When the government first announced plans to launch the Innovative Finance ISA (IFISA) in mid-2015, it marked a turning point for the peer-to-peer finance sector. Once considered to be a fringe element of the financial market, this new ISA status promised to bring P2P platforms into the mainstream.
But the regulatory road has been long and arduous to say the least. In order to offer the tax-free wrapper around P2P investments, platforms need full authorisation from the FCA before they can apply to HMRC for an ISA manager licence.
All platforms launched before 2014 (including the eight members of the Peer-to-Peer Finance Association) had interim approval from the Financial Conduct Authority (FCA), as the sector had previously been overseen by the Office of Fair Trading.
All of the big lenders have applied for full FCA approval but last week, Lending Works became the first major platform to receive authorisation, paving the way for its launch of the IFISA.
“To receive FCA full authorisation marks a momentous day for Lending Works,” said the platform’s chief executive Nick Harding. “This achievement is the culmination of what has been an intensive journey for us over the past year.”
As of Monday 17 October, the other big P2P platforms are still in the dark as to when they might receive the green light from the City regulator. It’s safe to say that the application and approval process has taken much longer than anyone expected.
Under usual FCA rules, approval can take up to 12 months and most lenders filed their applications between September and October 2015. However, there have been delays given the backlog of applications and the heightened due diligence involved.
Speaking to Peer-to-Peer Finance News after Lending Works received approval, FCA spokesperson Mark Dixon said: “Each firm’s application for authorisation is considered on its own merits. We will communicate our decision to each applicant firm once we have completed our assessment of its application against the threshold conditions.”
Before they can offer their own IFISA, each and every P2P platform has had to undergo unprecedented scrutiny by the FCA – in fact, for some of the smaller platforms this has been their first direct experience with the regulator. Unsurprisingly, there has been a steep learning curve for both parties, as the regulator gets to grips with the unique world of P2P lending and the platforms discover that when it comes to regulation, nothing happens quickly.
“There was initially a general expectation on all platforms that we had a decent chance of seeing some platforms approved before the end of the tax year, but obviously that didn’t happen,” says John Battersby, head of policy and communications at Ratesetter.
“There has been a massive exchange of information,” he adds. “The FCA has been very thorough in what they have done which I think is a good thing.”
Back in April 2016, a number of smaller and newer platforms appeared to leapfrog the bigger brands by winning the first wave of IFISA approvals.
“We’ve been approved under the interim arrangements which we were told was the quick way of getting FCA approval,” says Kevin Caley, co-founder and chairman of ThinCats. “Little did we know that the long way would end up being a lot quicker.”
The “long” route to FCA approval was to apply as a brand new entity, which would receive both FCA approval and IFISA status at the same time. As it turns out, without any active customer base or historical accounts, these new platforms were much easier to assess.
“I think the reason that they’ve gone through so quickly is probably because they’re newer so there is less for the FCA to go through,” says Battersby. “A new business is just much cleaner.”
While the FCA was still wading through a mountain of paperwork from the established platforms, emerging firms such as Crowdstacker and Crowd2Fund were already marketing their IFISA offerings. Crowdstacker told Peer-to-Peer Finance News last month that 50 per cent of its investment comes through the IFISA product – an exciting prospect for the larger platforms awaiting approval.
According to ThinCats’ Caley, more than one third of their active members have stated an interest in the accounts, while a number of established financial brands are developing their own P2P platforms in order to gain access to this potential customer base. Hargreaves Lansdown is currently working on its own P2P offering and there is a sense that IFISA demand could be extremely lucrative.
“The demand is there. Interest rates on cash are virtually zero in most cases so P2P loans offer attractive headline rates,” says Danny Cox, a financial planner at Hargreaves Lansdown.
“On the face of it the P2P industry is looking at half a trillion pounds of ISA money that could be coming their way but the reality is that the amount of money lent is only going to be matched by the money that is being borrowed.”
Hargreaves Lansdown plans to address this gap by offering business loans and by giving borrowers the chance to secure their loans against their existing investment accounts. The platform is set to launch in early 2017, and the firm hopes that it will have its IFISA approval before then.
Once the licenses are finally approved, the platforms will face a new challenge – managing the risk expectations of their client base. Unlike other types of ISA investments, it is not simply a matter of warning investors that the value of their capital may go down as well as up; in a peer-to-peer loan, the risk is that they could lose their capital completely. This has led some high profile people to issue very public warnings about P2P investments.
In July, Andrew Bailey, the chief executive of the FCA, told a Treasury select committee that he was “pretty worried” about the way P2P lending is sold to consumers, and earlier this year former FCA chairman Lord Turner said that “the losses on peer-to-peer lending which will emerge within the next five to ten years will make the worst bankers look like absolute lending geniuses.”
These statements received a lot of publicity at the time, and P2P lenders have been keen to stress their risk management credentials ever since. The default rate is still very low across the industry, and each platform has their own way of minimising these risks. Ratesetter claims that no investor has ever lost a penny with them, as a result of their multi-million-pound provision fund, while other platforms opt for secured loans in an effort to mitigate risk. However, it will be down to each individual platform to properly educate their clients as to the realities of IFISA investing.
“We definitely do have a job to explain to every single investor that their capital may be at risk and they may lose their capital,” says Caley.
“We have to do a lot of work to educate people and let them know what they’re getting into. I think on balance the risks are quite acceptable compared to the markets which are subject to economic forces.”
Ratesetter’s Battersby agrees, stating that “our view is that we are substantially less risky than stocks and shares as an asset class.”
While stocks and shares investments are at the mercy of market movements, P2P investors will either receive interest on their capital (present market rates are between five and nine per cent), or they will lose their capital altogether. For many retail investors, this is an unfamiliar type of risk and it may not be suitable for everyone.
“For most people, they should spread their investments and spread their risk,” says Cox. “They need to understand that in most cases P2P loans are illiquid so taking your money out is not easy, whether you have it in an IFISA or not.”
The success of the IFISAs will very much depend on the interest rates available and the risk profile of the retail investors, who will require a significant amount of education and explanation. If successful, IFISAs could transform the industry, making high quality loans available to lenders and borrowers alike, and place P2P lending on the radar of every taxpayer and investor in the country.