Evidence submitted by Funding Circle (SME0034)

Treasury Select Committee: SME Finance inquiry

Funding Circle is pleased to see small business finance being reviewed by the Treasury Select Committee. Driving further adoption of funding opportunities such as direct (or peer-to-peer) lending will have a positive impact on the economy and job creation.

Funding Circle  is pleased to share its view, as it believe its exclusive focus on the small business lending market makes it well-positioned to offer an informed opinion to the committee. This document will give a brief introduction to Funding Circle before addressing the various issues referenced by the inquiry and how it believes choice and competition in the small business lending market, and therefore access to finance for small businesses, can be improved.

Funding Circle Background

How Funding Circle works

●         Funding Circle is the world’s largest direct lending platform for small businesses, where investors lend directly to creditworthy small businesses. Funding Circle operates in the UK, US, Germany and the Netherlands and has facilitated more than £4 billion of lending to over 40,000 small businesses.

●         Funding Circle was founded in 2010 in response to the 2008 financial crisis, when small businesses could not receive the finance they needed to grow from high street banks, and a low interest rate environment meant investors were starved of yield. We therefore wanted to create the infrastructure, similar to a stock exchange or bond market, where any investor – big or small – can lend directly to small businesses.

●         A diverse range of investors are now lending through the platform, including 80,000 individuals, local government, the British Business Bank (BBB), the European Investment Bank (EIB) and other financial institutions such as pension and insurance funds.

●         In total Funding Circle has raised £250 million of equity capital from some of the largest and most sophisticated institutions in the world and was last year hailed by Rt Hon Philip Hammond MP, Chancellor of the Exchequer as: “a real success story for British Fintech”.

Funding Circle delivers a better service for small businesses and investors

●         Funding Circle delivers a fundamentally better service to small businesses looking to access finance. This differentiates it from incumbent banks and is based on seven key areas:

o         Speed: Businesses appreciate how quickly we respond to and processes their application: you can apply for a loan online in just 10 minutes, receive a decision from the credit assessment team typically within a day, and get money in your bank account within a week. This compares to an average of three months with many of the traditional providers.

o         Efficiency and accuracy of credit assessment: Speed does not mean it compromises on rigour. The credit assessment process combines technology and proprietary risk models with experienced underwriters to better understand a business and find the correct terms to suit its needs. The credit checks use the same data that banks use.

o         Flexibility: As an online platform we suit business owners’ schedules by offering greater flexibility than a bank. 50% of applications for loans come outside of working hours.

o         Transparency: Funding Circle does not have any hidden costs or early repayment fees. It publishes performance data on its website so customers can track how it is performing against expectations.

o         Independent choice from their bank: Banks typically only lend to their own banking customers. This means that if a bank says no, the business is faced with moving its entire banking relationship and infrastructure in order to secure a loan with another bank, Given this, non-bank sources of finance are fundamental in driving competition and choice.

o         Dedicated account managers: In a world where banks are closing branches and moving many small businesses point of contact to call centres, Funding Circle is giving small businesses a dedicated account manager for every step of their funding journey.

●         The average loan size facilitated by Funding Circle is £65,000, while the typical borrower is 10 years old and employs approximately 10 people - Funding Circle champions the “S” in SME.

●         At the same time, investors are earning an attractive, stable return at a time when interest rates remain low. The average annual return, after fees and bad debt, has been 6.4% to date.

Helping more small businesses to access finance has a significant impact on the UK economy

●         Funding Circle has proven to be a more popular choice of finance for the UK’s small businesses. Research by the Centre for Economics and Business Research (Cebr)[1] found that whilst 77% businesses initially shopped around for finance before choosing Funding Circle – 94% would come back to it first in future over a bank.

●         The same Cebr research found that lending through Funding Circle has supported the creation of ~75,000 new jobs, and for every £1 lent; approximately £2 is added to the economy in Gross Value Add (GVA).

●         Funding Circle is expanding the small business finance market, with a fifth (21%) of borrowers saying they would have been unable to access finance without Funding Circle.

●         The Funding Circle model is also helping businesses across the UK to access finance; lending is over-indexed in regions such as the North East, where the traditional finance system has withdrawn through branch closures and restrictive lending policies.

Access to debt finance remains a serious issue for small businesses

●         Despite the important economic contribution of UK small businesses, they have continued to struggle to access finance through traditional channels since the financial crisis. Bank of England figures show that between 2011 to 2017, 30 of the UK’s largest banks’ combined ‘amounts outstanding’ (the amount of money currently lent out to small businesses) has fallen by 14%.

●         This is due to poor net lending. Net lending (total minus repayments) is used by the Bank of England to discover the new amount contributed to the small business ecosystem or economy.

●         Whilst some recovery was seen in 2015, there has been a similar downward trend in lending to small businesses by incumbents since the 2016 European Union (EU) referendum.

●         In 2017, 30 of the UK’s largest banks lent an additional £680 million to small businesses on a net basis[2], whilst investors at Funding Circle alone lent an additional £600 million. Since the referendum, quarterly net lending by banks has steadily declined and was negative in Q4 2017, for the first time since Q3 2014. In the same quarter, an additional £155 million was lent through Funding Circle on a net basis.

●         Whilst Funding Circle’s increasing net contribution is encouraging, the Bank of England’s gross lending statistics show that lending through Funding Circle still only represents approximately 2% of the entire small business lending market and only one in ten UK businesses have heard of Funding Circle.

●         This means the opportunity is big, but also illustrates the size of the challenge Funding Circle faces in encouraging businesses to forgo a cultural change against the ingrained belief that banks are the only option when in need of finance.

Opening up new pools of capital to small businesses is crucial

●        Since launching in 2010, Funding Circle has grown and diversified its investor base significantly in order to open up vast pools of capital to small businesses.

●        By opening up pools of capital that were previously not available to small businesses, it has created a more stable ecosystem for the long term, and improved choice and competition in the small business lending market.

●        Funding Circle’s investors today include:

○        ~80,000 retail investors now lend directly through the platform.

○        In 2013, the UK Government began lending through Funding Circle and has committed a total £100 million, initially through the Business Finance Partnership (£20 million) and now the British Business Bank (£80 million). This has supported more than 15,000 small businesses whilst earning over £5 million of income in the form of interest for the Government.

○        In 2015 Funding Circle launched the first single-platform direct lending fund (Funding Circle SME Income Fund - FCIF), which is listed on the London Stock Exchange and has a total market capitalisation of over £320 million.

○        In April 2016, the first European securitisation of loans originated through a direct lending platform (Funding Circle) was brought to market (SBOLT 2016-1). KfW, the German development bank, bought a significant portion of the senior tranche with a guarantee provided by the European Investment Fund.

○        In June 2016, the EIB committed to lend £100 million to UK small businesses through Funding Circle - the first time the EIB has lent through a direct lending platform.

Choice and competition will further drive up standards

●        Choice for small businesses has increased hugely since the financial crisis meaning more competition now exists in the small business lending market than ever before.

●        In the last 12 months incumbents have begun to offer online access to business loans.

●        This increased competition, both from challenger players, platforms and incumbents, should have the desired impact of raising standards throughout small business finance. The constant process of new and traditional lenders and platforms improving their offering to customers helps to ensure that small businesses receive the service at a higher standard.

●        However banks continue to hold some competitive advantage, predominantly due to the fact that they hold large amounts of historic data such as current account information on small business customers.

●         The government has helped to significantly level the playing field with the introduction of the Commercial Credit Data Sharing Scheme and Open Banking, which we believe will be transformational to the way customers access financial services in time.

●         Funding Circle has also launched a number of partnerships and schemes to increase adoption amongst small businesses and tackle the ‘bank first’ mentality:

o         Relationship managers at high-street banks it is partnered with, who refer business customers directly to Funding Circle where they are not able to help. This helps the bank to retain the relationship with their customer whilst ensuring the business receives the finance they need.

o         A number of local councils are lending through the platform through treasury funds to earn a stable return.

o         Funding Circle has launched a number of strategic partnerships with organisations that work with large numbers of small businesses such as a partnership with JustEat and their ~30,000 small business restaurants.

The ability of small businesses to resolve disputes

●        Funding Circle has a robust complaints process and does not differentiate its approach in the way investors, sole traders, partnerships or small businesses of any size are treated.

●        As a fully regulated business, all complainants are dealt with under the Funding Circle complaints process which is compliant with the FCA rulebook.

●        In 2017, Funding Circle helped over 16,000 businesses to access finance. In that period it received 28 complaints with two of these raised to the Financial Ombudsman Service (FOS).

●        Currently, 90% of the small businesses it has helped to access finance are eligible to go to the FOS. Extending eligibility in the manner proposed in the FCA consultation would result in approximately a further 5% of borrowers being able to use the service (the remaining 5% have a turnover of more than £6.5 million although as already mentioned Funding Circle does not differentiate its approach towards these customers).

●        It is important that all small businesses who access finance have recourse to the FOS to resolve disputes, regardless of the regulatory status of the finance provider, to protect all small businesses and prevent regulatory arbitrage.

●        Funding Circle is supportive of initiatives that give small businesses a larger voice, and therefore supportive of the FCA’s proposal to extend the FOS.

●        Funding Circle would like to see more detail about how a tribunal system could work alongside the FOS, so would need further clarity before giving a definitive answer. However, it believes a new and separate tribunal could potentially introduce more complexity and will not be clear to customers where they should go especially as the FOS is relatively well understood by consumers.

Treatment of small businesses who are experiencing repayment difficulties

●        Since 2014 Funding Circle has had an in-house Collections and Recoveries (C&R) team which has allowed it to become a specialist at working with businesses that are experiencing difficulties repaying.

●        It is in Funding Circle’s DNA to help get businesses back on their feet whilst also protecting investor returns. Because of our model we are a natural arbitrator between both sides.

●        By not lending off our own balance sheet, we only exist because of the value we creates on both sides of the platform to investors and small businesses, creating strong alignment of interests.

●        By working with the borrower through the period of financial distress it is able to secure a higher level of recovery for investors whilst also supporting the small business owner.

●        The C&R team operates under the approach of ‘survival for revival’ and an approachable culture. The results to date show this approach is successful.

●        Funding Circle encourages businesses to communicate with it and be open during these difficult times, and works with a carefully selected panel of business advisors who specialise in business transformation.

●        Funding Circle does not seek to maximise recoveries before financial year end, since the costs of keeping impaired assets does not affect its balance sheet. Instead it looks for long-term solutions and repayments in full.

●        On average businesses take two loans across a five year period in order to continue to grow, and nearly half of Funding Circle’s revenue now comes from existing customers on both the lending and borrowing side. This highlights the importance of existing customers and why Funding Circle ensures that investors and borrowers alike are treated fairly.

Funding Circle has always been supportive of proportionate regulation

●        Funding Circle is supportive of regulation but also recognises that all small businesses have the same intention regardless of where they obtain finance, and therefore all lenders and platforms should be treated the same. This is not the case today.

●        Funding Circle is regulated to operate an electronic system in relation to lending, debt collecting, debt administration and credit broking.

●        We are supportive of the work of the government and FCA to date in relation to our core permission of operating an electronic system for lending; to have created a specific regime for this type of activity is ground-breaking and investors - both retail and institutional - have said they welcome this.

●        Consumer protection is paramount and Funding CIrcle has sought appropriate regulation since it first launched in 2010, both directly and as a founding member of the Peer-to-Peer Finance Association (P2PFA).

●        Funding Circle welcomes the FCA’s ongoing review and agrees it is extremely important that the regulatory regime develops alongside innovation in the sector. The P2PFA continues to drive high standards, requiring members to publish performance data in a consistent manner.

●        In relative terms, the sector continues to remain a small part of financial services as a whole or small business lending more specifically, and we believe the current legal and regulatory framework in which direct lending platforms operate is effective, and sufficiently proportionate to encourage innovation and serve the financing needs of small businesses in the UK.

●        Since Funding Circle is authorised by the FCA, it is also subject to the FCA’s Principles for Business (for example, Principle 6 - paying due regard to the interests of its customers and treating them fairly).

●        Funding Circle must also comply with the relevant FCA’s Conduct of Business Rules that apply to it (for example, acting honestly, fairly and professionally, and ensuring its communications with clients are fair, clear and not misleading). 

●        Funding Circle recognises that small business customers have been mistreated by a small number of lenders in the past, and these institutions were already subject to regulation. It believes the best way to eradicate such behaviour is through increasing choice and competition which in turn will drive higher standards across the market.

●        Funding Circle believes the extension of the Senior Managers and Certification Regime (SMCR) to non-banks is a positive step in ensuring all institutions are operating under the same framework. This is due to the SMCR imposing personal accountability on individuals in senior management functions and other employees in a financial services firm.

●        This could be further aided by making it clearer when companies are FCA regulated and ensuring small businesses know when they are able to go to the FOS.

The impact of Brexit on how global companies use data

●        Funding Circle takes data protection extremely seriously and supports the introduction of General Data Protection Regulation (GDPR) and related UK legislation. As a business it has prepared for the principles of GDPR coming into effect on the 25th May, and has always believed it is of the utmost importance to protect customer data.

●        Under GDPR, cross-border data transfers are generally prohibited unless a country has been deemed an ‘adequate jurisdiction’ by the EU. A country must have an adequate level of data protection to achieve this status.

●        On the basis of the proposed Data Protection Bill, we presume that the UK would be considered an ‘adequate jurisdiction’ (and so could continue to move data between the UK and the EU27).  If this were not the case, then it would present an additional headache for businesses with pan-European operations and global teams.  Also, thought should be given to ensuring that the UK will be able to maintain this status on an ongoing basis (the risk of divergence will increase over time).

Suggestions for improving access to finance for small businesses

Funding Circle recognises and appreciates the strong support the Government has given to the direct lending sector so far. It is keen to continue to work closely with Government to improve the financial landscape for UK small businesses and further enhance choice and competition within the market.

Funding Circle believes there are some areas the Government could further support in order to improve the offer that direct lending platforms provide to Britain’s small businesses. It has detailed these below.

Expanding access to Bank of England schemes to create a level playing field

●        It is not clear whether Funding Circle loans are currently Central Bank eligible, which means its institutional investors would be able to participate in schemes such as the Funding for Lending Scheme (FLS - now the Term Funding Scheme) and the Discount Window Facility.

●        Schemes of this kind disproportionately favour traditional high-street banks, which have not typically made good use of them for the benefit of small businesses, according to Bank of England FLS data.

●        Clarifying eligibility of these schemes to include alternatives would allow a wider range of investors, including banks, to lend to small businesses through Funding Circle. At present, many traditional institutions are limited by a mandate to only invest in loans that qualify for Central Bank eligibility.

●        This has the potential to make millions, if not billions of pounds’ worth of extra investment available to small businesses through the Funding Circle platform. Confirming eligibility would allow:

○        the central bank to stimulate the real economy via a direct transition mechanism;

○        the high street bank to meet their small business lending target as a condition of borrowing through the scheme by lending the money directly through Funding Circle’s platform;

○        Funding Circle to further diversify its investor base which makes for a more resilient ecosystem.

●        Conversations with the Bank of England have been positive to date but we require written confirmation that Funding Circle loans are Central Bank eligible.

Removal of state-aid rules governing the British Business Bank, allowing it to fill the space potentially left by the European Investment Bank

●        The EIB supported UK small businesses with more than £1.2 billion of investment in 2016, and uncertainty surrounding Brexit saw this fall to £582 million in 2017.

●        Through Funding Circle specifically, it has supported 5,500 British small businesses since it began lending £100 million directly through the platform in 2016.

●        Whilst Funding Circle sees a clear benefit to the retention of some form of relationship with the EIB, it also believes that expanding the capabilities of the BBB would deepen the pools of capital available to small businesses.

●        Current state-aid rules mean that the BBB is prevented from lending more than £100 million through a single platform, significantly capping further investment.

●        It is Funding Circle’s view that the UK Government should legislate to release the BBB from state-aid rules post-Brexit to provide the Government with a proven and effective means of directly stimulating the real economy in times of economic uncertainty.

●        In addition, should the Government not secure access to the EIB, it would also allow the Government to fill the funding gap created as a result.

Ensuring the UK FinTech sector has access to the best talent in order to retain position as leading global hub

●        Due to a lack of engineering talent in the UK, approximately 40% of Funding Circle’s engineering team are non-UK EU nationals, which increases to 60% when all foreign nationals are included.

●        It will be critical to maintain and expand this access to talent over the coming years, in order to retain the UK’s position as the leading global FinTech hub, and in Funding Circle’s case, continuing to help small businesses and the economy.

●        There are two policy areas which would help the UK to attract the best software engineering talent as well as develop home-grown talent, allowing the UK to continue to build on its leadership position in the tech sector.

1)       Introduction of immigration standards for UK tech companies

●        Funding Circle believes the UK should maintain access to the best high-skilled foreign talent but this is clearly a burdensome process.

●        The burden could instead be placed on companies who are hiring to adhere to immigration standards for certain defined role types and criteria. This would allow UK tech firms to compete for the best talent across the world.

●        Funding Circle would sign up to a system where the company is fined or prevented from further hiring if standards are not adhered to. This would allow hiring decisions to move at a fast pace replicating many of the benefits of freedom of movement for tech companies but on a much larger scale.

●        Funding Circle plans to provide specific information on how this system would work to government in due course.

2)       Improvements to the Apprenticeship Levy to develop home-grown engineering talent

●        Currently the Apprenticeship Levy can only be used on a narrow range of traditional engineering training courses. This means smaller companies using cutting-edge technology, such as Funding Circle, cannot use their levy funds in an optimal way.

●        The ability to use the levy to pay the salaries of apprentices and to hire a dedicated apprenticeship manager would allow Funding Circle to explore the possibility of setting up its own training programme to address the UK’s engineering shortage.

●        In addition, companies can only use the levy to fund courses that are within the upper spending limit of each funding band. If a course costs more than the upper limit, the company would have to fund the full cost of the qualification without using levy funds. For Funding Circle to send engineering apprentices to leading courses, it would be unable to use levy funding due to the upper limit.

●        By removing upper spending limits, companies could use their own judgement regarding which courses levy money is spent on, as well as ensuring that apprentices receive the best possible available training.

April 2018