Investor Guide To Alternative Lending Regulations. Part 2

This article the following topics, and aims to provide some clarity to potential investors into the alternative lending market.

• Alternative lending defined
• The state of regulation for alternative lending:

1. China
2. USA
3. UK
4. Asian markets

• The risk of over-regulation in Asian markets
• Blockchain as an alternative to regulation
• Conclusion — what to look if you are investor

SO, WHAT IS THE STATE OF REGULATION FOR ALTERNATIVE LENDING?

According to a World Economic Forum white paper, some of the major concerns for regulators include:

• Investor protection and securities laws
• Handling of client money
• Risk retention and capital requirements
• Secondary servicer agreements
• Credit analysis and underwriting
• Data protection
• Debt collection
• Interest rates

There is general agreement that regulatory certainty will help to stabilize what has been a “wild west” approach to online lending. This comes with the proviso that such regulation should not shut down the market or stifle innovation.

It might be useful to look at trends in regulation in the three major markets for alternative lending — China, the US and the UK — and then to consider what is happening in some emerging Asian markets.

China

The Chinese market has become the biggest online market in the world, with outstanding loans growing from $4 billion in 2013 to $112 billion in 2016. However, this growth included the collapse of several platforms and massive fraud, including ponzi schemes. The Chinese regulators have stepped in.

Stringent regulations have been issued by the Chinese Banking Regulatory Commission. They include limits for individual investment and borrowing, the requirement for lenders to be linked to custodial banks (to separate their own funds from client funds), disclosure on the use of deposits, risk management and shareholder credibility. An estimate from the Beijing-based Nanhu Internet Finance Institute is that 90% of all current lending platforms will not meet the requirements and will be forced into liquidation. Even a giant platform such as Hongling Capital has failed, primarily because its business model fell foul of the new regulations.

Ning Tang is founder and CEO of CreditEase, one of China’s largest fintech companies. He sees the actions of the regulators as necessary and positive. In a recent conversation with representatives of the Federal Reserve Bank of San Francisco, he noted that regulators have cooperated with FinTech companies to establish best market practices, while also preventing fraud and business failure.

individual retail investors dominate the funding segment in China. However, there is a growing trend towards institutional ownership of lending platforms. This may make it more difficult for smaller players to participate.

United States

In the United States, there is good protection for “consumers”, and therefore for P2P transactions. But it seems that P2B transactions may not be covered. For example, the Truth in Lending Act may not apply, so there may not be transparency over interest rates. There is no single regulatory body to cover alternative lending to business. Instead there are multiple federal bodies, many with overlapping authority, and differing regulations from state to state.

The proposed Financial Services Innovation Act may give more certainty as it is focused at a federal level. However, this might be in jeopardy with the recent introduction of the Financial Choice Bill, and the intention of the Trump administration to roll back many of the regulations put in place after the 2008 crash.

On the positive side, various federal bodies including the US Treasury, the Federal Reserve, the SEC and the OCC, have acknowledged the importance of marketplace lending. There are moves to support innovation and to reduce paperwork requirements for borrowers.

It is noteworthy that many traditional players, such as banks and hedge funds, are starting to partner with online innovators.

The United Kingdom (UK)

In the UK, there has been deliberate attention to supporting small business lending. This has included the development of new institutions (the British Business Bank or BBB), a dedicated regulator (the Financial Conduct Authority or FCA) and new regulations (such as submission of quarterly data on origination, loan stocks, costs and defaults).

Also, there is deliberate support for innovation:

• The BBB has invested capital into P2P lenders such as Funding Circle
• The FCA allows new entrants time to prove concepts through a “regulatory sandbox” scheme

The total size of the market is relatively small at about $4.5billion and individual investors are more prevalent than institutional investors. Loans to small businesses have overtaken loans to consumers.

The Asian markets

A major difference between the West (USA, UK and EU) and the East is that the countries in the East have been predominantly cash-based. With the advent of mobile technology, many people skipped fixed line phones, PCs and the internet and moved straight to mobile. They also skipped credit cards and other financial products and moved straight to mobile payments. This has resulted in a population that is smartphone-savvy but mostly unbanked and without formal credit histories.

Add to this that Asia has a massive number of unserved or underserved SMEs. For example, in Singapore, SMEs contribute 47% to the GDP, yet 40% have no access to finance. Even those with healthy financial records must be in business for at least three years before they can be considered for bank loans.

So, this is the perfect market for alternative lenders and for investors.

Some trends and indicators in the Asian markets support this statement:

#1. There is significant growth in the alternative finance market

• According to a KPMG sponsored report, the Chinese market grew from $5.56 billion in 2013 to $101.7 billion in 2015 — a growth of 328%.
• In the rest of the Asia-Pacific region, there was a growth of 313% between 2014 and 2015, reaching an amount of $1.12 billion in 2015.
• P2P forms the largest part of the market in China, followed by P2B. This is reversed in other Asian markets, with P2B being the largest segment, followed by P2P and balance-sheet lending.

#2. Asian regulators have been supportive of alternative finance.

Countries are indicating that they are open for business, and that they will welcome FinTechs.

Singapore:

• $225 has been set aside to develop and support local FinTechs
• Rules have been eased to allow for larger numbers of unsecured loans
• The Monetary Authority has an innovation lab (“Looking Glass”) in its building

Hong Kong:

• Hong Kong Monetary Authority brings together banks, FinTechs and the regulator to work together on developing innovative solutions

Japan:

• Japan has partnered with the Financial Conduct Authority in the UK to enable lending platforms to operate in both countries

Malaysia:

• Malaysia’s Securities Commission issued guidelines for P2P lending in May 2016. Their stated goal is to “enhance access to financing, increase investor participation, augment the institutional market and develop a synergistic ecosystem”.

Thailand:

• Initially, Thailand authorities tried to tweak their Financial Institution Business Act to accommodate online lending, but have now instituted consultations and are proposing regulations specific to FinTech.

#2. Banks have tended to cooperate rather than compete.

• Banks partner, invest and even acquire lending platforms. (eg, Singapore’s United Overseas Bank invested into the crowdfunding platform, OurCrowd)
• Some refer their own customers to lending platforms (eg, Singapore’s DBS has cross-referral agreements with Funding Societies and MoolahSense)

#3. FinTechs are cooperating with each other, locally and internationally:

• Alibaba from China has partnered with Lending Club in the USA to finance manufacturers in the US to buy products and supplies from China
• FinTechs have started to pool their data. According to Ning Tang, many Chinese fintech firms were initially reluctant to share information, but data sharing has turned out to be a benefit for the entire industry. It is particularly relevant because of the lack of credit ratings for potential borrowers

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