Referral Process For UK Small Businesses The Banks Won't Fund

As mentioned briefly before, UK banks have been so hopeless in referring businesses they can't finance to alternative lenders that the government has decided to create a mandatory referral process.

Currently, the largest four banks account for over 80% of UK SMEs’ main banking relationships. Most SMEs only approach their main bank for finance, with around 40% giving up their search if they are unsuccessful.  A proportion of those rejected are viable businesses who simply don't satisfy the risk appetite of the largest banks. The result is that other providers of finance aren't able to help because they are not seeing the need among SMEs, and the SMEs are unaware of the alternatives to their bank.

So the government will use the Small Business, Enterprise and Employment Bill to require the larger UK business lenders to refer any SME whose finance application is rejected (with the SME's consent) to certain designated private sector platforms. Those platforms will then connect willing SMEs with participating alternative providers of finance (ranging from finance companies, to invoice discounting providers to peer-to-peer lending platforms to challenger banks). 

The platforms will need to comply with minimum standards to help ensure that SMEs are in control and properly protected throughout the process. All types of credit products offered by large banks to SMEs will be covered by the referral requirement, although there will be a low threshold below which it would be too costly to refer the funding application. Some businesses may also be excluded for various reasons that would include where the initial funding application was rejected for suspected money laundering. The proposals are also designed to complement and work in conjunction with the government policy to improve access to SME credit data, a process that is happening separately, but in parallel.

In summary, the SME funding referral programme should work as follows:

• SMEs must consent to be referred, and will have their details anonymised. Alternative lenders will only be able to see key information that would allow them to make an initial assessment of whether an SME may be a potential lending opportunity.

• If a lender wishes to explore a lending opportunity with a business, it would need to make contact through the platform and request consent to see that business’s contact details and begin a direct dialogue. Where a lender wishes to make a more detailed credit assessment, it will be able to obtain credit data from the business’s main bank via designated Credit Reference Agencies.

• Platforms will be able to exercise discretion over whether they grant financial and business advisers and other intermediaries access, but the platform must clearly notify SMEs when it is an intermediary that wishes to contact them, and not a lender.

The minimum standards for the referral platforms will be stipulated by the Treasury on advice of the British Business Bank. Standards will include: 

• data protection – to avoid excessive or misleading approaches or credit checks without consent;

• fair access to all SME lenders that agree to terms and conditions regarding appropriate treatment of SMEs contacted through the platform; and

• accountability for alternative lenders who fail to comply with the terms and conditions they sign up to when joining the platform. 

The Treasury will be able to de-designate platforms that fail to adhere to the standards. The FCA will oversee the obligation on banks to share information with platforms, and the platforms’ requirement to give fair access to lenders. Sole traders and micro businesses will be able to complain about platforms to the Financial Ombudsman Service when dealing with designated platforms. 

Further detailed regulation, including the designation criteria that potential platforms must meet, will be set out in secondary legislation following the passage of the Bill.

UK Government: Gamble All You Like, But Don't Invest

You've got to wonder about priorities at the Department of Culture Media and Sport. They allowed UK bookmakers to harvest £46 billion through betting machines last year - not to mention the bingo and lotteries freely advertised on TV - while computer games companies complained they can't offer shares to fans who crowdfund games development. 

Consider this from today's Telegraph:

• Britons gambled £46 billion on betting terminals last year, an increase of almost 50% in four years.

• Gamblers lose up to £100 every 20 seconds on the fixed odds machines.

• 588,000 under-18s were stopped when they tried to enter a betting shop last year, six times as many as 2009, and 27,000 people were challenged once they had placed a bet.

• Bookmakers made profits of £1.55 billion from the terminals between April 2012 and March 2013.

Meanwhile, even though the FCA has said that ordinary folk will be able to invest to fund the development of a computer game, for example, they must first certify that they will not invest more than 10% of their 'net investible portfolio' and either seek financial advice or satisfy an "appropriateness test". That's because they say investing is risky for consumers... 

Compared to what?!

Image from RoehamptonStudent.com. 

Do TV Advertising Rules Limit Economic Growth?

There has been plenty of research into the alleged effect of TV sex and violence on human behaviour, but how does TV adversely impact our economic behaviour? 

This issue was recently highlighted by the FCA's proposed new rules on crowdfunding. Left in isolation, the current restrictions on financial promotions suggest the State would prefer us to play bingo or buy lottery tickets than invest the same small amounts in funding the growth of each other's businesses. 

The FCA is right to point out the risks of investing in start-ups, but it should compare those risks to the risks consumers face when putting their money into other products that are more freely advertised.

We rely on small businesses for over half of all new jobs and a third of private sector turnover. Yet, those small businesses struggle for funding while over half of the UK's adults engage in regulated gambling that is designed to cost consumers far more than they 'win'.

It may be true that over half of business start-ups fail within 3 years, but they still employ at least one person in the meantime. And maybe more of those businesses would survive if we lent them some of our bingo money, or bought their shares with at least some of the money we chuck away on the ponies. Better that the money goes in wages, and the goods and services that small businesses typically buy, rather than simply to line the pockets of the bookies - and you have the chance of getting a decent return on small business loans, or if you happen to invest in the businesses that succeed in the longer term. 

No doubt someone will raise the moral panic about 'good causes' being starved of lottery money if we don't allow the promotion of that form of gambling. But I'm not talking about any ban on advertising lottery or bingo etc., just a relaxation of rules on the promotion of productive financial instruments (though it would be more efficient to simply donate a third of your lottery money directly to good causes on a crowdfunding platform than to wait for it to filter through the books of a lottery operator).

Ads for apparently 'safe' bank savings products are not helpful here, since savings rates are low and banks are not focused on lending to small businesses. We have over £200bn sitting passively in low interest bank deposits, yet banks' savings rates are below the rate of inflation, and banks only lend £1 in very £10 to SMEs. The Financial Services Compensation Scheme might protect your deposit if the bank goes under, but that's another cost that consumers end up paying for, and it won't protect the value of those deposits against inflation. Stocks and shares ISAs and pensions are similarly 'passive' investments in financial assets, rather than productive ones.

The highly restrictive approach to financial promotions has neither prevented financial scandals nor created a sound financial system - two of many reasons why people have resorted to lending directly to each other, or investing directly in each others' projects and businesses. So why not allow these new alternatives to be promoted more openly - at least to the same extent as riskier, non-productive activities like playing bingo or buying lottery tickets?

We need to move away from rules that dictate what we can do with our money, to rules that enable a fully informed choice from amongst all the options. 

At any rate, the State should certainly not create a situation where the money-related messages which the average TV viewer receives do not include investing directly in the productive economy.

Image from RoehamptonStudent.com.

Google, Amazon and The Shape of SME Finance

In November 2007 it seemed clear that facilitators like Google and Amazon would capitalise on their alignment with their customers' day-to-day activities to disrupt banking. Both of these giants already have e-money licences in Europe (I helped Amazon apply for its own), and the latest foray is into trade finance. Google will offer a line of credit for AdWords advertising spend, while it appears Amazon will lend to selected small businesses against their projected sales over the Christmas season. 

While these services may be offered initially in the US, where there are lots of small business funding options, bear in mind that only four UK banks control 90% of the small business finance market and are lending less and less to them. And while some UK banks enable some merchants to obtain cash advances against their card receivables, it's not exactly a core activity.

The competition alone must prove welcome, yet the critical feature of both the Google and Amazon services is that they are seamlessly intertwined with customer behaviour. Both businesses could have decided to launch free-standing, me-too banking services (like the UK supermarkets), but they have not done so. No doubt they also intend to attract new customers with the latest services, but only by showing that they support what small businesses want to do - namely, sell their own goods and services across a staggering array of markets and demographies.

And by patiently facilitating their customer's activities, neither Google nor Amazon needs to incentivise staff to sell services to people who don't need them, as banks have done.

SME's Shun Bank Finance Offerings

Interesting report today that "less than half SMEs have taken action [to address cashflow pressures] with 11pc hiring an in-house credit controller, 9pc using invoice discounting and 8pc factoring". There are over 4.7 million SMEs in the UK (see demographics below).

According to the Telegraph:

"Peter Ibbetson, chairman of NatWest and RBS small business operations, is concerned that so few SMEs are using banking services to alleviate the problem but small business organisations believe companies are reluctant to incur extra charges after their bank borrowing experiences."

In other words, it appears SMEs would rather leave debt on their books, taking any loss and resulting income tax deduction, than become hog-tied by a bank at rates of about 36%APR in consumer finance terms - at least that's the rate we estimated Zopa lenders would have to beat to offer attractive trade finance. That's because you should factor in (excuse the pun) the charges on any additional accounts you're required to hold as part of the finance deal, the holding cost of any deposit held as a guarantee, as well as fees and the interest rate on any overdraft, loans, letters of credit and/or factoring. SME owners are also increasingly required to take a commercial credit card, which doesn't benefit from protection from all the old dirty tricks that are gradually being weeded out under consumer banking and finance regulation.

Yet more evidence the time is ripe for an alternative source of SME trade finance?

The most recent UK government statistics (published Oct '09) show that, at the start of 2008, there were 4.8 million UK private sector enterprises of which 99.3 per cent had 0 to 49 employees. Only 27,000 (0.6 per cent) had 50 to 249 employees and 6,000 (0.1 per cent) employed 250 people or more.

Further Boost To Non-bank SME Finance

Last week, The Receivables Exchange secured $17 million in funding from Bain Capital Ventures.

I've been watching these guys since I learned of their launch in a response to my post about Zopa's trade finance efforts in November 2008. The coincidence was striking then, but even more so when they announced their integration with Ariba Network, the spend management services provider, in December '09.

Here's the video on how the Receivables Exchange works.

The key feature about this form of trade finance is that credit risk can be tied firmly to the buyer, rather than the supplier listing the invoice for 'sale'. There are various ways to understand and mitigate that risk, depending on the size of the buyer and whether it's listed/rated. I'll spare you the detail. Interestingly, the UK Treasury has just launched a consultation on how the government might support non-bank business finance, focusing on corporate credit assessment and transparency.

Of course, the primary challenge is one of marketing this model to enough time-starved small business owners to build 'critical mass' (an expresson I have come to fear and loathe) - hence the $17 million.

Definitely a space to watch.

E-invoicing Integrated With SME Finance Platform

Alternative trade finance for small businesses is beginning to snowball - at least in the US. Early this month, the Receivables Exchange announced its integration with the Ariba Network, a leading provider of spend management services.

The press release says the integration will enable SMEs "to seamlessly transfer their invoices from the Ariba Network to the Exchange’s proprietary trading platform for auction. Leveraging a cash optimizer tool embedded in the latest release of the Ariba Network, suppliers can calculate their cash needs as compared to their eligible outstanding invoices and select the invoices they want to sell to help them optimize their working capital management and improve their cash flow."

This is virtually the same model Zopa and various collaborators took to potential UK clients and partners in 2008. Marketing was the only (major!) hurdle, and we were in talks with someone very big and friendly to support it. But, as is often the way with these types of services, there were simply too many interim integration steps competing against higher core priorities for the service to go into development.

Full credit to the Receivables Exchange for getting this launched - although I still think they need a bigger brand name that is already well-known to all SME's if they are going to get real traction against the established sources of trade finance. I wish them luck.

Maybe it's a signal that Zopa and its partners should dust off their plans...

Mezzanine CoCo Means Even Fatter Banking

Two recent funding initiatives not only fail to introduce openness and transparency in the credit markets, but also add complexity, shroud risk and perpetuate the enormous fees and bonuses inherent in the 'fat banking' model that many are complaining about.

Of course, I'm referring to the new form of 'contingent convertibles' or "CoCos" issued by Lloyds Banking Group and the 'mezzanine' product to be offered by the "Growth Capital Fund".

The £7bn worth of new "CoCos" issued by Lloyds Banking Group pay interest, but convert into equity if the bank's core tier one capital ratio falls below 5%. The tier one capital ratio is itself under a cloud, given its lack of predictive value in 2007 and recent analysis by Standard & Poors that "every single bank in Japan, the US, Germany, Spain, and Italy included in S&P's list of 45 global lenders fails the 8pc safety level under the agency's risk-adjusted capital (RAC) ratio." Furthermore, the ABI says it doesn't like these CoCos being included in bond indexes, because this would "effectively require some bond investors to buy these instruments and subsequently to become forced sellers if and when they convert into equity." It's worth noting that the UK government has had to invest £5.7bn (net of underwriting fees) just to avoid dilution of its 43% shareholding amidst the wopping £13.5bn in new shares. That underwriting fee must be enormous, no doubt made more so by the complexity of the new instrument.

CoCos are a type of convertible bond and are not really new. They started life as bonds that paid interest, but converted into equity if the issuer's share price hit a certain number. Apparently they were first issued by Tyco in 2000. They were popular because CoCos were not included in the diluted earnings per share calculation. However, their favourable treatment was removed and they more or less died out. Some also expressed concern about adequate disclosure of the risk that the contingency would occur, and the future impact of the conversion into equity... seems nothing has changed.

Meanwhile, Messrs Brown and Mandelson have also welcomed the recommendation for new "Growth Capital Fund" to allow medium sized businesses to publicly offer "mezzanine" debt - lending that is often unsecured, and ranks behind bank debt but ahead of equity on insolvency. Apparently, this product "would help address demand side aversion to pure equity, and provide a return above regular bank lending to reward investors". You can guess the reason for the premium to regular bank lending, and why it ranks behind banks. The Growth Capital Fund is designed to plug a "permanent gap" existed for up to "5,000 businesses" looking to raise between £2m and £10m in growth capital." It is noted that "neither banks nor equity investors were likely to fill this gap in the near future." They know that where you rank in an insolvency without security is largely academic, and there remains the very real issue as to how to effectively monitor the ongoing creditworthiness of a mid-tier company. Perhaps the proposed 'single fund manager' might find a solution. But I'll bet it will just sit there gathering money and sending statements to forlorn investors confirming the steady deduction of its fee as a percentage of gross funds under management. Already, Lloyds bankers say they are interested, no doubt hoping to recover some of their recent underwriting fees.

So it's clear that neither of these relatively complex instruments do anything to promote openness and transparency in the financial markets, but instead continue to funnel investment opportunities to intermediaries who can rely on their privileged regulatory position to charge enormous fees.

There are alternatives. At Zopa, for example, we helped figure out an invoice discounting process that is an easily understood, low margin alternative for SME trade finance, open to all - as is the Receivables Exchange. The challenge is marketing such low cost alternatives to busy SMEs amidst all the noise of the usual banking and investment marketing. Low margin financial services providers can't afford fancy advertising campaigns or to arrange open endorsement by Messrs Brown or Mandelson. Yet, to put an end to 'fat banking' and concentrated, poorly understood risk, we need to promote such open investment marketplaces, using instruments that are more easily understood and widely accessible.

Surely that's a challenge the government could help address, rather than lining bankers' pockets.

EU Public Sector Pays Too Slowly

It's SME Week in the EU, and finance is very much on the agenda, with all sorts of chat about micro-finance and other funding.

But the fundamental problem is that SMEs don't get paid on time.

In fact, given their limited cashflow, even early payment of invoices is actually highly beneficial.

And while we've had plenty of legislation on the subject, and governments have bailed-out the banks, still the European Payment Index survey of over 5,000 European businesses reveals that the public sector takes an average of 37 days longer than the private sector to pay business invoices. So it's high time the Accounts Payable staff in public sector bodies got their act together.

Imagine! A lean public sector that pays on time!

Other, general, findings in the Intrum Justitia report include:

• only 50% of all invoices are paid within 30 days, down from 53% last year, with 70% of respondents expecting that number to decline in the coming year.
  


• 2.4% of all invoices have to be written off as bad debt, an increase of 0.4% or €20 billion on last year.
  


• If all invoices were paid on time and in full, the money saved would equate to a liquidity injection of €270 billion into the European economy.

PS: The Irish government has changed its terms to pay on 15 rather than 30 days, though there is some doubt as to whether this will sound in practice.

Early Payment of SME Invoices

Today the FT reports that "88 per cent [of traders surveyed] reported bigger companies not paying on time – a factor that 72 per cent said had a serious impact on their business."

Early this year I was involved in discussions about a way for individuals with surplus cash to enable SME's to get their invoices to big corporates paid early - and at rates that are competitive with SME's current financing options, represent a great return on people's spare cash, and allow big corporates - and the public sector - to extend their payment terms. This would be additional to SME's current financing options, rather than interrupting or replacing them.

The parties required to implement the necessary process agreed how it should work in detail. Their remaining challenge was finding the SME-facing brand necessary to market the service effectively. Early discussions with the perfect brand yielded some progress, but ultimately launch depended on another of their initiatives progressing.

One way it could work, in basic terms, is that the supplier offers to assign the invoice to Zopa or a collection agent for the benefit of the Zopa members who chip in to pay it early. Notice would need to be given to the corporate buyer to pay the invoice amount to the Zopa members' account. Someone at Zopa would also need to call the corporate buyer to ensure it was happy with the arrangement and confirm the date the buyer is promising to pay. That promised date could go on the invoice listing. Zopa members could then study the listing and decide what discount rate to offer (credit reference data would be available for those that want it). There would be an auction, so pricing would be very transparent.

There's another model that would work in reverse, with buyers posting invoices it's prepared to pay - with a promised payment date - to suppliers' accounts. The suppliers could then hit a "Pay Me Now" button that takes them to the Zopa site where their invoice could be listed etc. While that model is certainly technologically possible now, I suspect that it would follow once people got the hang of the supplier-driven process.

At any rate, if you're a supplier to big corporates who's frustrated by their extended payment terms, why not contact Zopa and say you're interested in either model I've described?

Maybe the continuing explosion of the late-paying problem, coupled with falling savings rates on people's spare cash, will hasten the implementation of this solution.

B2B Lending

Gartner has recently warned banks that consumer peer-to-peer lending platforms are a force to be reckoned with. Any business with a UK consumer credit licence can lend directly to consumers at Zopa, but the timing also looks good for SME's to get into their own peer-to-peer market without the aid of the banks.

A recent survey commissioned by Belgian bank KBC amongst businesses with turnover of £10m to £1bn suggests that UK businesses are continuing to borrow, even at higher rates.

“The people in the real economy, not the financial economy, are saying: ‘We’re still going, but financial fuel is going to get a lot more expensive for us,’” said Cameron Marr, general manager of the London branch of KBC Bank.

At the same time, however, 70 per cent of respondents expect credit to become less easily available. They foresee the cost of borrowing rising and loan covenants becoming tighter. The number of corporate defaults is expected to increase."

Necessity, as they say, is the mother of invention...

Join the Quest for the Source of EU Legislation

This is the Last Straw. I've just seen "micro-enterprise" defined in a document called "2005/0245 (COD) LEX 797" as:

"an enterprise, which at the time of conclusion of the payment service contract, is an enterprise as defined in Article 1 and Article 2(1) and (3) [oh, don't forget 2(3)!!] of the Annex to Recommendation 2003/361/EC".

I'm thinking of launching a Quest to find those responsible for this latest gobbledigook and demand to know in plain English what "micro-enterprise" was intended to mean, without referring me anywhere else.

But where to start?

In 2005, the UK's Better Regulation Commission produced a fascinating, literal "map" of what we might really loosely describe as the 'European Union legislative process'. See especially page 14.

I'm not being sarcastic here. The report is a veritable base camp from which to begin the quest for the source and true meaning of EU legislation. It provides a guide, pack animals, tents, rope, torches and other basic tools. The rest of the specific search is down to good eyesight, a laptop or PC, broadband, physical fitness, strength, caffeine, food, and several towels that can be soaked in ice cold mountain springs and wrapped tightly around one's head. Oh, and a journey to Brussels. With a lobbyist.

Are you in?

It will be very crowded, but ours will be lonely work. Listening amidst the din of countless institutions and committees for the mystical whisper known as the "Social Dialogue". For it is only in that stream of semi-consciousness that we may dare to even hope to find the truth of the coded messages embedded in the "stakeholder input", "advice", "green papers", "proposals", "adoptions of proposals", "opinions", "consultations", "co-decisions", "common positions" and, ultimately the Regulations and Directives that emerge six or seven years later to drive us to distraction.

No?

Yeah, sod it. I'm staying in London to earn a crust.