Crowdfunding And Peer-To-Peer For SIPP And SSAS
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Now that UK peer-to-peer (P2P) platforms have originated more than £10 billion of loans, here are seven areas to review to reduce your risk of losing money
Whether You’re Lending Your Cash, ISA, SIPP Or SSAS Money In P2P, Here Are Seven Areas To Consider To Reduce Your Risk
Risk Reduction When P2P Lending
At a high level, P2P lending is simply the process of matching lenders and borrowers. However, it doesn’t disguise the fact this is an extremely complex and diverse market, comprising the same huge range of risk and reward as regular lending, be it unsecured loans to individuals, property backed business development loans, higher risk/higher reward bridging finance, invoice discounting, corporate loans to start-up or established businesses, and more.
P2P Risk Compared With Other Asset Classes
Don’t Risk Lending Your Money In P2P Before Checking These Seven Areas
Given the sheer variety of lending opportunities on offer, there’s an huge variation in risk between one type and another. To help reduce your risk of losing money, here are seven areas to consider in detail and more importantly, things you should do before you risk your hard-earned money on any P2P platform.
1. Platform Risk
Check out the platform’s key personnel to ensure they have financial services experience. Whilst there’s nothing wrong with investing with a ‘new kid on the block’, you might encounter less risk if they already have a proven track record. Find out how well capitalised is the platform. As the bigger ones have been around a while now, ask for some independent third party due diligence to assess how robust it is. Simply relying on its website saying how great it might be will do nothing to mitigate your risk. Some of the more insightful reviews are provided by lenders with live experience: the P2P Forum is one of the largest resources.
Lending comes in so many different forms. You could choose a platform where you’re able to select the borrower, and many people believe this is the best way to reduce risk. Others think that leaving the choice of borrowers entirely to the platform by automatically lending to everyone who’s approved by the platform is a better way to mitigate risk. Perhaps you like the idea of an ‘easy access, bank-like, deposit account’, where you often have no clue who’s taking control of your money. You might like something more complex and hands-off like a bond with a fixed term and little transparency.
2. Protection Risk
Find out what protection you might have if a loan goes wrong, for you can be sure it’s likely. After all, lending your money to individuals and businesses is not without risk. Some platforms invest in every loan alongside investors, so if the loan goes wrong, the platform will take the first hit. Having ‘skin in the game’ helps to ensure your interests are protected, for it’s reasonable to assume a platform isn’t going to risk its own money unnecessarily. Another method of protection is via a ‘provision fund’: a reserve of money that can be used in the event of default. You need to check out the size of the fund and what percentage of defaults will wipe it out. If it’s a very low figure, you need to decide whether it will help reduce your risk of losing money, or whether it’s merely there for marketing purposes, providing a mere veneer of security.
3. Security Risk
Unsecured lending to individuals or businesses is arguably a very high risk exercise, so if you’re going down this route, make sure you’re adequately compensated with a pretty high interest rate. And expect losses. You can reduce your risk by limiting your lending to loans secured with underlying assets, typically property. However, make sure you base your lending on the ‘forced sale’ valuation of the asset: the value it might achieve if it's realised within six to eight weeks. For in the event of a default, it’s most unlikely its ‘market value’ will be obtained. After all, if you’re a buyer thinking about purchasing a property quickly from a platform to repay a loan in default, you’re bound to offer a price that's well below market value!
4. Borrower Risk
Each platform tends to appeal to specific types of borrower. These can be individuals or businesses, each with a wide range of requirements and risk profiles. Don’t be bamboozled by the interest rate. Find out, wherever possible, to whom your money is actually going, and don’t lend unless you’re completely comfortable. The larger platforms publish their complete loan books either on their websites or on AltFi.
The FCA has recently discovered that some ‘money lending businesses’ have been borrowing money from platforms to lend on to their clients. This could massively increase your risk, for you’re unlikely to know to where your money may be going and therefore the risk being taken with it. It’s possible there could be criminal activity involved here, which is why the FCA wrote a ‘Dear CEO’ letter in February 2017 to all platforms to highlight this issue and the associated risk for lenders.
5. Underwriting Risk
The risk associated with your lending is often dependent on the quality of the underwriting undertaken by the platform, or specialists on its behalf, so ask your chosen platform for a complete breakdown of what is reviewed. It’s reassuring to find out details of the people actually doing the loan underwriting, with a breakdown of their industry experience. You need to know how loans are assessed, what credit profiling is undertaken, details of the security and how it’s valued. Comprehensive information on every borrower is vital, for as it’s often said on Dragons’ Den, you’re essentially investing in people, trusting them to be successful enough to cover your loan interest and repay your money back in full and on time.
6. Failure Risk
Whilst wide-ranging due diligence and underwriting investigations will help reduce the risk of loans that are more likely to fail, inevitably some will. That’s the nature of it. So ask the platform for its published loss rate and beware of those that don’t openly publish it. That said, past performance is no guide to future success or failure. Interestingly, the P2P industry is keen on standardising the way it reports defaults, and that should make it easier to compare one platform with another.
7. Change Risk
Change is a fact of life. That’s not just at P2P Platform level. Change can affect you, too. When you pledge your money to others, you should be prepared to lend it for the full term of the loan. But if your circumstances change, you need to know how you might be able to access your money before the end of the loan term, without the risk of losing a large percentage of it. Before you commit, find out what your options are, and what costs or penalties you could suffer. Some platforms offer a secondary market. Others might have sufficient resources to buy you out. And others still might just reply “computer says NO”.
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Crowdfunding And Peer-To-Peer Risk Warning
When a platform has been assessed and approved by a SIPP or SSAS operator, this does not imply that any loan or investment opportunity is endorsed in any way. A SIPP or SSAS operator's due diligence review is limited to ensuring the processes and procedures of the platform are in line with both FCA and HMRC principles. It's entirely your responsibility for carrying out your own due diligence on any loan or investment opportunity before agreeing to lend or invest your pension money on a platform. As a SIPP or SSAS operator will continually review platforms from a regulatory perspective, it's possible for a platform to become 'unapproved' if something changes.
With peer-to-peer lending, your capital is at risk if you lend to individuals and businesses. You may lose some or all of the capital lent if the borrower defaults and is unable to meet its liabilities. Historic loan default rates are not necessarily indicative of future default rates. In addition, lending is an illiquid investment, which means you may not be able to access the capital you lend for the duration of the loan period, even if the platform offers a secondary market. Investing in any business involves risks, including illiquidity, lack of dividends, loss of investment and dilution, and it should be done only as part of a diversified portfolio. Crowdfunding is generally targeted at investors who are sufficiently sophisticated to understand the risks and make their own investment decisions, based on their knowledge, experience and financial capacity. Neither crowdfunding nor peer-to-peer lending is covered by the Financial Services Compensation Scheme. The tax treatment of your investment is dependent on your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of crowdfunding investment or peer-to-peer lending, you should consult a suitably qualified independent financial adviser.