How the SEC Custody Rule is impacting Alternative Finance and Investors

Scaling Institutional Investment in Trade Receivables requires creating Infrastructure and that includes Custodians (and not the janitorial kind).

There are two big areas of third party alternative finance lending opportunities.  The first is marketplace lending which is more developed than the second, funding approved invoices from B2B Networks (and that includes purchase to pay capabilities around eProcurement, eInvoicing, business information networks, etc.)

Unless you develop the infrastructure, including custody services around this, you will not scale institutional investment in this space.

I recently spoke with Meg Zwick, Director of Alternative Custody Services from Millennium Trust Company to talk about what they have done in this space.  Millennium Trust Company offers niche alternative custody solutions to institutions, advisors and individuals.

I asked Meg how Millennium got started.  In 2011 they were approached by Lending Club who were offering pooled funds in the peer to peer loan space and needed to meet the requirements to the SEC Security Custody Rule.  Lending Club got in touch with Millennium and that is how they got introduced into this space.  Millennium really helped pioneer electronic custody in the peer to peer space and is providing custody services at the pool level and then doing independent reporting to investors.

Meg mentioned the watershed moment for Marketplace lending was when both Lending Club and Prosper registered their issued notes with the SEC as securities which in turn made the notes subject to the SEC Custody Rule.Meg mentioned that it didn’t take long for investment managers to begin structuring private funds or separately managed accounts (SMAs) that invest in marketplace loans, and the first securitizations of these loans occurred roughly one year ago.

So getting back to scale, the big question is who act as fiduciary for investors? That is a critical question.  Technology guys are just  platforms executing typically their client (large corporate buyers) wishes.

SEC Custody Rule was passed by Congress as part of the Dodd Frank act.  Simply put, advisors cannot have complete control over clients and investor assets, that includes anything defined as a security.  It also required third party reporting to investors, either via a custodian or having an independent audit.

When you get into AltFin, it is tricky to find a custodian.  Banks, Broker Dealers, and others are not equipped here.   The Advisor cannot sell an asset without the Custodian’s consent.  This is a critical control point.

As institutional money continues to be attracted to the alternative finance space, investors must have the assurance that operational systems are sound.

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