Alternative Finance Industry in The UK Is Still Not Transparent Enough

As the alternative finance sector scales up and entices more conventional investors, platforms have a job to help those investors. Financial advisers work out to determine the portfolio where these investors fit in — through this, the level of risk is identified.

Investments without risks are not possible. The challenge lies in the identification of the potential risks, and whether they are worth taking for the potential ROI (Return On Investment).

What risks are there in alternative finance?

Asset risk, which is fairly obvious to anyone with investment experience, is considered to be one of the most important risks when it comes to crowdfunding and online lending. This is the risk of the end investment – the person or business who borrows your money. What will they do with your money? When can you expect a return? What is the probability that their plan will work out? What happens if the plan fails?

Risk in the instrument is another example. What do you get for your money — is it going to be bonds, or share, or a loan contract perhaps? Are there any other lenders? Are you senior or junior? Is it secured?

Aside from that, there’s one question that an investor should never forget to ask which is often neglected: to what extent can the platform help you understand, price, spread or limit risk?

Sad to say but this can mainly be the case when people are lending to businesses, and at volumes of £4bn a year, it is by far the largest subdivision in UK crowdfunding.

Transparent platforms

Crowdfunding should show their ‘being transparent’ in their performance and that means being transparent about fees for starters. How does that platform get paid — by the lender, the borrower or a bit of both? When does it get paid, and do they take a spread?

Knowing how much money you would get and what rate the borrower is paying, is a much better indication of the risk profile of that investment than the rate you are being offered.

Being transparent also means transparency about how the return was set. What is an A+ versus a B risk? What are the default rates?

Due diligence

There’s been a lot of innovation in lending to businesses, through bonds or through peer-to-business loan contracts.

Several P2P finance platforms are built around an automatic bidding process, which comes with spreading each lender’s funds across multiple borrowers.

On the other hand, this also means that moneylenders are not only entirely dependent on the platform to evaluate risk, although there are instances that lenders also have very slight view of what companies they are actually invested in – or the due diligence criteria used to pick these businesses and what led to their credit risk rating.

On the contrary, some platforms present investors with only a few of much bigger bids, increasing single investment risk but also enabling the platform to take a much more straight forward approach to due diligence.

This will be written in an offer document; hence all investors can have an impression on how the investee (company) has been investigated and judged before deciding to take things any further.

The Future

Platforms should earn their fees and those should be entirely and visibly set out too.

Suitability tests and caps on the amount of investment are just some of the approaches that platforms can implement to aid in risk management. However, the thing that has the greatest importance for investors to be aware of is that not all platforms offer the same levels of disclosure and protection.

As an industry, we must provide more transparency to the end investors. As platforms, our primary role is to help investors recognise the risk they are taking and assess whether the investment gives a good enough risk-adjusted ROI.

Final Comment: Always check out the platforms Terms and Conditions and understand the questions and answers they stipulate normally via their FAQ’s