Back to the Future: Bitcoin, Blockchain and how Marketplace Lenders are Using Technology to Overtake Banks in the Race to Attract New Lenders.

4/12/15

Encumbent institutional investors themselves admit that they have a lot of catching up to do before they can compete with the ‘upstart’[1] marketplace lending providers. A Morgan Stanley research paper published in June discussed how banks were hampered both by their due diligence restrictions, and by the backwardness of their big data analysis techniques.

Because the new marketplace lenders have less operating costs, they are attractive to borrowers as they are able to offer lower commissions; their risk assessment criteria are less exacting than banks, and they incorporate demographic data into their analysis. Thus they are able to offer lower interest rates to interested investors.

Morgan Stanley analysts wrote: “Traditional banks excel at originating loans and underwriting credit, but are slowed by the batch process and portfolio approach to their deposit and loan legacy systems, which are the backbone of the US and global payments system, and by liquidity and capital rules.”

Disruptive Innovations

As well as raising the bar in big data analysis, both for existing users and in targeting potential loan seekers, many in the marketplace lending sector have enthusiastically adopted Bitcoin and the blockchain in their payments system.

BTCjam was among the first forums to facilitate lending in Bitcoin. Founded in late 2012, in 2013 it gained a wealth of sponsors in Ribbit Capital, 500 Startups, FundersClub and the Bitcoin Investment Trust. By the end of 2014, BTCjam had facilitated bitcoin loans of over of $10 million in value, with more than 100,000 users in over 200 countries. The fact that its due diligence procedure only goes so far as an “optional soft credit check” helps explain its popularity.

Bitcoin and BTCPOP both offer bitcoin-denominated loans, of the ‘instant’ and collateral-tied variety. Loanbase, formerly known as BitLendingClub, specialises in bitcoin loans to developing countries, where beneficiaries might not have a bank account.

Why Not Create A New Currency With Your Payments System?

Another start-up has created an entire new currency, LoanCoin, which appreciates as interest is paid on a loan. Once the interest and principal are paid off, the attached LoanCoin is destroyed and exchanged for a currency of the Coinholders’ choice, so the currency value is preserved.

Within the system created by the developers Lending DApp, aspiring loan issuers, or ‘officers’, can source and guarantee new loans for Coinholders and charge fees for their service. Financial institutions, marketplace lenders, and even individuals can act as loan officers; though their commission and the size of the credit or ‘Trust line’ extended to them is dependent on their credit record. Lending is also at the issuer’s own risk and in the event of default or missed payment, the loan officer loses their collateral.

The Trust line is calculated by applying an aggregate function to its collected weighted trust ratings. The network is thus able to draw on the accumulated knowledge of its participants when assessing a loan officer’s reputation and creditworthiness. Percentage of performance fees is dependent on the difference between the risk-adjusted performance of the loans selected by the loan officer, and the mean risk-adjusted loan performance of all loans in the network.

Lending DApp, with its innovative decentralised business model, which relies almost wholly on pre-programmed systems, is typical of the new hybrid marketplace lending product, where banks and what we loosely define as “P2P” lenders co-exist to mutual profit.

Smittipon Srethapramote, who covers the North American payments industry at Morgan Stanley, confirms this is a growing trend. He says “The fastest growing marketplace platforms are not really peer-to-peer but institutional investors partnering with tech platforms to cherry-pick borrowers, often with offline marketing.”

 What The Future Holds

Max Rangeley, who works for the Cobden Centre, a thinktank which has been charged with creating a Bitcoin exhibition for the European Parliament, explains how the Bitcoin transfer system, the ‘blockchain’, might be adapted for other purposes. One potential use is to allow users to better insure the asset they use as collateral on a loan.

“Transactions can be conditional on any event which can be programmed into the blockchain (or even other events, if there is third-party verification whether the event occurred or not). Smart property (property registered on the blockchain) can be used either as collateral or for repo loans, are when the “lender” effectively buys the property from the borrower and sells it back to them at the original price plus interest after a specified period of time.”

 

 

 

 

 

 

 

[1] https://www.morganstanley.com/ideas/p2p-marketplace-lending

 

Tide Turns Against Offshore Listings

The regulatory climate in Europe has tightened the screw on money-laundering and counter-terrorist financing, with the result that many institutional investors are warier of offshore-listed funds without a similar level of transparency…. How widespread is this offshore aversion, and will it prove an enduring trend?

 The EU’s 4^th AML Directive now requires EU states to keep central registers listing info on the ultimate beneficial owner of corporate and other legal entities; as well as compelling trusts to make information available to relevant financial authorities and “obliged entities” e.g. banks conducting “customer due diligence” duties.

Publicly listed companies, i.e. non-trusts, will be forced to make such information available to any inquirer with a “legitimate interest”, be it investigative journalist or concerned citizen.

However, these requirements will not be imposed on the Cayman Islands, which foreign office minister Grant Shapps recently announced would subscribe to an alternative scheme that also includes the British Virgin Islands and Bermuda.

Under this alternative plan, “corporate service providers” themselves will be responsible for making available information on company ownership to law enforcement agencies within 24 hours of a request being made.

So if Interpol comes knocking, they must respond promptly. But does this really amount to a legislative change? What was the window of response time before?

Shifting sands of investor sentiment

Pension funds, and any fund structure which takes risk assessment seriously, are averse to investing in opaque structures where it is difficult to pinpoint the party which is ultimately liable in the event of compensating for losses, failure to meet targets; or, in a worst-case scenario, actual bankruptcy.

The Caymans and other ‘tax-neutral’ jurisdictions are attractive to many fund managers, particularly hedge funds, because registering the company here means they can bypass paying capital gains on their astronomic profits. But at the same time, these island governments have such a laissez-faire attitude to corporate regulation, they are also a haven for criminal gains disguised under ‘shell’ companies with no officially registered connection to their actual owner.

There have been several recent controversies about the Caymans’ use as a cash transfer node in what it is alleged is a network of illegitimate wire recipients.

On 17 July, Fidelity Bank’s sideline money transfer service, Western Union, closed its Cayman Islands branches, as well as those in Turks and Caicos and the Bahamas. Fidelity Bank (Cayman) CEO Brett Hill told the Cayman Compass, “It’s been an increasingly marginal business for us,” because fees had fallen along with the business becoming higher risk.

 In May, Western Union was forced to pay a 1.75 million euros (US$1.9 million) by Irish officials, for having insufficient policies and procedures in place against money laundering; part of the aftermath of the FIFA scandal. In fact, Jeffrey Webb, the former FIFA and CONCACAF (Confederation of North, Central America and Caribbean Football Associations) official now facing corruption charges in the United States, worked as Western Union’s local agent.

People prefer UCITS

The risk-averse investors’ favourite course, Undertakings for Collective Investment in Transferable Securities, are popular because of the greater insurance they offer to investors. UCITS have an independent supervisory entity, a ‘depositary’, which has no commercial interest in either the fund or external commercial links with the fund’s investment managers.

Prime brokers who act as counterparties to a fund on swaps, options or other derivative contracts, are not permitted to act as its depositaries. This further guarantees the integrity of its assets and capital deposits.

The depositary has two main roles: first, it acts as custodian over the fund’s assets; second, it performs legal oversight of a UCIT’s sales, repurchase and redemption of units or shares is carried out in accordance with applicable laws. This includes verifying the net asset value of units, calculated in line with national accountancy standards.

A recent (2014) amendment enhanced the ability of UCITS depositaries to meet their obligations in the event of the assets being “lost in custody”. Should this occur, the depositary will have to provide replacement assets to investors without requiring an investigation to establish liability. Unlike in a dodgy Caymans ‘fund’, where it is sometimes impossible to establish where the buck stops.

Of course, because the core EU UCIT framework is open to changes under different national interpretations, countries like Ireland have found ways of sweetening the deal. The Central Bank of Ireland (CBI) has removed the requirement for UCITS fund promoters to be approved by the bank. This opens the field for a variety of smaller, unregulated placement agents to conduct the marketing and sales process for new UCITS funds.

Simultaneously, the CBI has taken action to enforce standards in the repo and and securities lending markets, demanding all counterparties involved in securities lending, repo or reverse repo lending transactions have a minimum credit rating of A-2 or equivalent.

Demonstrated Preference

UCITS have remained in demand globally, despite rival pan-continental regulatory structures being instigated in Asia: the Asean Collective Investment Schemes, as of August 2014, which clears funds for distribution across Singapore, Malaysia and Thailand; the Apec Asia Region Funds Passport, which provides a similar unified framework across Australia, New Zealand, South Korea and Singapore.

Yet, as CEO of Hong Kong’s CitiTrust, Stewart Aldcroft, pointed out in an FT op-ed:

“Malaysia and Thailand have similar schemes to allow the approval of locally domiciled funds to operate as feeder or fund of funds, where they use third-party products such as UCITS. In both markets, these have proved to be more successful and popular than anything under the Asean passport scheme.”

Fund registration figures show that across the three principal markets of Hong Kong, Singapore and Taiwan, there are over 4,500 listed UCITS funds; though as many of these are listed more than once, the total of unique funds runs closer to 1,200.

And recently there have been significant new UCIT fund registrations with an Asian focus. Noteworthy is Neuberger Berman’s new Asian-focused fixed-income vehicle, which invests across debt grades, from government to high-yield. This new Asian Debt Hard Currency fund will be joined, Neuberger states, by the launch of a China bond fund and Asian debt local currency fund.

All of the emerging market products are sub-funds of the Irish domiciled UCITS fund feeder, Neuberger Berman Investment Funds; a clear indication of investor preference for Ireland’s regulatory environment.

Neuberger is particularly optimistic about opportunities for UCITS in the Chinese market. The asset managers were granted a Reminbi Qualified Foreign Institutional Investor (RQFIII) status in December 2014, allocating a quota of certain non-strategic mainland Chinese Renminbi-denominated equity and credit-based securities.

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