Has Murray peered into the Future?

The Wallis Financial System Inquiry in 1997 famously devoted just a couple of pages to superannuation. The 2014 Murray version has super as a major focus.

Meanwhile the Murray FSI interim report has just four references to peer-to-peer lending, a technology enabled challenge to traditional financial services its proponents think will deliver massive change. Will P2P be Murray’s super? 

In February 2014 financial market authorities in New Zealand approved regulations for P2P lending as part of their governments financial market overhaul, prompting the observation the Kiwis lead Australia in this regard.

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The New Zealand Commerce Minister Craig Foss noted “with these new regulations coming into force on 1 April 2014, New Zealand will lead the Asia-Pacific region in the development of P2P lending and crowd-funding regulation”.

Financial regulators around the world have also been active in opening up these lending options. In the USA the Jumpstart Our Business Startups (JOBS) Act of 2012, dramatically changed the landscape for many small and medium-sized enterprises to raise capital. 

Within the JOBS Act is the CROWDFUNDING Act, which opens up the opportunity for underfunded entrepreneurs and small businesses, to use equity based crowdfunding. This allows the sale of limited amounts of equity to a large number of investors, via social networks and various internet platforms, which prior to the Act was illegal under the US securities laws. 

In the UK both crowdfunding sites and peer-to-peer lenders have come under new rules from the Financial Conduct Authority (FCA), also from 1 April 2014, which makes them subject to the FCA's oversight and consumer protection regime. 

P2P lending differs from equity based crowdfunding in that individual P2P lenders are supposed to receive their capital back, with interest, at the end of a specified term. Indeed, P2P lending can be defined as a loan between previously unrelated individuals', without the intermediation of a traditional financial institution, such as a bank. 

Crowdfunding on the other hand, puts the investor’s capital more at risk, as there is no guaranteed return on their investment, but they may receive other benefits, dependant on the project that they are helping to fund. Under the FCA's new regime, equity based crowdfunding (but not P2P lending) is subject to the '10 per cent ' rule, whereby investors must certify that they are not committing more than 10 per cent of their net investible assets, excluding their home, pensions and life insurance. 

Nevertheless P2P lending in the UK has grown rapidly, with now more than GBP 1 Billion of debt financing secured through online platforms in 2013, which makes it the third largest market for P2P lending, after China and the USA. 

Note that this is still only 1 per cent of the UK lending market, but the advent of P2P does threaten the traditional lenders dominance of the market, by disintermediating them, in much the same way as the betting exchange model as exemplified by Betfair, has disintermediated much of the traditional bookmaking industry. 

In a recent development (June 2014), Santander became the first major UK bank to refer some of its small business customers that are seeking finance to the P2P lender Funding Circle, through its website and in letters. 

In return, the Funding Circle will signpost its customers to Santander, for day-to-day banking support. P2P lending is thus increasingly offering an alternative to the major banks, as they have become more wary of lending to small and medium sized businesses. 

Australia has so far largely avoided the full impact of both crowdfunding and P2P lending but this is likely to change in the very near future. The Australian Government’s Corporation and Markets Advisory Committee, released a discussion paper in September 2013 on Crowd sourced equity funding, which concluded with a number of regulatory response options. 

Crowdfunding sites such as Pozible and Kickstarter already exist and new entrants, such as Our Crowd are arriving. P2P lenders are also entering the market here, one example being RateSetter which will launch in mid 2014,whilst existing Australian lenders, such as Westpac are covering their bets by investing in the so far only existing Australian P2P lender SocietyOne

The interim report of the Murray FSI noted “ASIC has recently been working with P2P lenders to develop appropriate regulation”. 

“Entrants in the nascent Australian P2P lending market submit that regulation is valuable in ensuring the industry begins with and maintains high standards. Existing regulation is not seen as an inappropriate barrier to entry, but rather as a mechanism for ensuring new entrants are competent. Regulation is perceived as lifting industry standards and enabling operators to compete based on providing better products and services to customers. 

“Submissions from P2P lenders voice support for the current regulatory regime, noting its importance for protecting customers and providing industry with guidance. In this way, regulation can help develop a well-managed, innovative industry.” 

It is claimed that the success of P2P lending has been built on the failure of the traditional banks to provide risk-adjusted pricing in personal loans - which means all customers pay roughly the same interest rate - and the 'good' customers have to effectively subsidise the 'bad' customers, who fail to repay. 

The Murray FSI interim report, in its Banking Sector section, requests further information on whether “there evidence that spreads in SME lending reflect reduced competition”. If that were true it would draw attention to P2P lending/ funding, for which one of the arguments of course that SME borrowers pay less for funding whilst lenders get a better return. 

In a submission to the Murray FSI, RateSetter outlined how its business model fits the objectives of the FSI, as regards efficiency and competition to the mainstream retail banks. Founded in 2009, RateSetter aims to match lenders with highly credit worthy borrowers, to then facilitate personal loans that are attractive to both lenders and borrowers. 

The firm claims their success has in part been delivered by their Provision Fund, which is a pool of money funded by borrowers, but which protects lenders in the event of a borrower's default. The practice of P2P lending takes place on online platforms and is facilitated by sophisticated borrower identification and credit checking. 

This will be enhanced in Australia by the introduction of the new privacy laws from March 2014 which allow the collection of a wider range of information that can then be shared with credit reporting bodies. 

RateSetter's recommendations to the FSI argue any new regulatory regime needs to ensure that high competence thresholds are maintained for operators, either already or wishing to provide P2P lending services. 

As the FSI terms of reference objectives are to examine how the financial system could be positioned to best meet Australia's evolving needs and support Australia’s economic growth and if this is to be achieved by supporting new entrepreneurs and existing SME's that want to grow, then the FSI may well decide to support the disruptive innovation that P2P and crowdfunding offers. 

Although on the basis of the interim report, it doesn’t look a priority.

Graphic: Trueffelpix

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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