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In recent posts I have mentioned the ongoing crisis of trust towards Baltic crowdfunding, in response to scams, problematic business practices and increasing defaults.
With the added impact of coronavirus, I believe we have reached a critical point. Many investors are withdrawing their entire investment; some are willing to offer massive discounts or pay heavy early-exit fees. Funding volumes are plummeting, causing liquidity issues for platforms, loan originators and borrowers.
This goes beyond the natural response to an economic crisis. Crowdfunding platforms in Israel are much less affected. Even in the Baltics we see different levels of impact on different platforms, depending on the original level of trust in each platform’s integrity and business model.
Stronger platforms might be tempted to see this as an opportunity to weed out the competition. They are wrong: Every additional platform failure will only encourage investors to exit Baltic crowdfunding altogether. We are tired of playing Russian Roulette with our money.
Time for action
When Kuetzal and Envestio went bust, Grupeer released a statement condemning scams, which seems very ironic in retrospect. Lately, platforms have been publishing statements regarding the measures taken to cope with the pandemic. Such communication is important, but it’s not enough. I believe it is time for platforms to take a step further.
My suggestion? An alliance of crowdfunding platforms (of all sorts: P2P, P2B, real estate, and loan refinancing marketplaces). Not the kind of alliance where anyone can join for a fee to get a stamp of approval for the website footer. A true, active alliance aiming to separate good platforms from scams, reinforce business practices and rebuild trust. At the core of this alliance: A set of mutually-agreed standards for operating an honest and stable platform.
Those familiar with my TORCH initiative will recognise some of the proposed standards. While TORCH received overwhelming support from the community, it went largely ignored by platforms, for two reasons. One, there was no need to improve as long as money was flowing. Two, every platform was comparing itself to low market standards. “Why should I advertise actual returns when my competitor advertises the average interest rate? My number would seem less impressive!” For this reason, it’s important to improve practices across the industry.
Here are a few of my proposed standards:
– Transparent ownership structure.
– Full disclosure when offering investment opportunities by related parties.
– Publication of quarterly/annual financial statements of the platform and loan originators.
– Transparent display of the loan book status: current, late and default loans, and updates on recoveries.
– The borrower’s actual payment schedule must be visible to users.
– Loan agreements must include the identity of the investor, mediating platform, and pledgor (except for individual borrowers).
– Transparent and accurate display of loan info and project details. Personal loans must show the affective APR charged to borrowers. Real estate projects must show the address and cadastral number. Any secured loan without a buyback guarantee must include a list of pledged assets and their valuations. Valuations must be supported by documents. LTV must be calculated accurately – never show only the LTGDV.
– Informative display of key financial figure, e.g. monthly funding volume and portfolio size, instead of cumulative figures.
– IT should be structured in a way that accurately represents transactions. For example, scheduled payments should only appear as “paid” after the money completes its entire route from the borrower, through the loan originator, to the platform, to investors’ accounts. Users’ account balance should only be reimbursed with actual money present in bank. Loan amount displayed to investors should match actual amount transferred to borrower/LO.
– True segregation of funds using escrow accounts (registered to a trustee). Each and every platform in Israel had been doing this even before it became a regulatory imperative.
– Buyback guarantee and sell-back guarantee must be supported by transparent numbers, and must have clear terms and conditions, especially with regards to terminating those guarantees (as with any legal contract).
– The entire transaction database must be backed up on a daily or weekly basis. Backups must be safeguarded by a third party.
– Honest risk warnings (required by law in many jurisdictions, like the UK).
– Every platform must conduct simulations of different game-changing scenarios (like the one we’re currently in…), construct a business continuity plan, and publish it.
The Alliance can operate similarly to the EU: separate entities collaborating under a mutually-agreed set of rules, and supervising each other through a committee of representatives. The formation process can also be inspired by the EU: The founding members will assemble a list of standards, adapt to them, and then begin accepting new members, which will need to undergo a process of accession to become full members (and get a stamp of approval). Monitoring will proceed regularly, not just for new members.
What about standards which can only be verified through internal inspection (e.g. accurate representation of bank transactions)? Every platform will need to go through surprise inspections, either by a 3rd-party auditor, or by another member of the Alliance. This means that Platfom A can show up at the office door of Platform B at any time, and receive access to certain parts of the loanbook, transaction records and IT code (excluding trade secrets, of course).
Sounds crazy? Think about it. Is there a more powerful PR move than allowing your competitors to inspect your operation from the inside out? Just imagine the community’s enthusiastic reaction to photos of PeerBerry’s CEO handing a badge of approval to Mintos’s CEO after a surprise inspection, or vice versa, with both teams sitting for a beer afterwards (insert Corona joke here).
Don’t play games
When I floated these ideas to friends, they called me “naive” and said that businesses can’t regulate themselves. They offered an alternative approach, where we investors form our own Association, whose goal would be to inspect platforms with the help of local lawyers and consultants.
My issue with that idea is that it won’t fundamentally change the familiar dynamics. Investors have been trying for years to assess platforms, asking for more information, and pushing them to improve. Some progress is made, but evidently not enough. Trust is declining instead of rising. I think it’s time for platforms to pick up the gauntlet and start pushing things on their side.
But it can only work if platforms adopt these ideas seriously. An alliance cannot be formed by platforms declaring that their current model is ideal and should be adopted by others. Such attempt will be viewed as a total joke by the investor community, because none of the Baltic platforms currently stands up to every expected standard (the closest is probably NEO Finance).
Some investors are already looking to hire local lawyers and business consultants to inspect platforms (and not just the platforms that turned out to be scams). Don’t make us go there.
Why do it?
Let’s be honest: The Baltic states are currently considered the “wild west” of crowdfunding. This is why you mostly see young and adventurous investors with small portfolios – and even they are reconsidering their investments. To regain their trust, and draw in more conservative investors, Baltic platforms need to show the world that they are solidifying.
In the absence of regulation, and in light of recent events, it is evident that self-regulation is crucially needed. One way to get there is by applying for Investment Firm or EMI licenses. These steps are highly appreciated, but take months or years to accomplish. My suggestion can start rolling almost immediately, and also bring platforms closer to future regulatory requirements.
As an added benefit, close collaboration and information-sharing can boost internal business practices. Members can keep a shared database of lending regulations in different markets, exchange information regarding loan originators and borrowers (similar to a national credit score system), and discuss practices for dealing with market changes.
Collaborating with competitors may seem counter-intuitive, but I truly believe that it’s the best way for the industry to survive this crisis and improve as a whole. In the future, the Alliance can grow to include platforms from other countries, making the Baltics a true global centre of sustainable crowdfunding.
So… Any takers?