In the ‘80s movie “Back to the Future Part II,” our hero travels forward to where kids get around on gravity-defying hoverboards, people watch flat-screen TVs and biometric IDs give access while drones fly above. It would be interesting to know how the film’s writers would have predicted the evolution of finance and data. Blockchain, machine learning, big data and the Internet of Things are all new frontiers driving innovation and challenging our thinking.
Beyond the technology, “Back to the Future” attempted to predict changes to social norms – but would they have predicted that technology would enable consumers to fund each other’s businesses, bypassing the need for a bank to intermediate? That gadget-hungry consumers would join together to fund the creation of an untested product simply to be one of the first users? That a small, young company could raise equity capital directly from a group of investors scattered across the world? Like many of the predictions imagined in the movie, these are becoming realities. In fact, it’s conceivable that in another 10 or 15 years brick-and-mortar bank branches will have disappeared, and securities and loans will be actively traded “peer-to-peer” facilitated by the blockchain, without the need for brokerage accounts or stock exchanges.
And demographics as well as technology support this vision: According to a 2015 Goldman Sachs research report, 33% of Millennials believe they won’t need a bank in five years and 14% of small business owners already use alternative (non-bank) financing. Regulatory changes such as the U.S. Congress passing the JOBS Act Title III have also formalized that crowdfinancing is here to stay and is set for exponential growth. The World Bank has predicted that the market will reach almost $100 billion by 2025 – if you believe the prediction above, this misses the mark by a massive factor (remembering U.S. GDP alone is about $17 trillion).
Peer-to-peer (P2P) lending and equity crowdfunding as a source of financial returns
The term crowdfunding is often linked to sites such as Kickstarter where pretty much anyone can raise working capital to fund a project, usually in return for a product or service. Because these “deals” could be positioned to regulators as pre-orders – securities laws didn’t need to be enacted to allow this new source of working capital to emerge. To date Kickstarter alone has raised more than $2 billion, providing funding for roughly 100,000 projects.
The term crowdfinancing is specifically used to describe two business models bringing financial returns for investors:
- Peer-to-peer lending: Where individuals lend money directly to other consumers or small businesses via online platforms such as Lending Club, Prosper, Funding Circle and CreditEase. As institutional money has started to tap the higher returns (narrower spread) markets, marketplace lending has also become a commonly used term.
- Equity crowdfunding: Where early stage and smaller companies issue equity to individuals, again facilitated by online marketplaces. Examples of the sites include AngelList, Seedrs and SeedInvest.
These websites facilitate borrowers’ and issuers’ access to the large pool of individual lenders and investors.
Sites are regulated to varying degrees – for example in the U.S. by the SEC and the Financial Industry Regulatory Authority (FINRA). The sites are responsible for screening of borrowers and lenders and setting up procedures to prevent such platforms being used for money laundering.
How crowdfinancing works
Regulation as a key market driver
Changing consumer behaviour, technology enablement, the current macro environment including all-time low interest rates – and most of all – regulatory changes have driven the emergence of the crowdfinancing market. Authorities, led by the U.S. and UK have supported alternative finance, with certain Asian jurisdictions expected to follow.
The JOBS Act, signed into U.S. law in 2012, was the key enabler for the crowdfinancing industry in the USA. Title II allowed for companies to advertise that they are accepting capital from new investors – but investors still had to be accredited. Online platforms had to facilitate confirmation of accreditation.
On 30th October, 2015, the SEC approved Title III of the JOBS Act – paving the way for non-accredited investors to participate. This means that starting in May 2016 all U.S. citizens regardless of their net worth or income can invest in start-ups via online portals. The SEC has placed limits on how much of an individual’s annual income can be invested to minimize possible total losses.
Peer-to-peer platforms have already been able to operate with the true consumer crowd as they have operated through an SEC no-action letter to engage non-accredited investors by offering fractional shares of payment notes which the platform creates daily and holds on its balance sheet.
Estimated growth in volume of funds raised by crowdfunding platforms worldwide
Global phenomenon which comes in different shapes and sizes
Regulatory reform has led to a growing number of crowdfinancing platforms. It is between 1,200-1,500 globally – and increasing.
Crowdfinancing is also taking many different forms. Some equity crowdfunding platforms have taken a co-investment approach. For example, SyndicateRoom and VentureFounders invite individuals to invest alongside professional investors. There are also various platforms focusing on specific verticals such as technology companies, property, consumer goods or art.
Increasing collaboration between Wall Street and the crowdfinancing ecosystem
In the beginning crowdfinancing was all about the crowd but it has evolved to include institutional money – asset managers and hedge funds investing not only on the actual platforms but also through the platforms in actual deals. The market has also seen increasing collaboration through partnerships. Examples of this include Lending Club, Citi and Varadero Capital launching a partnership where Lending Club helps lower the cost of credit for borrowers; Santander referring UK business loans directly to Funding Circle and BBVA partnership with OnDeck to connect banks’ clients to more capital quickly.
This is a two-way street. Crowdfinancing platforms can get access to a larger pool of deals, while banks can facilitate lending to their business customers without the need for additional capital on the balance sheet. There may also be a geographic angle to this where banks can expand their footprint to new regions.
Some Wall Street institutions have also decided to make a move in this space. One of the first movers was Goldman Sachs with a decision to launch its own peer-to-peer lending platform; it is also notably active in the blockchain space.
Thomson Reuters response – It’s all about the data – for now
Crowdfinancing is an exciting new frontier from the Thomson Reuters perspective. On the one hand – it’s potentially a new consumer market for market data. On the other hand – it could lead to some challenging consequences for some of our largest customers.
As a technology and information company we are well-positioned to resolve real challenges in this space to serve both our customers and the growing crowdfinancing ecosystem. After all, we collect a lot of data from market participants. We aggregate this data and deliver it back in the form of feeds or derived data analytics. We facilitate the screening and onbording of participants with products like WorldCheck® and our KYC Managed Service (Org ID).
In this market, high-quality data, reliable information and unique insights are more important than ever. This is where Thomson Reuters can help. Here is what we have been doing so far, and there is more to come.
Improving transparency with Crowdnetic and PermID
As discussed in this article, Thomson Reuters has partnered with Crowdnetic to improve transparency and create new opportunities for innovation in an industry that now requires a more substantial information infrastructure that Thomson Reuters is well suited to provide. Crowdnetic has also adopted Thomson Reuters Permanent Identifier (PermID) as its primary symbology system for the recording and tracking of crowdfinanced transactions. The move brings investors more insight into the dynamics of this fast-growing investment area.
Evaluated pricing offering with mountain view for hard-to-value loans
Thomson Reuters has also launched evaluated pricing for marketplace lending derived by Thomson Reuters Pricing Service (TRPS) and MountainView IPS to assist fixed-income investors and investment managers with third-party, fair market valuation and price verification for hard-to-value loans. MountainView IPS, a subsidiary of MountainView Capital Holdings provides independent/third-party valuation services for hard-to-value fixed-income assets. The company prices mortgage- and asset-backed securities, residential whole loans, collateralized loan obligations (CLOs), collateralized debt obligation (CDOs) and marketplace lending loans.
The new offering will be part of the TRPS global solution that provides users of the DataScope suite with evaluated prices to support portfolio, fund and single-security valuations. Fixed-income investors need more industry education around the platform risks, credit risk underwriting and valuation transparency. The role of independent valuation service providers is very important in that investors need their internal pricing methodology documented and validated by an independent third party for their daily and monthly NAV process.
Collaborating with universities on the Asian crowdfinancing space
The Asian crowdfinancing market is rapidly developing and therefore Thomson Reuters has collaborated with Cambridge Centre for Alternative Finance at Cambridge Judge Business School, Tsinghua University Graduate School of Shenzhen and University of Sydney Business School in support of the launch of the 2015 Asia-Pacific Alternative Finance Benchmarking Survey.
The survey is the first-ever comprehensive study of equity crowdfunding, peer-to-peer lending and other forms of alternative finance across the Asia Pacific region – including mainland China, Hong Kong, Taiwan, Japan, South Korea, Singapore, Malaysia, the Philippines, Thailand, Indonesia, India, Australia and New Zealand. All local platforms operating in the Asia Pacific area were invited to contribute to the survey. Results and a report will be made available free to the public early in 2016. All findings will be in aggregated form either by country, region or alternative financing model and no individual platform/provider’s data will be divulged.
Disruption is good – it drives innovation
Crowdfinancing as a new frontier is all about better access, transparency and efficient process. It gives more options to consumers and also to the financial institutions.
It pushes boundaries making traditional Wall Street institutions rethink their operating model and how to make it more efficient. Various institutions have set up their innovation centres and are finding ways to collaborate with the new wave of start-ups and market players.
In the end it’s all about innovation and driving the thinking forward – we might see those flying cars sooner than expected.