The debt-based securities market in alternative finance might not be worth the £5bn that peer to peer lending is forecast to reach in the next two years, but it is undergoing rapid growth that could see it get much closer to the size of P2P. In our recent debt report we found that a range of yields and risk profiles are available, capable of fulfilling a variety of investment objectives, meaning good value debt-based securities can be found that can generate outperformance, some with limited additional risk.
The research shows one of the market drivers is the expected impact of the Innovative Finance Individual Savings Account (IF ISA) for which unlisted bonds, debentures and loan notes became eligible in November 2016. After a slow start, the FCA’s latest ISA managers list shows that it has now authorised well over 50 to manage IF ISAs and that number is likely to continue to rise. So, providers clearly see the value in offering the IF ISA, with many persevering through the congested HMRC authorisation process, although other major players are still mired in it.
Why are we seeing this trend? The combination of capital gains tax exemption on sale profits and zero tax on interest earned as well as the yield potential and diversification properties are a big draw. As a result, the IF ISA is generating major interest among both advisers and investors, putting a spotlight on the investments that can be held within it. Early indications are certainly encouraging. Bruce Davis, founder and joint managing director of Abundance says: “The second half of last year was essentially a test of whether the demand for the IF ISA will increase. And the answer is an emphatic ‘yes’.”
That said some have expressed concerns that the ISA brand will confuse the public, who may not understand that risk is involved in IF ISA eligible offerings. However, we have had the stocks and shares ISA for almost a decade now. Furthermore, there was some controversy over the allowance of debt-based securities because of the perceived dangers of unlisted bonds. But many are unaware of the fine print of the of the IF ISA conditions, which require additional investor protections:
- The security must be transferable
- The investment must be arranged by a crowdfunding platform with investment-based crowdfunding FCA permissions (article 25 of the Regulated Activities Order 2001) which are more onerous than the P2P regulatory framework
- The platform must treat the investor as its client
- The platform must make and receive, on behalf of the investor, investment payments and exercises rights under or in respect of the investment.
In practice, this excludes non-transferable bonds, debentures and loan notes which are completely illiquid and are self-promoted by companies where there is no requirement to be regulated.
In addition, it brings into play up to £50,000 FSCS cover if the platform (as an authorised entity) is negligent and unable to pay any penalties awarded to investors. Perhaps just as importantly, it gives investors a single party, outside of the issuer, with ongoing involvement, that can act on their behalf in the event of problems.
On this basis, the inclusion of debt-based securities as IF ISA eligible assets is an indicator from the government that it is making a conscious distinction between self-promoted, unlisted debt instruments with little regulatory scrutiny and those with much broader investor protections. This demonstrates its support for the growth of the latter as both a funding source and retail investment.
The power of the IF ISA to engage new investors and advisers is making it a useful tool to encourage all issuers of debt-based securities to implement the minimum requirements for IF ISA eligibility. This is a potential win-win for IF ISA managers, qualifying IF ISA product providers and investors.
Guy Tolhurst is Managing director at Intelligent Partnership
Complimentary copies of the report are available to download from the Intelligent Partnership website and advisers can also request hard copies.