Deep distrust of peer-to-peer lending from “battle weary” pension providers is holding back the market, but is this sensible protection or are clients potentially missing out on valuable returns?
Sipp firms and advisers remain sceptical as research reveals the wide of variation in attitudes to cash buffer funds in the event of loans defaulting.
Likewise, the Government’s failure to resolve an issue around HMRC’s connected party rules are blocking the development of a functioning market.
But some smaller providers have jumped at the opportunity, forging partnerships with P2P companies amid claims the industry is being overly cautious.
Advisers’ reluctance to consider P2P means the asset class is likely to be pushed direct to consumers, so could non-advised clients be left exposed?
P2P loans rose to prominence a decade ago as banks tightened credit conditions in the wake of the financial crisis.
Now a firmly established market – with the likes of Ratesetter, Zopa, Lending Works and Funding Circle lending billions – the Government has signalled its intent to boost the number of investors further.
Firstly it launched the Innovative Finance Isa which since April has allowed returns on P2P investments to grow tax free. More recently, the Treasury has held talks with the pension industry over bringing the asset class within the scope of Sipps.
Ratesetter – which provides loans to both individuals and companies – has set up partnerships with Sipp firms such as London & Colonial, Greyfriars and European Pension Management.
Ratesetter business development manager Ceri Williams says: “We have a fundamental desire that within five years people will be as comfortable as buying consumer loans as they are buying equities.”
However, the pension industry has deep concerns over the market, not least the capital being held by P2P platforms.
Research shows the cash platforms’ set aside to cover bad loans varies enormously.
While Zopa and Ratesetter hold £12.9m and £17.6m respectively against loans worth £2.8bn, Lending Works has just £325,000 set aside and Funding Circle holds nothing at all. A Funding Circle spokeswoman explains the rationale.
She says: “A provision fund introduces new risks; it either has too much money in it which means investors aren’t earning the return they could be, or potentially not enough if losses increase significantly.
“Our investors diversify their lending across hundreds of businesses instead to manage risk.”
The FCA regulates crowdfunding and P2P providers and does have financial requirements for fully-authorised firms. Currently this is the higher of £20,000, rising to £50,000 from April 2017, or a tiered amount as the value of loans increases, from 0.2 per cent of the first £50m to 0.05 per cent of any balance over £500m.
However, firms holding interim permissions are not subject to the requirements until they become fully authorised. This explains how Funding Circle can hold nothing in reserve.
The Treasury’s attempts to bring P2P into Sipps has been met by silence from an industry left “battle weary” by years of scandals centred on unsuitable investments.
James Hay head of technical support and Amps chairman Neil Macgillivray says: “Small, bespoke Sipp providers will probably look at it, but more mainstream firms will be rather more cautious. Sipp firms are becoming battle weary, which is a shame because Sipps used to be about innovative investments and ways to get finance for clients’ businesses.
“The issue of holding P2P is just too onerous, but these are the times we are living in. Sipps used to give choice but that has unfortunately been tainted by bad investment choices and providers now will just not have the appetite to go down that route.”
HMRC’s ‘connected parties’ rules have been a major barrier for providers. Under existing legislation it is possible for a pension scheme to offer commercial loans provided these are not made to scheme members, ex-members or anyone connected with them.
However, in practice a pension scheme may be unable to determine whether an individual is connected to a member or ex-member.
Hargreaves Lansdown head of retirement policy Tom McPhail says: “There’s strong industry and consumer appetite to allow access to P2P investments through Sipps but the industry is concerned about connect party transactions and so the majority of Sipp providers are not accommodating P2P loans within their products.
“We would like to do it, but we don’t feel comfortable at the moment. The issue has been raised and the Government are listening.”
Talbot and Muir head of pensions technical Claire Trott says the bigger problem is around client understanding what they are investing in.
She says: “You’ve got numerous levels of risk you could be going into, so we need to look at whether we have the right protections in place to make sure you haven’t got low risk investors going into high risk P2P. It’s about being the gatekeeper
It’s very difficult for us, we’ve always said we should not be monitoring what people invest in unless it is going to cause them tax charges but if there is not a regulated adviser they will come back to the Sipp provider when it goes wrong and we need to distance ourselves from that.
She adds: “It does feel a bit smoke and mirrors and people say it is like investing in cash but it’s not, you are lending money and people may or may not pay it back.”
Like cash, but better
But Ratesetter’s Williams says there is an “inevitability” about P2P’s place within pension portfolios.
He says: “Because we sit between cash and stocks in terms of the risk profile, but still making an investment, it is a bond proxy. People do have to take on risk but we mitigate it to such an extent in a Sipp wrapper when people are just looking for income, they are not looking for double digit returns they want solid investment-grade returns.
“There’s an inevitability about how well this would look in a wrapper. I’ve got one myself and it provides me with unbelievably good compound growth.”
London & Colonial offer Ratesetter’s loans, which are made up of unsecured consumer loans; secured professional property developers; and SME commercial lending – to their Sipp customers, both advised and directly.
While Williams thinks the growth will be in the direct market, L&C head of product and business development Adam Wrench says at the moment this is “not actively marketed”.
He says the firm is “relaxed” over others’ concern P2P could breach connected parties regulations and believes loans have a big role to play post pension-freedoms.
He adds: “We sit this fitting very nicely with drawdown. With cash deposits not producing much of a return we feel being able to invest in third party loans which provide higher returns can be used to underpin drawdown. We don’t expect it to be used for all of the funds, but as part of a broader strategy.
“Advisers are sometimes a bit slow to adopt to changes in demand but ultimately market demand has pushed back. It’s just a matter of time – the more advisers hear from clients wanting to invest and get more information and how they can benefit, they will get their processes and heads around this – including in terms of compliance.”
ThinCats claims to be the first P2P platform to enter the pensions market. Investors can save through a Sipp administered by SIPPclub for £350 plus VAT a year. They must self-certify as “experienced investors” and confirm they do not need advice.
Founder and chairman Kevin Caley says: “One of the unique advantages of peer to peer lending in a SIPP is that as well as being used to preserve and grow capital it can also be used to provide a regular monthly income.”
He says the ThinCats Sipp allows withdrawal at about 8 per cent a year without eating into the fund value.
“This is at least twice the income that can be expected from other investments and quadruple the income from an annuity.”
In addition to fears about the sustainability of loan books and contravening HMRC rules, Sipp firms are put off by the potential for P2P is increase their own capital requirements. The loans are classified as non-standard assets due to their illiquid nature.
However, SSAS firms are not subject to capital requirements and provider Whitehall also has an arrangement with Ratesetter.
Director Richard Mattison says: “You can argue the SSAS is the right vehicle for non-standard investment types, because it is a standalone scheme. If a problem occurs with one SSAS no other SSAS is affected, Sipps are one big scheme with lots of members. If something goes wrong with a few the whole thing can collapse like a house of cards. That’s why the FCA had to intervene.
Mattison says P2P can work within HMRC rules, adding: “We feel we have built in enough protection to make this work.”