What is marketplace lending?
Following the financial meltdown of 2008, banks substantially curbed their lending activities due to increased government regulation as well as overall risk aversion. To fill the vacuum, non-bank lenders emerged, leveraging financial technology or fintech applications to create online platforms that serve as virtual financial centers where lenders and borrowers from around the world gather and engage in what is known as marketplace Lending. There are marketplace lending platforms for a variety of purposes including consolidation loans for individuals, small business loans, financing for investment properties or commercial real estate, and even loans for physicians. Lenders range from individuals to accredited and institutional investors.
How does it work?
Those seeking to lend and borrow money enter the marketplace through an online portal that performs all the administrative functions of a traditional bank, such as borrower screening and application processing. As with many structured finance vehicles, marketplace lending platforms are often owned by special purpose entities with separate balance sheets that are typically Delaware limited liability companies or Delaware statutory trusts. Using these ownership structures increases lender confidence that, in the case of a bankruptcy, they will not be competing with numerous unknown creditors of the platform sponsors or others.
How are lenders’ interests protected?
In most marketplace lending programs, borrowers don’t pledge collateral for their loans; that could become very complicated, involving piles of paper, notarizations and public filings, and drive up the legal and administrative costs of the program. Lenders and the platforms (also known as issuers) execute promissory notes called borrower payment dependent notes, which are debt obligations tied to the performance of the loans. The lender agrees it will only be repaid to the extent the issuer is able to collect from the borrowers. The issuer is afforded a range of options to maximize collections from borrowers including the ability to modify payment schedules and even to forgive a portion of the debt.
To protect the interests of lenders, marketplace lending issuers enter into a legally binding contract called a trust indenture which appoints an indenture trustee to enforce the terms of the borrower payment dependent notes. Public offerings must be registered with the Securities and Exchange Commission and are governed by the Trust Indenture Act of 1939 that mandates a basic form of trust indenture. An indenture trustee’s most essential duty is to have the power to pursue certain remedial actions with respect to the issuer upon an event of default as defined in each trust indenture. Having an indenture trustee gives lenders comfort that, if the issuer causes an event of default, an independent third party will be in place to protect their rights.
Where is marketplace lending headed?
It has been said the only constant in life is change and we should expect that marketplace lending and other fintech applications will continue to evolve to meet the needs of the financial world. For example, tech developers are currently working on ways to revolutionize secured financing by holding and transferring collateral on the blockchain, which consists of electronic record keeping blocks designed to prevent data modification. This may someday eliminate much of the red tape and cost associated with securing collateral. When we see how much the world of finance has changed since 2008, it’s almost unimaginable what innovations await us in the future.
How can we help?
Delaware Trust Company, a Delaware state chartered trust company and wholly owned subsidiary of CSC, is a leading provider of indenture trustee, Delaware statutory trustee, and custodial services for marketplace lending and other fintech programs. Please visit cscgfm.com for more information.