TrustBuddy breaks trust

The recent collapse of the Swedish P2P lender is a cautionary tale for investors.

All good things must come to an end. For the last few years, alternative finance has enjoyed a honeymoon, where nothing could go wrong and opportunity was boundless. But a developing scandal in Sweden is a reminder that peer-to-peer (P2P) lending and crowdfunding is not for the faint-hearted and that caution is always needed.

P2P lending platforms have gone bust in the past. For example, a small student-focused outfit called GraduRates went under in December 2014. However, the blow-up a few days ago of TrustBuddy, a Swedish payday P2P lending platform, is in a different class to anything that's gone before. TrustBuddy had what seemed like a profitable business model lending short-term cash to consumers at more reasonable rates than Wonga. It was founded in Sweden, but had moved across Europe with its online offering and listed on Nasdaq OMX, the Stockholm market.

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A Swedish scandal

Now, it all seems to have gone wrong. On 12 October, the board of directors informed Nasdaq OMX and the Swedish financial regulator of suspected misconduct by the company's former management team, which was replaced in September. TrustBuddy has reportedly been using lenders' capital "in violation of their instructions", or "without their permission". It seems that client money has not been held in accounts that are separate to the company accounts and there is a Skr44m (£3.5m) discrepancy between the amount that the platform owes to lenders, and the available balance of the client bank accounts.

In addition, it seems that, of the Skr300m that has been lent out by the platform, Skr37m is not assigned to lenders. TrustBuddy had also apparently been reassigning existing loans (a significant portion of which were non-performing)to new capital deployed by lenders.

It's not exactly clear how either of the above forms of misconduct played out, but both are in clear violation of internal and/or external regulation. The new management team's investigation has indicated that all of the above practices are likely to have been in place since TrustBuddy began operating.

Clearly, this is bad news for TrustBuddy's investors and shareholders. The Swedish regulator demanded that TrustBuddy cease offering its services with "immediate effect". All TrustBuddy services have thus been suspended, meaning investors may not currently make any withdrawals or deposits. Trading in the company's shares was halted on 7 October. A planned rights issue which was scheduled to run from 14 October until 30 October has been suspended. The board of directors has apparently filed a report on the matter with the Swedish Police Authority.

Now, it's important to say that TrustBuddy had a very different model from the mainstream alternative finance platforms here in the UK. It was effectively a payday lending firm using technology to leverage a pan-European business. That's very different from the big mainstream platforms such as Zopa, Funding Circle and RateSetter. But I'll put my hands up and admit that I was surprised by the TrustBuddy story.

I'd written in various places, including MoneyWeek, that its model seemed interesting and the shares compelling. Luckily, I sold out my shares at the end of last year after the company had a run-in with the regulators in Denmark but I'm still at a loss to explain what went wrong.

So what can we learn from this meltdown? One question at the forefront of my mind is how a platform involved in an incredibly high-margin business (lend out for hundreds of percent but give investors 12%) could lose money so spectacularly. Is the hard truth that lending to deeply subprime consumers is simply a mug's game? And if neither Wonga in the UK (which announced a £37m loss in August) nor TrustBuddy in Europe can make a robust business franchise out of lending to poorer customers, what hope has anyone else?

Lessons for lenders and platforms

More broadly, investing in alternative finance is not saving (notwithstanding the fact that P2P lending will soon be permitted in Isas, which may lead some to view it as similar to a savings account).It is risky. That doesn't mean that it's only for spivs and speculators, but it should be a home for only a small percentage of your total portfolio.

From the other side, alternative financiers need to think carefully about public markets and initial public offerings. It now seems that TrustBuddy was too immature to list on the stockmarket and corporate governance was weak. What rules need to be in place? Should firms be at least three to five years old before listing?

I still think the potential to make decent returns is real. There are platforms making compelling margins. For example, on the day the TrustBuddy story broke, UK P2P lender LendInvest announced its latest results, reporting its second annual profit only two years after launching (£3.1m off revenues of £15m). LendInvest is not yet listed, but there are rumours that it might float in due course. But TrustBuddy's woes are a reminder that we need to focus on how viable individual platforms are, rather than just how much they have lent.