Is innovative finance worth the risks?

  • Innovative financing Isas invests in P2P loans that can pay attractive interest rates
  • This type of debt carries a number of risks, including default, insolvency and lack of liquidity.
  • There are fewer P2P options for private investors than before

Innovative Financing Individual Savings Accounts (Ifisas) have their roots in the fallout from the 2008 financial crisis and credit crunch. At this time, it was becoming much more difficult for individuals and businesses to borrow from banks and other traditional lenders, at the same time as savers were frustrated by the lowest interest rates on their conventional bank accounts. Peer-to-peer (P2P) lenders such as Zopa, Assetz Capital and Funding Circle have emerged as attractive alternatives to fill this void. These websites cut out banking middlemen, acting directly as financial middlemen between people with money to lend and personal or corporate borrowers.

The industry has grown by leaps and bounds: Research by UK innovation agency Nesta and the University of Cambridge found that transaction volumes – the amount of money flowing through P2P lending platforms – have increased from less than £100 million in 2011 to £2.9 billion in 2015.

To encourage private investors to take advantage of the trend, Ifisas were launched by the government in April 2016. These are tax packages offered by P2P lenders that allow investors to accumulate P2P returns free of tax. They can be held alongside cash, stocks and shares, and Isas for life, and you can currently invest £20,000 a year in Isas in total.

But it should be noted that most investors are not taxed on the interest they receive from P2P loans held outside Ifisas, as the returns from the P2P loans are covered by the personal savings allowance. This allows base rate taxpayers to receive interest in cash or on certain types of debt worth £1,000 tax free, and higher rate taxpayers to receive £500 tax free .

According to independent P2P ratings website, this means base rate payers can generally lend between around £12,000 and £30,000, and higher rate payers between around £6,000 and £15. £000, before being taxed. But an Isa wrap removes any uncertainty about the tax implications and is useful if you’re already using some or all of your personal savings allowance for cash and bond interest.

P2P investments

There are several types of P2P categories, including loans for individuals and businesses, and for real estate development. There are also crowdfunding opportunities with a social purpose.

Most P2P lenders focus on property. Ben Yearsley, Chief Investment Officer at Shore Financial Planning, who is personally an Ifisa investor, explains: “It provides investors with some comfort and asset backing, assuming of course there is a first charge on the loaned property.”

He adds that other types of assets such as professional equipment can also be used as collateral.

The principle in each case is more or less the same: as an investor on a P2P portal, you lend to a specific type of borrower or basket of borrowers. And because there’s no bank involved, you’re likely earning a significantly higher interest rate on your money than you would with a regular cash savings account.

To put this into context: the best two-year fixed-term savings rates from conventional banks were around 2% in early April, according to comparison website MoneySavingExpert. In contrast, provider Ifisa Kuflink offers one-, three- and five-year loan opportunities against UK property development schemes from just £100, with rates between 5% and 7%.

Not all Ifisa are fixed-term products. For example, easyMoney offers a range of quick access accounts focused on property investments with interest rates between 3% and 5%, depending on how much you need to invest.

Higher risks for higher returns

These rates might make your head spin if you’ve spent the past decade watching your money earn increasingly stingy returns. But although Ifisas pay interest and look like cash accounts, they carry significant risks.

Unlike a savings account, the advertised return and the security of your capital are not guaranteed. The risks include the borrower you are lending to defaulting; the lending site goes bankrupt; fraud or negligence; lack of access to your money; and the difficulty of spreading your investment across enough borrowers to minimize damage to your overall portfolio in the event of a loan default. And, unlike other types of Isas, your money isn’t protected by the Financial Services Compensation Scheme if the P2P platform you’re lending through goes down. Some P2P lenders have emergency funds to cover such situations, but they don’t guarantee that they will.

The risks involved, coupled with evidence that people were treating Ifisas like cash accounts, led the Financial Conduct Authority (FCA) to tighten the rules in 2019. You can no longer hold more than 10% of your investable assets in P2P loans unless you have taken financial advice. And Ifisas can only be marketed to more experienced and wealthy investors.

As a result, evidence suggests that the market for Ifisa is steadily shrinking. Government figures for 2019/20, the latest available, show that while the total number of adult Isas subscribed was 13 million, only 34,000 of them were Ifisas. And that figure has been steadily declining, having stood at 49,000 two years earlier.

There are still around 30 P2P platforms that offer an Ifisa wrapper, although here too the number is down from around 40 three years ago. Those that still offer an Ifisa include Assetz Capital, CrowdProperty, Downing and LendingCrowd.

Several P2P platforms have shut down since 2019 due to increased regulation or following allegations of poor practices in recent years. The fallout from the Covid pandemic has caused further hardship in the form of increased defaults or late repayments, and led to widespread suspensions of retail loans.

Additionally, a number of leading platforms, including Ratesetter, Zopa and, in recent weeks, Funding Circle, exited the retail market following corporate restructuring. Funding Circle explains that after a two-year pause in new investment from private investors “as we navigated and adapted to the Covid pandemic”, the company has decided “the time has come to close retail lending” .

In response to a request for comment on Ifisas’ outlook, P2P industry body 36H responded by noting that “they don’t really have anything to contribute as it’s not something their members raised with them”. The industry body is called 36H to indicate that member platforms are fully authorized by the FCA under section 36H of the Financial Services and Markets Act 2000.

It’s hard not to conclude that P2P platforms as a whole really aren’t focused on retail market growth.

“It looks like a slow death for the sector,” comments Yearsley. “Obviously there were quite a few scandals which didn’t help, added to the fact that the rates of the most secure Ifisas also fell sharply. There is something of a self-fulfilling prophecy here – without investor funds, providers cannot make promises to their end-borrowers, and without scale, it is difficult to operate in this market.

Moreover, as we enter an era of rising interest rates, the dynamics within the industry are likely to change. Rising rates will attract lenders, but make life more difficult for borrowers. And as Yearsley points out, they’re also likely to increase bad debt, “which ultimately will be bad for investors.”

His view is that while there are still “a few decent players in the market”, rates are now too low to make Ifisas worthwhile for most investors. “Once rates have increased and plateaued, that might be a better time, if there are still vendors around,” he says.

Eethical options

One area where there are some interesting P2P and crowdfunding options is in the ethical realm. For example, you can invest through an Ifisa in social bonds through Triodos Bank’s crowdfunding site. Those proposed include a renewable energy bond to refinance two community solar projects in the UK, which pays 4.25% interest, linked to inflation and has a term of 16 years.

Energize Africa also has an Ifisa through which you can invest in environmental projects in Africa and the three bonds it offers pay 5-6% interest over terms of 18 months to two years. Lendwise, on the other hand, focuses on direct student loans to postgraduate students, with personalized interest rates averaging 9%, reflecting not only their credit score but also their future earning potential.

Whichever route you take, investing in an Ifisa should never be confused or aligned with putting money into a cash Isa. It’s an inherently risky proposition, so do your homework, think carefully about the risks involved, and only invest the money you can afford to lose.

About Janet Young

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