The COVID-19 pandemic has sharply deepened the need of funding on the market. Filling in the gap where traditional lenders couldn’t or wouldn’t, the growing industry of alternative lending should be supported by legislators across the EU and worldwide. Some countries are well advanced in setting up the legal framework for alternative lenders while others are still cautiously testing the waters. Nonetheless, ignoring a market with a 52% increase year-on-year worldwide is not wise.
ALTERNATIVE LENDING FILLS GAP LEFT BY TRADITIONAL MARKETS
Alternative lending is any lending activity that occurs outside of a conventional financial institution framework or the raising of capital on the traditional capital markets (e.g. the NY Stock Exchange or the London Stock Exchange). Examples of alternative lending are crowdfunding platforms, marketplace lenders (i.e. peer-to-peer lenders either to businesses or to consumers) or investment funds acting as financier.
Historically, alternative lending gained ground a decade ago in the context of the 2008 financial crisis when banks were unwilling or unable to lend fresh money, leaving space for alternative lenders to fill the gap. This is especially true for businesses and sectors that credit institutions were unwilling to lend to, or when they did not offer tailored products to serve a specific need.
While the economic effects triggered by the pandemic do not have the same cause as the 2008 financial crisis, the situation is ripe again for a further scale up of the alternative lending sector and for governments and public institutions to take measures to support it.
BANKING IS MUCH MORE THAN LENDING
Banks are essential in financing both corporates and consumers in Europe, as they can build on their customer-oriented relationships and are able to offer a full range of financial services. However, following the 2008 financial crisis banks have become subject to stricter regulations in connection to their capital requirements, liquidity ratios but also credit policies and criteria on risk analysis.
In this context, alongside banks, alternative lenders have become a viable option by priding themselves on faster procedures, faster availability of funds and eligibility criteria that would allow them to grant financing to those who might have been rejected by banks before. The development of alternative lending increased market liquidity and improved risk allocation by diversifying the sources of financing available to customers, including during distressed times such as these.
As long as the source of the funding of alternative lenders is coming from investors rather than customer deposits, an argument could be made that lending should not be reserved to banks. This is the case in Europe where lending may be performed also by non-banking entities. However, significant legal challenges remain for alternative lenders due to the disparities among EU Member States. This is the case when it comes to crowdfunding for instance, or other alternative business models, which run into several legal barriers that ultimately prevent the free movement of capital between EU Member States.
The case for alternative lending is compelling and offers competitive advantages. However, all these lenders do rely in their business model, in one way or another, on the services of a bank. Therefore, any regulation applicable to alternative lenders must aim to achieve a level playing field also when it comes to compliance matters with which both banks and alternative lenders should comply. This levelling of the applicable regulatory regime would ensure a symbiosis between the various classes of financiers opening the door for new business models.
DO WE NEED (MORE) REGULATION?
Ensuring a level playing field is one of the core pillars when designing the capital markets union at the EU level. For alternative lenders, the picture at the EU level reflects great disparities in legal frameworks. In some EU Member States such as France, Germany and Poland, specific legislation regarding alternative lending is in place, offering alternative lenders a stable ground to grow. In others such as Romania, Bulgaria or Croatia, there is a lack of a legal framework, hampering growth of the market despite the demand.
In testimony to such disparities, the Global Alternative Finance Market Benchmarking Report, a study conducted at the global level by the Centre for Alternative Finance at Cambridge, shows that in France, Germany and Northern Europe, a significant number of platforms operating investment models reported struggling with the strictness of regulations. On the other hand, Ireland and the UK serve as examples of countries showcasing a very high level of adequacy of existing regulations as perceived by platform operating debt, equity and non-investment models.
THE EU HAS TAKEN (A FEW) STEPS TO CREATE A LEGAL FRAMEWORK
At the EU level, although work is still in progress and a lot must be done, a few steps have been taken to lift such hurdles and barriers.
First, in 2018 the European Commission published a proposal for a regulation on crowdfunding service providers with the aim of implementing a single set of rules and an EU passport, as is the case for other services providers (e.g. payment services providers) which may expand more easily throughout the EU.
Second, the Consumer Credit Directive (Directive 2008/48/EC) was amended last year to provide additional assumptions for the calculation of the annual percentage rate of charge, adding to an already robust legal framework regulating consumer protection.
Third, most non-bank lenders and the funds they manage are subject to the requirements of the Alternative Investment Fund Managers Directive (Directive 2011/61/EU), which sets out a uniform framework in relation to EU Alternative Investment Fund Managers (AIFMs) and Alternative Investment Funds (AIFs).
In relation to certain categories of alternative lenders such as AIFs, there may not be a further need for regulation considering that these entities are already regulated and that they have to maintain adequate investment policies, match the liquidity arrangements of their funds with the liquidity profile of their lending activity, implement risk management systems, including stress testing, to identify, monitor and manage risk arising from their lending activity. However, in relation to other categories of alternative lenders or business models, there is room for further regulation and alignment among EU countries with the aim of removing the current legal barriers and offering a legal framework for alternative lenders to establish their businesses both locally and on a cross-border basis. This could be partially achieved by aligning alternative lending requirements with those of banks.
LOOKING AHEAD WITH AN EYE FOR OPPORTUNITY
The Global Alternative Finance Market Benchmarking Report shows that in 2018 the European alternative finance market (including the UK) grew by 52% from $11.9 billion in 2017 to $18 billion in 2018. This is in line with the overall trend of the increase in 2018 when alternative finance platforms facilitated USD $304.5 billion.
The economic effects that the COVID-19 pandemic has caused have led to an increase of demand for alternative finance. However, this increased demand in finance comes as double-edged sword. On the one hand, it offers a growth opportunity for alternative lenders, and it is a good financing option for the companies in need, especially SMEs which are struggling to survive. On the other hand, it comes at a time when funding sources may dry up due to various moratorium laws imposed across a number of countries, which cut short the funding cycle without offering at the same time support to alternative lenders.
In this battle, alternative lenders that will be able to source funding, which have adequate credit risk assessment criteria to be able to satisfactorily identify the default risk of the borrower, stand the chance to exit the storm and grow bigger and stronger in a market of alternative lending, which is on the rise. For other players, the stormy economic (post) pandemic environment may entail a consolidation or a change in ownership.