number of risks from crowdfunding have been identified by the
regulator, including:
· A lack of minimum standards of due diligence
or disclosure. In particular, the reporting requirements on borrowing
businesses may be lower than for listed companies;
· Investor over-optimism, particularly if
due diligence or disclosure has been poor;
· Problems with technology, IT security
or the internet; and
· A potential lack of regulatory experience
or, with regard to loan-based crowdfunding, lending experience
in crowdfunding firms.[500]
264. Crowdfunding/peer-to-peer finance is in principle
a welcome addition to the UK SME lending market. For some SME
borrowers, it can offer a credible alternative to bank lending.
It represents a step towards more effective competition in the
market.
265. Crowdfunding/peer-to-peer finance's market
share of SME lending remains relatively small. Borrower awareness
and understanding remain the most significant barriers to wider
adoption. The Government has set out plans to require banks to
refer those rejected for bank finance to alternative lenders.
These are welcome in principle.
266. Commercial risk should remain with the lender.
Crowdfunding and peer-to-peer lending platforms have a duty to
explain clearly and fully, to those who wish to lend or invest
through them, the risks that they are taking.
470 Financial Conduct Authority, Policy Statement 14/4,
March 2014 Back
471
Funding Circle, Understanding risk, 17 February 2015 Back
472
Financial Conduct Authority, Policy Statement 14/4, March 2014,
p 10 Back
473
Financial Conduct Authority, Policy Statement 14/4, March 2014,
p 11 Back
474
SME0154 Back
475
Nesta, The Rise of Future Finance: The UK Alternative Finance
Benchmarking Report, December 2013, p 7 Back
476
Nesta, The Rise of Future Finance: The UK Alternative Finance
Benchmarking Report, December 2013, p 10 Back
477
Liberum AltFi Volume Index AltFi, as at 19 January 2015 Back
478
Q 922 Back
479
Q 922 Back
480
Q 929 Back
481
Q 920 Back
482
SME0154 Back
483
SME0108 Back
484
SME0139 Back
485
Q 931 Back
486
SME0110 Back
487
SME0115 Back
488
SME0093 Back
489
SME0080 Back
490
SME0011 Back
491
SME0101 Back
492
SME0104 Back
493
HM Treasury and BIS consultation, Help to match SMEs rejected
for finance with alternative lenders: summary of responses, August
2014, p 3 Back
494
Q 968; SME0108 Back
495
Q 968 Back
496
SME0068 Back
497
Small Business, Enterprise and Employment Bill, HL Bill 57 2014-15,
20 November 2014 Back
498
HM Treasury, The Small and Medium Sized Business (Finance Platforms)
Regulations 2015 Regulations: draft regulations, 6 August 2014
Back
499
Financial Conduct Authority, The FCA's regulatory approach to
crowdfunding over the internet, and the promotion of non-readily
realisable securities by other media, March 2014 Back
500
Financial Conduct Authority, The FCA's regulatory approach to
crowdfunding over the internet, and the promotion of non-readily
realisable securities by other media, March 2014 Back
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