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Friday, 17 October 2014

A Short History Of The P2P Marketplace Model in UK Finance

During a recent panel discussion at the annual conference of the Society for Computers and Law, I explained briefly how the online peer-to-peer marketplace, pioneered by eBay in the US, came to be applied in financial services in the UK. The slides are here, and below is a slightly longer written explanation. Note that the focus is on the history, rather than explaining the differences between various types of 'crowdfunding'.

eBay pioneered person-to-person sales of second-hand items in the US from 1995, proving the concept to be hugely attractive. The particular "'Aha!' moment" came when people actually paid for the item they'd agreed to buy, not to mention the delivery of the item.

In 1999, the team at X.com (later PayPal) expanded the eBay model into payments by enabling consumers to pay each other using a credit card. This was rapidly adopted by eBay users (to the point where eBay eventually had to buy PayPal as a defensive measure). Coincidentally, in the same year it became clear to the entrepreneurs who had created PlusLotto, an online lottery in aid of the Red Cross, that the payment part of their system, which enabled people to prepay funds in many different currencies to centralised bank accounts then log-in to their data accounts or 'wallets' to purchase lottery tickets with the balance, should be made available to other merchants. They started Earthport as a separate payments provider the same year, and I was among those asked to join the board of the new entity. The initial strategy was to roll-out the wallet offering directly to consumers and merchants. But in 2000 we raised £25m through a private placement - literally weeks before the DotCom bubble burst - to fund a switch in strategy. The plan was to leverage the marketing budgets of banks, telcos and major Internet portals to offer own-branded wallets to their customers. Of course, those plans ran into the headwind created by the tech slump. But I'm happy to report that Earthport remains alive and well.

Meanwhile, in 2003, a team at artistShare in the US adapted the P2P payments model to enable music fans to donate money to fund musicians and music projects. The reason for this donation-based model of 'crowdfunding' was the need to avoid US securities regulation, which is notoriously rigid and complex, and applies expensive registration requirements even to very simple loans. The battle to liberate that regime continues to this day (see below).

At any rate, late in 2003, a small group of executives left Egg, the internet bank (which also happened to be one of Earthport's early customers), to try to reinvent financial services. During their brainstorming process, Dave Nicholson, suggested 'eBay for money' and the idea took hold. Coincidentally, they approached me in the summer of 2004 to see if I could help avoid any US-style regulatory problems. By the time we launched Zopa, the P2P lending platform, in March 2005 we had moved away from the idea of eBay-style 'auctions' to a more automated marketplace for personal loans. Borrowers and lenders had told us they did not want to reveal too much about themselves to each other, but were happy to give Zopa enough information to guard against fraud, assess creditworthiness and match their bids and offers to produce loan contracts directly between them.
 
In 2010, the team at FundingCircle applied the P2P lending model to the small business lending market. They also enabled direct loans between each lender and business entity. But to provide security for the additional risk of lending larger amounts to businesses, they introduced a separate entity that would hold security over the assets of the borrower in trust for the lenders. That trustee entity could then enforce the security on the lenders' behalf if the borrower defaulted under the P2P loans. Since then, this model has also been introduced to the commercial property sector.

It was only a matter of  time before the P2P marketplace model penetrated the investment world. In 2011, Crowdcube launched the concept of enabling many individual investors to finance unlisted start-up companies in return for shares. And a team that included Bruce Davis, an ethnographer who had helped develop both Egg's and Zopa's marketing propositions, launched Abundance Generation to fund alternative energy projects by selling long term debentures to retail investors who could use the returns to pay their own energy bills.
 
The same year, the Peer-to-Peer Finance Association was launched to call for proportionate regulation of the peer-to-peer lending sector.
 
Since 2011 many different types of P2P lending, crowdfunding and crowd-investment platforms have launched. Approximately 30 platforms signed a letter to EU and UK policy makers at a P2P finance policy summit held in London in December 2012, and many others have launched since.
 
In March 2014, the first FCA rules took effect which specifically regulate both peer-to-peer lending and crowd-investment. The EU has since convened a "European Crowdfunding Stakeholders Forum" to help determine whether there is scope for EU regulation to help develop the sector.
 
Clearly we are still witnessing the dawn of this trend. 
 
PS on the US:
 
While this post has focused on the UK, it is worth mentioning that we attempted to launch Zopa's P2P model in the US during 2006-07. However, it was clear from our own regulatory discussions, and the subsequent experience of Prosper.com, that the Securities Exchange Commission was determined to view simple loans as securities that require registration and intermediation using the same model that applies to more complex instruments. Zopa declined to launch that type of model, but it had to be deployed subsequently by Lending Club and Prosper (a similar version was also deployed by Prodigy Finance in the UK, due to the need to support international cross-border lending activity). Essentially, rather than agreeing loans directly with individual borrowers, investors buy bonds that are backed by loans made to those borrowers by a licensed lending entity. The lending entity sells the loans to the bond issuer, which distributes the loan repayments to the bondholders. While the JOBS Act was supposed to liberate crowdfunding in the US, the SEC has been less than enthusiastic in implementing it. Fortunately, UK regulators have been positively supportive and it's important to note that the SEC does not have any responsibility to promote innovation and competition, while the FCA clearly does