A proposed solution to the challenges of retail disclosure

By Rupert Taylor on Tuesday 31 July 2018

Editor's PickOpinionAlternative Lending

More disclosure does not always equate to better disclosure, argues AltFi Data founder Rupert Taylor.

Friday’s proposed changes to the regulatory framework for loan based crowdfunding (p2p lending) have exactly the right aims. As the report explains, the FCA intends to create an outcome where investors a) have the ‘necessary information’ to help them make ‘informed decisions’ b) have ‘clear and accurate information’ about investment risks and c) ’are appropriately rewarded for the risks they are taking’. However, the details of the proposals risk undermining these aims with unnecessary complexity. With a collaborative approach the industry can ensure that the regulator’s aims are satisfied without creating an additional burden. Indeed, the information required has direct synergies with what is already being requested by the burgeoning institutional market for loans. 

I write this as a respectful service provider - the FCA subscribes to AltFi Data’s standardised analysis of loan based crowdfunding. I hope that my client will take our observations in the spirit in which they are meant - constructive feedback aimed at establishing an effective regulatory framework that is realistic and proportionate. To date the FCA has been a world leader amongst global regulators for this space and there are some excellent initiatives in this report that suggest that will continue. However, at AltFi Data we are particularly attuned to the complexity of ‘disclosure’ and we have a firmly held belief that sometimes providing more data can obscure the picture. What matters is to provide the right data in a useful format. 

With that in mind Friday’s FCA review includes some concerning elements. To my eyes it is in danger of adding significant complexity to little effect. Furthermore, it does not seem to encourage the effective framework of self-regulation that is already being developed by originators, in both the UK, and elsewhere. 

Preparedness to be held to account

Before getting into the details of the proposals for loan based crowdfunding, it is worth addressing one of the most striking aspects of the report. These proposals seem to equate equity crowdfunding (investment crowdfunding, to use FCA parlance) with p2p lending (loan based crowdfunding), at least with regard to rules relating to promotion and disclosure. There is no such equivalence. There are fundamental differences in the underlying products, and this can be demonstrated in the shape of gains and losses to date. Equity offers capital appreciation for the simple reason that this is the compensation required for the heightened risk that the investor loses their entire stake. Loans offer no capital appreciation, merely an interest payment, exactly because the lower risk profile requires less compensation. The riskiness of the two asset classes is not comparable. The differences in risk profile can be demonstrated by numerous equity crowdfunding failures to date that have resulted in a total loss of principal for investors. Meanwhile, in loan based crowdfunding, losses occur with proportionately far less frequency, and when they do occur the write-offs tend to be smaller. It is notable that many loan based crowdfunders have willingly embraced attempts to quantitatively demonstrate their track record. Close to 75% of the UK p2p market allow third party performance verification to a consistent standard. As a result, an index exists showing the return that has been achieved from a diversified portfolio representing 4 of the biggest UK lenders. This index shows that the sector has consistently delivered annualized net returns between 4 and 7% over the past 10 years.

There is no such index in the equity crowdfunding sector. At AltFi Data we worked hard to help the equity crowdfunding platforms to create one. However ultimately our attempts were thwarted by a lack of interest from the originators in creating any kind of standardised track record (with a small number of notable exceptions). Indeed equity crowdfunding platforms have not yet even agreed a common standard for reporting volumes. For this latest FCA report to suggest that loan based crowdfunding needs to have its promotions more aggressively policed, and its disclosure improved, whilst providing less onerous suggestions for equity crowdfunding originators, seems completely back to front. The loan based crowdfunding industry should be praised for the extensive disclosure that is already being provided. In addition, the large parts of the market that have volunteered to provide the scrutiny delivered by third party verification to a common standard should be given additional credit. Meanwhile equity crowdfunding, which involves the issuance of a product that is significantly riskier, has failed to make any progress in this regard, and is seemingly not being encouraged to do so. In simple terms, a majority of p2p lenders are volunteering to be held to account to a common standard. Meanwhile, in equity crowdfunding, accountability for performance is being avoided.

More disclosure does not always equate to better disclosure

In this context the proposed disclosure requirements for loan based crowdfunding appear to be adding a significant new burden without providing commensurate enlightenment to the investor. When it comes to data, more disclosure does not always equate to better disclosure. The industry, on both sides of the Atlantic, has already acknowledged this lesson with a gradual reduction in the relevance of static loan book disclosure to be replaced with an increase in the uptake of standardised analytics. The problem with the former is that vast tracts of data that is un-standardised and difficult to consume appears reassuring, but is of little practical use in terms of holding originators to account for the quality of their lending. The key is to ensure the disclosed data is meaningful. For this to be the case, disclosure needs to be both easy to consume, and like for like comparable between originators, risk bands, geographies etc.

Comparability is the key

The FCA has long emphasised the importance of direct comparison, and continues to do so, explaining that its new ‘more granular disclosure requirements…should be easy to understand and make comparing the investment opportunities across platforms as easy as possible’. Indeed they should be. But the proposed framework may not encourage this.

Quantitative always trumps qualitative

The new proposals would require originators to answer a long list of additional questions including a description of how ‘loan risk is assessed’ and indeed how loans are priced. This may provide some useful background for a conscientious retail investor but reassuring words about a rigorous process will deliver no actual accountability. Furthermore qualitative descriptions never deliver meaningful comparability.

Ultimately the most important numbers an investor needs to understand are:

  • what is the underlying rate that the borrower pays
  • what is the historically achieved, and projected, net return after fees

The actual rate that a borrower is paying, in particular when compared to the return achieved, is the best approximation for risk, and is a quantitative data point that can be readily compared. The net return, calculated on a comparable basis, measures rewards, whether historically achieved or projected. These are the numbers that an investor needs to understand, and, to be able to compare like for like. Encouraging the uptake of standardised metrics that provide quantitative comparisons, is the best way to inform the investor and create accountability to a track record on the part of the originator. It is by facilitating this kind of comparison, rather than by introducing a series of subjective new data points, that investors will be best protected. 

The proposed disclosure requirements for ‘discretionary platforms’, which would seem to include the bulk of origination by volume, runs to 16 new data points. None of these data points will be meaningful in isolation, even assuming that the retail investor is inclined to review them for ‘each p2p agreement they have entered into’. Nor are these new requirements in any way comparable. Furthermore, disclosing some of these data points may force the originator to give away commercially sensitive insights into how they price risk. This amounts to an unreasonable request and may result in either over-simplification or non-compliance. We must remember that the p2p lending market is increasingly funded by institutional capital. Originators could decide that servicing retail investors is not worth the additional complexity thereby killing off an attractive new asset class for the retail investor. Worst of all this information is not needed to hold lenders to account for the quality of the loans they originate, or to provide investors with insight into the risks and rewards of the loans that they are buying. What is required is a distillation of all of the various factors that contribute to loan performance, in terms of risk and return, to provide performance metrics that are comparable and accessible.

Metrics to serve both retail and institutional

At AltFi Data we have always believed that our aims are well-aligned with those of the regulator. Just as in any capital market, the existence of high quality data upon which to base analysis is to the benefit of all market participants. We do also acknowledge that we have initially focused on building tools for an institutional audience. But the solution that we deliver to institutions - standardised and verified performance analytics - should also satisfy the FCA’s stated intention that the risks and returns of platform lending can be more easily compared by the retail investor. To ensure that originators can efficiently satisfy the regulatory requirement to provide the retail investor with meaningful metrics, we would be happy to work towards developing a solution appropriate for a retail audience. 

Ultimately the institutional investor is trying to understand exactly the same things as the retail investor. As a result, at AltFi Data, we have spent close to 5 years figuring out how to best distil all of the factors that contribute to the risk and return of a diverse set of lenders, into a small number of metrics that are comparable across platforms. Our framework, conceived in the UK, is now being adopted in the USA and in Europe. We provide not only a comparable measure of net return, but also a consistent standard to allow comparison of the riskiness of that return. (Did you achieve a net return of 5% after losses of 2% or after losses of 10%?). To date, this analysis has been historic. We can show the net return achieved, at what rate of loss, in a like for like comparable format across platforms, geographies, and risk bands for all participating platforms. These metrics are intuitive and can be presented in a format that can be understood by the retail investor.

Most recently we have also created a product that models projected returns. Assuming the existence of sufficient track record, we can provide a projection for an individual loan, or for a cohort of loans, to a standardised methodology, but based off actual historically achieved rates of loss, recovery, pre-payment etc. Both of these tasks require the cleansing and analysis of huge amounts of raw data, and represents work that would be impossible for even the most sophisticated retail investor to replicate. By asking originators to disclose this information themselves, in formats that are not standardised, the regulator is proposing to impose a huge additional burden on originators without no assurance of providing any useful comparison to investors.

Cooperation offers a solution

We applaud the intention of these proposals, particularly the emphasis on the provision of like for like comparison. We will continue to develop standardised analytics for originators who want to offer both insight and accountability to institutional investors. These metrics also answer the fundamental concern of the FCA – namely, they illustrate the return being offered in the context of the risk being taken in a comparable format. We therefore believe that, at this point in the evolution of the asset class, rather than encouraging a proliferation of qualitative, un-standardised metrics, the industry, regulators and industry bodies should work together to encourage the adoption of a standard which distills risks and rewards into metrics that can also be provided to the retail investor. This can be done in a manner that is efficient for originators. The alternative could be that, as proposed, the new framework would end up discouraging originators from seeking retail capital by creating an unnecessary administrative burden that may only obscure what really matters.

With cooperation, meaningful statistics that provide the insight and accountability required can be efficiently delivered to the retail investor, without adding an unnecessary burden to the originator. 


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