Peer-to-Peer Lending as an Alternative Investment Asset Class in the EU

Peer-To-Peer Lending (P2p): Background

Fintech’s rise was catalyzed by the aftermath of the 2007-09 Global Financial Crisis and the Euro Debt Crisis’ damage to the brand and business of many large legacy financial institutions. After the collapse of large institutions such as Lehman Brothers, Lloyd’s and Northern Rock in the UK, Bankia Bank in Spain, Anglo Irish Bank, Allied Irish, Bank of Ireland, and others throughout the continent, people doubted the soundness of their trusted institutions. From that doubt and despair, the search for alternative houses of savings began in earnest. Episodes of suspected malfeasance at institutions like Deutsche Bank, Goldman Sachs, and other institutions came to light:

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  Banks played the role of supporting both parties in transactions they helped foster and even participated in

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  The role of some banks in originating and promoting flawed asset-backed securities and derivatives

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  Trading scandals such as the Jérôme Kerviel trading scandal at Société Générale, and

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  The Libor rate manipulation scandal involving banks like UBS, Barclays, and Royal Bank of Scotland – the consequences of which involved the daily credit transactions and major purchases of almost everyone on the continent.

Amidst the damage to the financial industry and its reputation came the collapse of fixed-income asset yields. Investors of all stripes bolted “risky” assets like stocks and non-investment grade bonds, pouring their money in safer assets like sovereign debt of safe havens like US Treasuries, German, Swiss bonds, and the Yen. As the EU economy collapsed from the aftermath of the 2007-09 Global Financial Crisis (and again in 2012 amidst the Euro Debt Crisis), the flight to safety precipitated a drop in sovereign debt yields (see Figure 1) compelled individual retail investors to liquidate and avoid any further pain from persistent losses. Outflows of European mutual funds and ETFs, for instance, peaked in the aftermath of both crises (see Figure 2). Much of the post-crisis gains in mutual fund and ETF investment levels, however, did not come from increased investment flow but through asset appreciation. Indeed, while large institutional investors including hedge funds and private equity funds benefitted from the recovery in asset prices, many household investors missed out on the market rally. Only now with the passing of time and the waning of memories, the hype over gains in more speculative assets in the media, and the dearth of investment opportunities, are household investors slowly (and reluctantly) seeking yields through increased investments.

Figure 1.

Sovereign long-term bond interest rates for EU-28 nations

Figure 2.

Mutual fund and ETF holdings by EU retail investors

As the supply of available sovereign debt to the public contracted (in part due to increased buying of bonds via quantitative easing programs by major central banks), the yields on similarly-rated corporate bonds collapsed as demand bid prices higher. Those investors who participated in the flight from stocks and mutual funds were further hit by low savings interest rates and collapsing Euro exchange rates versus such foreign currencies as the US Dollar and the Japanese Yen (due to a combination of the European recession and other central bank actions). The sheer size of investable funds worldwide, especially in Europe, sought investment in an environment where prudent investment opportunities were scarce. In fact, even speculative investments were bid higher, as illustrated by the collapse of non-investment grade (junk) corporate bond yields. Yields on interest-bearing savings and money market accounts (accounts investing in corporate commercial paper) were anemic – typically on the order of 5 basis points (0.05%) as of October 2017 (see Figure 3).

Figure 3.

Euro-area household interest earned on deposits