Innovative Finance Isa: peer-to-peer lending enters the Isa sphere

  • Innovative Finance Isa allows access to P2P loans
  • P2P is seeing exponential growth
  • You can only invest in one P2P lender in any given year

The new tax year will see the launch of the latest innovation in the tax-free savings and investment space: the Innovative Finance Isa. Announced in the 2014 Budget, the Innovative Finance Isa will be a third branch of the current Isa format that will allow investors to incorporate peer-to-peer (P2P) loans into their portfolios.

The launch, heralded by those in the P2P industry as a watershed moment for this burgeoning asset class, represents a seal of approval from the highest authority in the UK - the government.

PEER-TO-PEER LENDING: UNDERSTANDING THE RISKS

However, like all investments, P2P loans have risks attached, and potential new investors should understand those risks fully before diving in.

The Innovative Finance Isa, to be launched on 6 April 2016, will allow investors to include P2P loans in their Isa portfolios. P2P loans allow savers to lend directly to borrowers, usually through online platforms where providers pool and distribute funds. Anyone can become a lender for as little as £10.

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Borrowers can apply for loans through a provider's website. These loans should not be confused with equity crowdfunding, where individuals invest in start-up companies in return for a share of future equity - the latter is considered higher risk than P2P loans and can't be included in an Innovative Finance Isa.

Although the Innovative Finance Isa is different from the existing two forms of Isa (cash and stocks and shares), it will be subject to the same total annual Isa savings allowance of £15,240.

Currently, Isa savers can split this allowance any way they choose between a cash account and a stocks and shares account. From 6 April they will be able to do so across the three types of Isa. They can put money into only one of each type of account in any single year.

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Draft legislation produced by HMRC in December 2015 hints that, in addition, savers and investors will be able to transfer balances from either cash Isas or stocks and shares Isas into an Innovative Finance Isa, although as of 4 March, this is yet to be confirmed.

The draft legislation also indicates that investors will be able to access Innovative Finance Isas through existing P2P lenders. These lenders will then be able to offer access to their loan books, meaning that investors can only access one lender through any one year's Innovative Finance Isa.

To offer Innovative Finance Isas, P2P lenders must be authorised by the Financial Conduct Authority (FCA), which took over regulation of the P2P industry from the now defunct Office of Fair Trading in late 2014.

Due to this relatively recent switchover, however, as of 4 March, only a handful of P2P lenders were FCA authorised - and none of these were are among the more well-known providers.

AUTHORISED PROVIDERS

The industry trade body, the Peer-to-Peer Finance Association (P2PFA), has eight members which it claims represent 92 per cent of the P2P industry. Three are the so-called 'big three' lenders: Zopa, Ratesetter and Funding Circle. However, none of the eight are FCA authorised.

The P2P providers currently authorised include Formax Credit, Crowdstacker, Investden and Crowd2Fund (not all of these are offering the Innovative Finance Isa though).

potential-innovative-finance-isa-providersThe situation is, however, changing daily, and most lenders - particularly the biggest - say they are confident they will have full authorisation by 6 April.

Investors can consult the FCA register if they are concerned about a P2P provider's status.

The introduction of the Innovative Finance Isa reflects the UK government's desire to encourage and support new sources of individual and small business financing, due in large part to the banks' reticence to lend to these segments of the economy following the financial crisis.

This dearth of traditional lending has resulted in exponential growth in the P2P industry. According to the P2PFA, as of December 2015, more than £4.4 billion had been lent to UK consumers and businesses through P2P platforms. The figures suggest the sector will double in size every six months in future.

Most providers expect the introduction of the Innovative Finance Isa to boost the industry further. 'We've only been going since June 2015, but we're seeing an acceleration in preparation for this.

'We launched two businesses in late February and saw quite high demand for them. We think a lot of it is in preparation for the Innovative Finance Isa,' says Karteck Patel, founder of small-business lending platform Crowdstacker, one of the few P2P providers to be fully FCA authorised.

Colin Hodges, head of investor operations at Ratesetter, takes a similar view. He says his firm is 'expecting a significant takeup' of the Innovative Finance Isa, potentially in the 'thousands'.

RISKS AND REWARDS

The abysmal rates offered on cash deposit accounts since the financial crisis, due to the Bank of England's quantitative easing and ultra-low interest rate policy, have played a key role in the growth of the P2P industry.

While a cash deposit account currently earns around 1 per cent a year, P2P providers offer annual returns of between 3 and 10 per cent, as well as low minimum investment requirements.

However, the comparison with cash is problematic as, unlike cash investments, P2P investments are not protected by the Financial Services Compensation Scheme, which will reimburse savers' losses up to £75,000 should a provider go bust.

Despite this, the industry has attracted large numbers of those who, before 2008, might have been more likely to save in cash Isas. Average investments on Ratesetter and Zopa are around £5,000.

According to Hodges, a recent survey conducted by Populus suggests that one in four cash Isa holders are considering moving their cash to an Innovative Finance Isa when the product is launched.

Innovative Finance Isa ISSUES

One potential problem with Innovative Finance Isas is that, as mentioned, HMRC legislation means only P2P lenders will be able to offer them, granting access only to their individual loan books (in contrast to fund platforms that enable stocks and shares Isa investors to spread their investments across a range of funds from different managers).

This means investors are limited to investing through one P2P lender in any given year.

Jake Wombwell-Povey, founder of P2P platform administrator Goji, is particularly unhappy about this and is lobbying HMRC to allow all Isa providers - particularly aggregator platforms - to offer Innovative Finance Isas. In the meantime, the potential for diversification is limited to the opportunities available through a single lender.

Wombwell-Povey says investors should fully investigate the loans on offer: 'Really try to understand the loans platforms invest in. Away from the bigger platforms, it's not always clear what investors are exposing themselves to - and that's important, because they have to know whether they are getting into small individual loans or property lending, for example.'

It is also essential that investors look into the company itself. While the P2PFA's eight members represent more than 90 per cent of the industry, the trade body says there are around 70 providers in total in the UK alone, underlining the fact that many small and potentially high-risk providers are operating in the market.

As with all financial products, potential new investors in P2P loans should investigate the asset class as fully as possible before parting with any money. An Innovative Finance Isa investment is not without risk. For those already invested in Isas, however, the Innovative Finance Isa will be a welcome addition to their tax-free investment options.

KEY FACTS FOR Innovative Finance Isa INVESTORS

  • To be launched on 6 April 2016
  • Allows tax-free access to peer-to-peer loans, but not to equity crowdfunding
  • Subject to an annual £15,240 Isa allowance, which can, in addition, cover one cash and one stocks and shares Isa
  • May allow investors to transfer existing cash Isas and stocks and shares Isas
  • Accessed through existing P2P lenders, so offers access to one lender only
  • Will be subject to legislation that has not yet been finalised

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