Search This Blog

Tuesday, 28 October 2014

Adding Peer-to-Peer Loans To #ISAs

The Treasury is consulting on how to implement the government's decision to allow us all to hold peer-to-peer loans within our Individual Savings Accounts (ISAs). This is revolutionary because it increases the range of assets that can be held in ISAs - increasing diversification and therefore the value of the ISA portfolio - and significantly improves the visibility of where your investment money ends up (as I've argued for some time). Adding P2P loans will also change the way ISAs and ISA managers operate, which raises the various questions that the Treasury is consulting on (set out below). This post explains the difference between P2P lending and investing in funds typically held in stocks and shares ISAs, and addresses the main issues outlined by the Treasury.

What are peer-to-peer loans?

Peer-to-peer (or 'P2P') loans are just simple loans agreed directly between lender and borrower. There is no bank or fund manager in the middle, and the operator of the platform on which the loans are agreed is not a party to the loans.

How is P2P lending different to investing in funds?

Perhaps the best way to understand the difference is by starting with the role of the fund manager as opposed to the P2P platform operator. In simple terms, a fund manager collects money paid by investors in return for 'units' in the fund, and then controls the investment of that money in its own name (or that of the fund entity) - so the manager controls the management of the money or other assets in the fund, not the investors,.

However, the operator of a P2P lending platform enables many lenders to lend small amounts of money directly to many different borrowers, and then simply administers the individual loan contracts in accordance with their terms.  So the lenders on a P2P platform, rather than the platform operator, keep control over the management of their money and loan contracts. This is a key reason why P2P loans are a fundamentally different asset class to units in investment funds.

What does this mean for ISA managers?

These differences present a challenge for today's ISA managers - whose job it is to enable you to invest using your annual ISA limits, and keep track of those for HMRC.

Currently, when you buy units in an investment fund through an ISA manager, the manager adds your order to many other orders that it receives and then buys the total number of units in the investment fund in its own name. Each unit is standardised with the same price/value and issued by the same entity. The manager then records how many units it bought on your behalf in its own systems. You have no direct contract or any other link with the investment fund at all.

But on a P2P platform, you agree many small loans directly with lots of other people for the purposes specified, and different platforms tend to specialise in different types of loans (personal loans, working capital for small businesses, commercial property etc). Everyone's holding is different, even though some lenders end up lending to the same borrower. You also directly agree the platform's fee, if any, which may be waived in some cases (sometimes the borrower pays the fees, for tax reasons, leaving the lender with just the net income).

So existing ISA managers will probably need to make systems changes to enable it to track your own unique holdings of P2P loans in your ISA, and it seems likely they'll want to see a lot of demand before they do so. Accordingly, to meet demand for P2P loans in ISAs it's likely that the operators of P2P lending platforms will become ISA managers in their own right.

What does this mean for ISA rules?

You will probably be able to withdraw P2P loans from ISAs without having to sell them and take the cash.

ISA assets can typically be transferred between ISA managers, but that isn't practicable between different P2P platforms, so it's likely that any transfer would only work by selling the loans and transferring the cash directly to the other ISA manager. However, the Treasury is not sure whether to require this, as it could discriminate against platforms that do not have ready secondary markets for the loans agreed on their platforms. Another reason not to insist on transferability is that even if there were a secondary market, there could be a delay in finding a buyer for the loans, as opposed to just waiting for them to be repaid; and a 'forced' sale could mean a low market price, even from a market-maker or underwriter.

The Treasury is also interested in arrangements for continuing to manage P2P loans in ISAs in the event that the P2P platform operator ceases to qualify as an ISA manager, similar to the FCA requirements for administration of loans in the event that the operator ceases to trade.

The Treasury is still not sure whether to allow P2P loans to be kept in their own ISA or in a stocks and shares ISA. However, assuming P2P platforms are likely to need to become ISA managers in their own right, it would seem unduly onerous to make them apply for the extra FCA permissions required to offer other investments available through stocks/shares ISAs. So I'd suggest that there will need to be a third 'P2P loans ISA', or at least the ability for platform operators to offer a stocks/shares ISA that is limited only to holding P2P loans.

The Treasury expresses some concern that P2P lending on behalf of children through Child Trusts Funds (CTFs) or Junior ISAs could mean that the parent or guardian and not the child will be the one who understands the business activity or loan purpose of the business/personal borrower. But this is no worse than investing in a managed fund where you don't know the precise mix of the constituent stocks/shares or even the actual issuers and therefore their businesses or use of proceeds.

Finally, the Treasury believes that title to P2P loans made via CTFs and Junior ISAs would need to be held by the ISA manager or some third party, as loans made by minors are not enforceable (as a matter of contract law).

Those Treasury questions in full:
  1. In relation to the proposals generally, what necessary set-up costs (one-off costs) would be necessary for your business to arrange peer-to-peer loans meeting the proposed eligibility requirements for ISAs? What would be the estimated ongoing annual costs of doing so?
  2. Do respondents agree that the government’s proposed approach provides sufficient clarity as to which peer-to-peer loans will be eligible for ISA inclusion?
  3. Do respondents agree that the proposed regulatory requirements strike the correct balance between investor protection and a proportionate regulatory regime?
  4. Are existing ISA managers considering offering peer-to-peer loans alongside other ISA eligible investments? What factors may affect this decision?
  5. Are firms operating peer-to-peer platforms considering seeking authorisation to act as ISA managers if the government permits this? What factors may affect this decision?
  6. Do respondents have any concerns regarding FCA-authorised firms operating peer-to-peer platforms being allowed to act as ISA managers? If so, what are they?
  7. Do respondents see any risks arising from firms operating peer-to-peer platforms approved as ISA managers not being required to have legal ownership of peer-to-peer loans held within ISAs?
  8. Are there any drawbacks to the proposed withdrawal procedure for peer-to-peer loans? If so, what are they?
  9. If the transfer requirement is applied to peer-to-peer loans – do respondents foresee any risks or detriment for consumers resulting from the proposed modification of the current ISA requirements? If so, what are these?
  10. Following the sale of the peer-to-peer loan and transfer instructions from the investor, what would be the most appropriate time period within which the cash realised should be transferred?
  11. Is the proposed modification to transfer requirements t likely to present any difficulties or administrative obstacles for ISA managers (including those receiving transfers)? If so, what are these?
  12. What are respondents’ views on requiring the existence of a secondary market in order for a peer-to-peer loan to qualify for ISA eligibility? Would such a requirement provide a useful degree of reassurance to investors?
  13. Would a requirement to offer a secondary market pose any problems or difficulties for peer-to-peer platforms and if so, what are these? Could secondary market arrangements of this type be easily defined?
  14. Do respondents think that a guarantee of a sale at market value within a given period would be desirable in addition to the proposed requirement of a secondary market?
  15. Is there merit for investors in requiring that there must be a mechanism by which loans can be sold at market value within a given period? What period should this be, taking account of the times taken at present to achieve sales on existing secondary markets?
  16. Are there other ways in which to facilitate transferability, besides those described above? If so, how might these work?
  17. Overall, do respondents feel that the benefits to investors from applying transfer requirements to peer-to-peer loans held in ISAs outweigh the possible risks of doing so?
  18. Do respondents have suggestions as to how loans held within ISAs could continue to be managed by an ISA manager in cases where either a firm operating a peer-to-peer platform collapses and they were acting as ISA manager, or where such a firm becomes ineligible to act as an ISA manager following removal of its FCA permissions?
  19. How important is it that investors should be able to mix peer-to-peer loans with other eligible investments within their ISA in a single tax year? Do respondents believe most investors wishing to place peer-to-peer loans into an ISA account will additionally want to invest in other types of non-cash ISA investments within the same tax year?
  20. Would a third ISA type be helpful in alerting investors to the different rules which will apply to peer-to-peer loans within ISAs? Overall, would a third ISA type aimed specifically at alternative finance products such as peer-to-peer loans be a good thing – and if so, why?
  21. What potential difficulties or challenges might the creation of a third ISA type present for savers, investors, ISA managers or others?
  22. If the government decides not to introduce a third ISA type, how can we best ensure that customers are clear about the special characteristics associated with peer-to-peer loans, for example that they are not covered by the FSCS, and that they may be difficult to liquidate?
  23. Do respondents have any concerns about offering a tax advantage where loans made by or on behalf of children might be made without knowledge of the intended recipient(s) or usage of the loaned funds? If so, what are they?
  24. Do respondents agree that if peer-to-peer loans are made eligible for CTFs and Junior ISAs, these loans should be in the legal ownership of the ISA manager? If not – what alternative approach might be considered?