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Alarm bells ring over Innovative Finance ISAs
Investors are being urged not to get blindsided by the impressive yields advertised by Innovative Finance ISAs amid concerns providers could lower their lending standards.
Innovative Finance ISAs are designed to hold investments made via peer-to-peer (P2P) platforms; interest from your investments is tax free.
Zopa, the biggest player in the P2P lending market, put a temporary freeze on new investments at the end of 2016 when the number of creditworthy borrowers fell. The company refused to lower its underwriting criteria and did not want investors’ money sitting around for weeks before it could be lent out.
Trevor Clark, operations director at financial advice firm Rutherford Wilkinson, warns that other P2P lenders might not employ the same stringent standards, especially if they have launched specifically to take advantage of the Innovative Finance ISA opportunity.
P2P platforms are regulated by the Financial Conduct Authority (FCA) and have reserve funds that aim to protect the lender in the event of a borrower default. But in a report on the post-implementation review of crowdfunding rules, the FCA said some firms applying for authorisation hadn’t demonstrated that they meet the required minimum standards.
‘By achieving authorisation, we can hopefully say they have met these conditions, but the issue lies in the fact that as a nascent sector there isn’t enough history to test such standards,’ says Clark.
‘Regarding continuing to meet regulatory standards once in the market, the FCA said firms may not always meet their expectations and they have challenged some firms to improve their client money handling standards.
‘Commercial pressure with the launch of the Innovative Finance ISA and the popularity of the sector may lead firms to relax creditworthiness and underwriting standards.’
Clark says investors should wait until the sector is more mature before making the plunge.
If you are still attracted by the high yields on offer, there are a few things to check before making an investment.
Providers usually publish details on their defaulted and written-off loans and late payments. Clark says investors should look for the level of detail provided and how far back it goes.
‘A longer history of low rates in these areas is more reliable and the P2P lender should be able to provide you with information on their due diligence processes in assessing the creditworthiness of borrowers. Some providers give you more control over which businesses (rather than individuals) to whom you lend your money and this can facilitate insight into their due diligence process,’ he explains.
Zopa, whose Innovative Finance ISA is due to launch in April, says the temporary freeze put in place in December last year reflected the seasonal downturn in demand for loans from high quality borrowers. ‘We believe money should be simple and fair, so we don’t think it’s fair for investors to wait too long to lend out their money. As expected, borrower demand picked up again in January,’ it says.
The provider claims it only allows lending to carefully selected borrowers who meet strict criteria. As a minimum, borrowers have to be at least 20 years old, have a credit history, have a good track record of repaying debt, be a current UK resident, have at least three years of UK address history, and have an annual income of at least £12,000.
Allocating your money
A shortage of creditworthy borrowers could result in your money sitting idle rather than being invested, but most Innovative Finance ISA providers claim this situation wouldn’t arise. Michael Todt, content manager at Lending Works, says the company has been entering partnerships and using other initiatives to unlock new channels for loan origination.
‘As such, we have continued to strike the right balance between incoming lending capital and prime borrowers, and we expect this to continue for the foreseeable future,’ he says.
Karteek Patel, chief executive of Crowdstacker, which facilitates loans to businesses rather than consumers, says the firm doesn’t work on an allocation basis, so monies would never sit idly for weeks on end in a holding account.
‘And for this reason also we don’t envisage freezing investment. If there are businesses on our platform asking for a loan, then lenders will be able to lend immediately,’ he states.
Your money would take longer to be invested if you opted for the likes of Landbay, which lends money to landlords applying for buy-to-let mortgages. Consumer loans take a few days to underwrite whereas buy-to-let mortgages can take up to four months.
John Goodall, Landbay’s chief executive, says if there was an imbalance of borrower supply and investor demand, Landbay would queue funds ready to be invested once loans become available.
‘The recent launch of our Innovative Finance ISA and our relationships with a growing panel of key intermediaries that are continuing to drive new business and capital inflow mean this scenario is uncommon, however we are committed to ensuring that loan security wouldn’t be compromised if it did,’ he states.
Higher risk period
The next 12 months are likely to see more Innovative Finance ISA providers enter the market. Patrick Connolly, head of communications at independent financial adviser Chase de Vere, says investors should stay alert to the fact that P2P lending is an investment and not a savings account.
‘There will be some instances where they will go wrong and it is likely that some people will lose money,’ he says.
‘While it is positive that P2P lending is regulated by the FCA, it still isn’t covered by the Financial Services Compensation Scheme. This means if a provider defaults those who invest could be left out of pocket,’ he warns. (EP)