One subject that seems to come up in almost every conversation I have about alternative finance at the moment is institutional money. The mention of it produces a fair range of reactions but there’s no doubt that, for one reason or another, it’s on most people’s minds – so much so that the P2P Finance Association says its leading members are to put in place rules to prevent large institutional lenders gaining privileged access to the best loans and leaving the weaker credits for the retail brigade.

 

Figures published last week by Altfi Data make clear why this subject is attracting attention. They suggested that the proportion of lending now funded by institutional investors on Zopa and Funding Circle is edging towards 50%. Ratesetter, meanwhile, says that just 10% of its loan book is funded from this source.  

 

Some worry about the growing role that asset managers are playing and suggest it signals the end of peer-to-peer lending in its pure form. Others, such as Kevin Caley at Thincats, see attracting more institutional funding to their platforms as a key priority. Reflecting on recent news and discussions prompted a series of thoughts on the subject, which follow in no particular order.

 

It depends on the asset class

Obvious, admittedly, but important. Operators that focus on big-ticket lending such as larger business loans and mortgages will scale much more readily with a good infusion of institutional money. Even with their level of access to retail liquidity, the team at Funding Circle was concerned in the early stages of its move into property lending that these larger loans would struggle to fill. They moved cautiously and gradually expanded their capacity. LendInvest built its P2P business by syndicating property loans to the crowd that had already been completed by its sister property fund, Montello. In the consumer market, Ratesetter’s rapid pace of origination, fuelled almost entirely by retail money, proves that you don’t necessarily need lots of institutional money to grow fast in smaller-ticket lending. So in some areas of the P2P market at least, it’s possible to build a significant loan book either with or without institutional funding.

 

It depends on why you’re in the game

Alternative finance attracts both purists and pragmatists. For some the priority is to democratise finance. For others it is to create a large-scale lending business that will one day command a major valuation. In practice, I suspect most of the leading players have a foot in both camps. They want to create something genuinely different for ideaslistic reasons, but they also want their business to reach a significant size and become sustainably profitable. In that case, having separate markets for retail and institutional lenders makes sense – as long as retail investors can remain convinced that deals are apportioned fairly and that they are not simply left with the scraps from the table. The P2PFA is wise to worry about this, particularly in view of the campaign that former New York attorney general Eliot Spitzer waged a decade ago against Wall St, during which he extracted vast damages from banks that let favoured clients into hot deals and kept others out, and those that knowingly marketed poor deals to clients. The longer-term question about running separate markets, however, is whether operating in this way will continue to look credible if one side were to grow to 20 or 50 times the size of the other.

 

It depends on how wedded you are to the idea of a dynamic market

This concept is fundamental to businesses such as Ratesetter (and to Funding Circle’s retail investor market for fractional loans). These were based on the principle of a market for money in which the rate at which an individual was prepared to lend could have a direct effect on overall pricing. If you want a market in which individuals’ decisions can have a meaningful impact, you cannot afford to let in a wall of institutional money that could swamp those decisions.

 

It depends on what you want out of the institution

Institutional money can provide liquidity that enables a platform to arrange more loans and increase its revenues. It can provide an implicit seal of approval of the platform’s operations and processes that will add credibility to its pitch to retail investors, for example. And it can provide advantageous brand positioning for one or both parties. The tie up between Zopa and Metro Bank, announced last week, is interesting from this perspective. The deal is important because it positions both participants as leaders in the process of mapping out how alternative and conventional finance will collaborate and combine in the years ahead. On a practical level, Zopa probably doesn’t need a lot of extra liquidity right now, given that sourcing enough borrowers of the right quality tends to be the main challenge for P2P lenders. Metro has far more cash on deposit than it is currently able to lend out via its own operations, and so the chance to access another source of borrowers via Zopa’s platform will be helpful, although it is unlikely to be big enough to make a serious dent in Metro’s stock of excess deposits.

 

It depends on how much you worry about leverage

Listed investment trusts are now entering the P2P lending market and are finding plenty of demand for their shares from both retail investors and fund managers. Investors like the instant diversification and lack of effort involved – buying shares in one fund can allow them to spread their money across a wide range of platforms in Europe and the US. They also like the returns: these listed trusts are typically offering yields in the high single digits. But if you look at where they have invested the money they’ve raised, it’s mainly in consumer loans that will be yielding lower single-digit returns. How do they bridge that gap? Leverage. By using cheap borrowed money alongside the funds they raise from investors these trusts can generate attractive yields for their shareholders (as well as paying their own fees) while putting a good proportion of their funds into much lower-yielding consumer loans – and in the process arguably changing people’s expectations of what return they should expect from P2P lending. The results will be welcomed by both professional and retail investors, but should the platforms be happy about this? I suspect that will depend on how many of these listed trusts emerge and how big they get.