What are the legal issues to consider when setting up an alternative lender in the UK?

Continuing our series of articles on alternative lending, Stephen Moller introduces the legal issues to be considered when setting up an alternative lender in the UK.

The threshold question for any alternative or non-bank lender is whether its lending business will involve a "regulated activity" in the UK and will therefore need to be authorised and regulated by the Financial Conduct Authority.  While making a loan to a company for its own business is not a regulated activity, carrying on the business of lending to individuals will be a regulated activity unless the business purpose exemption (or another applicable exemption) applies. In addition to the regulatory perimeter analysis, new entrants into the alternative lending market have to a navigate a range of legal issues from AML/KYC compliance to intellectual property and privacy considerations.

Alternative lenders are generally dependent upon external funding to build their loan portfolios. While a number of different potential funding models exist, the current market largely consists of debt funding lines provided by banks, funds and other institutional investors. The funding line will normally feature a revolving period during which the facility can be drawn to fund the purchase or origination of new loans which meet pre-agreed eligibility criteria followed by an amortisation period. Typically, the  funding line will be a securitisation for the purposes of the UK and EU Securitisation Regulations giving rise to risk retention, due diligence and reporting requirements.

The requirements of potential funders should be built into the alternative lender's business from the outset. For example, the alternative lender's standard lending and security documentation must address the issues typically covered in a due diligence report provided to a funder. The alternative lender's policies and procedures in relation to origination and collection must also be fit for purpose from the funder's perspective. If a problem comes to light during the due diligence process, it may be too late to correct it. The group structure of the alternative lender should also be designed with the requirements of funders in mind, with different issuers or borrowers for different funding lines and the servicing function conducted by another group company.

Other issues to be considered when setting up an alternative lender, include employee incentives, tax, insurance requirements, outsourcing arrangements and any cross-border aspects. There is also the question of whether the alternative lender would, in fact, be better off being  authorised and regulated as a bank/credit institution. 

This article  provides an overview of legal issues which any alternative lender should take into account in its business model. It is essential reading for anyone who is thinking about entering the alternative lending market.

Read the full article Setting up an Alternative Lender.