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Tomorrow's HNW Clients Will Be Glad Shadow Banking Is Entering The Limelight

Tom Burroughes

4 June 2014

Sometimes referred to as “shadow banking” or “alternative funding”, the sector that finances business outside the traditional marbled halls of banking has become more noticeable as bank lending is squeezed by regulatory capital controls.

And for any wealth management firm wondering where its future clients are going to come from, it is essential that investment in new firms continues. If small and medium sized enterprises are starved of funding, there will be fewer liquidity events for wealth managers to tap into in the long run. Wealth managers have a very clear interest in ensuring capital finds those able to use it.

It is generally encouraging, therefore, that the non-banking sector has displayed so much entrepreneurial energy. And it is also unsurprising. Capital, like water, finds its level sooner or later, however hard regulators try to control it. If banks can’t, or won’t, fund businesses, others assuredly will. The upshot, of course, is whether alternative providers are prudent and if clients understood what’s at risk.

The non-banking sector covers a wide front: peer-to-peer lending; crowdfunding; angel investing, venture capital and pension scheme-backed financing. While there has been a media hype around areas such as crowdfunding, not all of these areas are particularly novel – often the only really new element has been the ability to harness the wonders of the Internet to put providers of capital in touch with the demand side.

According to a report by the Economist (10 May), the business of direct lending or private debt is booming; investment funds making loans in this space lent $97 billion worldwide in 2013 and are due to overtake that figure this year. Peer-to-peer lending, about which the UK authorities have sought to tighten controls recently, is a fast-growing sector. The value of loans organised by Lending Club, a large organisation in this sector, totals now over $4 billion; that organisation has been around since 2007 (source, The Economist). And let’s not forget that one of the most traditional forms of non-banking funding for a business is called the equity market.

Use a pension
Among recent developments has been the alternative funding space. The UK government, in its March budget of this year, proposed to ensure that if a request for funding by a bank is rejected by a bank, the request must be passed to an alternative funding portal.

One of the businesses operating in the “alternative funding” space is , a founder of a UK-based network called Alternative Business Funding (now containing eight members, with more due to join). Adam Tavener, chairman, is a bullish advocate of this market and explained how small and medium-sized firms can unlock pension fund assets to fund financial needs, with a business’s intellectual property as collateral. (Under official rules, movable physical assets such as a car or piece of machinery aren’t eligible as security.)

"There is a tremendous amount in the pensions industry - about £2 trillion ($3.34 trillion) - and about £100 billion of that is from business owners,” he said in a call to this publication.

"We fund on average around 20 to 30 businesses every month; we have funded about 2,200 so far, with a total involved of around £230 million," he said.

After the-then Labour government in the UK initiated legislation in 2004 to facilitate pension-backed company funding, the market got going in 2006 with the “A-Day” reforms of that year.

A firm such as Clifton acts as an arranger: it will calculate what a would-be client's pension fund is worth; pensions that can provide the money can include the client's private pension schemes, such as SIPPs, as well as defined benefit schemes. The affected pension money must be that of the business owner and not from others, given the obvious need to protect outside parties from misuse of such funds (as infamously happened with the disgraced media tycoon Robert Maxwell in the late 1980s).

When providing financing, Clifton will ensure that the pension fund in question holds a right to a business's intellectual property as collateral; the IP is valued independently by a third party. The financing takes the form either of a loan or a sale and leaseback agreement. Depending on the type of funding, duration can be up to 10 years.

Not all proposed funding will be accepted: much depends on the riskiness of a business. To ensure the commerciality of a transaction, Clifton will calculate what would have been the interest charge that a bank would have imposed to see if the risk is bearable or not.

Luxury items for lending
At what perhaps might be the other end of the spectrum, where individual cash needs are involved, are a clutch of firms offering collateralised finance where valuables such as jewellery, art, classic cars and other items are put up on a loan. This has sometimes been described, with typical media cheeky play on words, as “posh pawn” – referring to the traditional pawnbroking industry practice of providing hard-up people with small sums of cash in return for holding jewellery. The collateralised lenders whom this publication spoke to argue they are very different animals and reject the “pawnbroker” tag completely.

One example of a new firm operating in the collateralised lending space is first charges on property to around 15 per cent for high LTV second charges on property and more unusual assets (eg classic cars, fine wine)," he said.

To compare, a spokesperson for , elaborating on its charges, said the current rates are as follows: "Monthly interest is from 2.49 per cent up to 5.99 per cent per month; fees range from 2 per cent up to 12 per cent (depending on the asset), although a typical fee is 5 per cent. Insurance and storage costs are included here but are factored in depending on the asset type. For example, supercars, wine and fine art even some antiques will need to be stored in de-humidified storage."

So how does all this differ from pawnbroking?

“Pawnbroking, in many minds, is about going into a shop with a gold watch or something similar that is worth a few hundred quid and getting some money in return for later getting the watch back, but usually in the knowledge that you probably won’t be able to get the watch back,” Shaw said. “I do not, by contrast, expect borrowers and borrowers can borrow in mid-double digits,” he added.