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Jackson Mueller
Associate Director, Center for Financial Markets
Jackson Mueller is an associate director at the Milken Institute's Center for Financial Markets. He focuses on fintech, capital formation policy and financial markets education initiatives. Prior to joining the Institute, Mueller was an assistant vice president at the Securities Industry and Financial Markets Association (SIFMA), where he focused on...
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Peer-to-peer lending lands in Congress

By: Jackson Mueller
May 19, 2015
   
   

In the first event of its kind, the House Small Business Committee held a hearing in which lawmakers explored the potential for peer-to-peer lending and the industry’s importance in addressing small businesses’ and entrepreneurs' biggest concern: access to capital.

In opening remarks, Chairman Steve Chabot (R-OH) focused on a recent survey conducted by the Federal Reserve that found that in the first half of 2014, roughly 20 percent of entrepreneurs looked to peer-to-peer lenders for credit. He added that such lending, if it continues to expand, “could have a tremendously positive impact on small businesses and their growth and on the American economy overall.”

Ranking member Rep. Nydia Velázquez (D-NY) focused her remarks on the drawbacks of peer-to-peer lending and noted that the space is dominated by institutional lenders—“the same institutions [peer-to-peer lending] was meant to circumvent.” Focusing on the findings from the same Federal Reserve study, she noted that only 8 percent of small business loan applications were accepted by the largest peer-to-peer platform, Lending Club, between 2007 and 2012. The study also found that the average interest rate on a peer-to-peer loan was more than 13 percent—“double that of traditional sources.” Velázquez was additionally concerned about increased investor risks underscored by the higher default rates on peer-to-peer loans.

Among the themes that emerged during the hearing:

Regulation. Panelists agreed that the current regulatory structure around peer-to-peer platforms was working. Sam Hodges of Funding Circle, the only platform represented at the hearing, said his firm must abide by various federal regulations emanating from legislation that includes the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940. The platform also has to comply with myriad state regulations as well.

Peter Renton, the publisher of Lend Academy and the co-founder and CEO of the LendIt Conference, brought up a Securities and Exchange Commission ruling from 2008. The loans issued by Prosper and Lending Club were in fact securities, the SEC said, making the two platforms, which were among the few operating at the time, subject to a lengthy registration process with the SEC to allow them to remain open to nonaccredited investors. “To this day, these companies are the only peer-to-peer lending platforms to have undertaken this registration process,” Renton noted, with all other platforms open only to accredited or institutional investors.

Retail Investor Fairness. On top of Velázquez’s concern, a few other lawmakers pondered whether the influx of institutional investors into peer-to-peer lending could sideline retail investors, or at least create an unfair advantage.

While there is “no doubt” that institutional investors are devoting large sums of capital to the space, Renton dismissed the idea that retail investors are at a disadvantage. He remarked that “the playing field is level” and retail investors can continue to get good deals on their investment.

Marketplace Abuse. Renton also stated that there have been no marketplace abuses by investors or the platforms themselves. While the fear persists that some borrowers may be seeking to commit fraud, he noted that the platforms have done a good job isolating and rejecting such activity.

Throughout the hearing, Hodges underscored the importance of transparency and disclosure in the peer-to-peer lending space and said that platforms provide a wide range of detailed information to investors, much of it SEC-mandated. Given the growing institutional interest and platforms’ partnerships with banks, Hodges spoke of the need to conduct spot checks “to make sure every part of the business is clean.”

Self-Regulation. The Funding Circle executive also discussed how the industry is policing itself, reporting that his firm and other peer-to-peer lenders are working together to develop responsible standards around disclosure, effective rates, and collections and servicing practices. Funding Circle “is committed to working with small business lenders, other responsible credit providers, and small business advocates to promulgate effective self-regulatory standards for non-bank small business financing,” Hodges said.

While many platforms are focused on self-regulation and developing standards, “to the extent that disclosure particularly came up as something that folks could take a closer look at, I do think that disclosure around rate and effective financing charges might be a good place to start,” he said.

Hodges was also critical of the overlapping rules at the federal and state levels pertaining to the borrowing, lending, and securities portions of the business, noting that Funding Circle has invested upward of $1 million to figure out how to operate under “archaic” lending and securities rules. Simplification would be beneficial, he remarked.

Current state blue-sky laws and federal rules also make it difficult to build a liquid secondary market for peer-to-peer offerings, according to Hodges, which locks investors into illiquid positions. In the UK, by contrast, a “meaningful share” of Funding Circle’s fractional notes is traded on a secondary basis.

Indeed, Hodges and Renton highlighted the UK’s support of its peer-to-peer lending industry. Key points in that effort: a simplified regulatory framework for peer-to-peer lenders; investment in certain loans by the state-owned British Business Bank, strengthening confidence and credibility in the sector; and the requirement that banks must refer rejected small businesses to alternative lending platforms.

Additional information, including the archived webcast of the hearing and witness testimony, is available here.


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