Card Acquiring Remedies for SMEs

After finding that the UK card acquiring market was not working for businesses with a turnover of £50 million, you might have expected that the Payment Systems Regulatory would have come out with some pretty heavy remedies. While apparently simple, however, these remedies should strike at the heart of the problems, as previously discussed:

• Summary boxes containing key, bespoke information on price and non-price factors must be sent/displayed individually to each merchant for use in connection with... 
• New online quotation tools, which acquirers must provide to help merchants compare all available offerings. 
• Trigger messages must also be sent/displayed to prompt merchants to shop around, timed to coincide with the expiry of minimum contract terms or, where contracts are indefinite, provided at least once every 30 calendar days. 
• Lease/hire contracts for point-of-sale (POS) terminals must be limited to an initial term of 18 months, after which they should be terminable on a maximum of one-month's notice.

The regulator has directed 14 firms to implement the changes to POS terminal contracts from January 2023, and the remedies for summary boxes and trigger messages from July 2023. 

The independent sales organisations (ISOs) of those firms must also ensure they are compliant with the requirements. 

The PSR will monitor compliance and the impact of the remedies to determine whether any further action is required. 

I've advised merchants of all sizes and card acquirers, ISOs and payment facilitators; and these initiatives should aid the work required to search for the right acquiring service and organise a switch. 

If you need assistance, please let me know.

Lifting the Lid on UK Banks' Current Account Services

In a belated effort to improve competition for personal and business current accounts, new rules require banks to publish data on account opening, service availability and major incidents from 15 August 2018. Data on account-opening and debit card replacement will have to be published from 15 February 2019. Banks will need to start recording and measuring the time taken to open accounts and to replace a debit cards from 1 October 2018. Comparison sites are also likely to publish the data.

The measures exclude 'premium' customers who receive a better level of service linked to minimum credit balances or monthly deposits, and who represent fewer than 20% of customers. Otherwise, their experience could distort the picture of services that typical customers get.

The rules cover banks with more than 70,000 relevant personal current accounts or 15,000 business current accounts (held by ‘banking customers’) per brand. Other firms not required to publish the data may do so, in which case they should comply with the same rules to aid comparison (but are not in breach of any rules if they do not). 

UK Continues To Clear The Path For Growth Of Alternative Finance

Draft legislation has now been published to allow bad debt relief for investors in peer to peer loans, in addition to the new Personal Savings Allowance announced in the Summer Budget.

These measures are among those that address the key regulatory problems and perverse incentives that have been preventing the flow of finance to people and businesses who need it and improved returns to savers and investors. The first regulatory initiative was to regulate P2P lending, announced in 2013; while the first step in addressing incentives was to include P2P loans in ISAs - first announced in 2014.

In introducing the latest incentive measures the government says it remains "determined to increase competition in the financial sector, where new firms such as P2P platforms can thrive alongside the established players and compete to offer new and improved services to customers. This new relief will create a level playing field for the taxation of income from P2P lending when compared to the taxation of traditional forms of retail investment available from those established players."

The government's commitment is critical, given that the financial system is now less diverse than before the financial crisis blew up in 2008. Few bank reforms have actually taken effect - and some are being watered down. Recent fines and scandals also reveal little change in mainstream financial services culture from that described in the report of the Parliamentary Commission on Banking Standards and most recently in the damning report into the failure of HBOS.

From 6 April 2016, individuals investing in certain P2P loans will be able to set-off the losses they incur from loans in default against income they receive from other P2P loans, when calculating their savings income for tax purposes. 

In addition, under the Personal Savings Allowance announced in the Summer Budget 2015, the first £1,000 of savings income will be exempt from tax for basic rate taxpayers and the first £500 for higher rate taxpayers. An individual’s PSA will apply to interest they receive from P2P lending after any relief for bad debts. 

A Financial Innovation Federation?

On Friday, the Finance Innovation Lab brought together various people who are active in the financial policy space to consider whether disruptive policies can help deliver a sustainable financial system. Chris Hewett explained where various policy ideas feature  in the evolution from a 'glint in the eye' to 'political battleground'. He then introduced short speeches on Reshaping the Banking Sector (from Tony Greenham of the NEF), Re-interpreting Fiduciary Duty (from Catherine Howarth of Fair Pensions) and Enabling the Growth of P2P finance (from yours truly, summarising recent submissions to government and the response - slides embedded below). Chris then invited us to discuss the best policy ideas based on the 3 approaches.

Our particular break out discussion focused on how a new regulatory 'channel' might "create an environment for responsible financial innovation to flourish". The context for this exercise was the government's reluctance to amend the financial regulatory framework and related tax incentives to promote alternative finance.

We thought that financial innovation could flourish within a forum comprising groups or networks that reflect the functions within any business - IT, marketing, finance, operations, legal and so on - with a group focused on facilitating the development of innovative business plans through a series of local, regional and national 'finance innovation labs'. Let's call this overall environment a "Financial Innovation Federation". The Federation could be governed via a council that would facilitate agreement on the criteria against which innovative ideas would be judged as being 'responsible' or not, as well as the governance of the body itself and that of its members.  Such agreement could be facilitated via an open, web-based system of governance in which all the members of the Federation could share their knowledge and vote on governance rules and so on. The council could comprise representatives of member businesses and their customers, independent non-executives, and representatives of the Financial Conduct Authority, HM Treasury and Business Innovation and Skills, so that the key regulators and policy makers would be directly engaged with the process of self-regulation and could not claim to be somehow separate from or 'above' the innovation process. The presence of government representatives would mean the approach would be better described as 'co-regulation', which has parallels in other industries. Proportionate formal regulation could evolve as necessary and appropriate.

The basic criteria against which innovative ideas could be judged as 'responsible' or not would be their simplicity, direct connection between participants, product neutrality, the promotion of diversification and whether a real customer problem is solved. The rules relating to the operation of the 'approved' services would focus on managing shared operational risks at the platform level, such as the Rules and Operating Principles of the Peer-to-Peer Finance Association (P2PFA). The overall result would be the creation of a 'safe harbour' in which many different innovative business models could flourish under the watchful gaze of a community of those with expertise in managing operational risk, as well as those charged with protecting consumers and the financial system itself.

In essence, this has already been happening over the past 6 months or so, in the context of submissions made to the Red Tape Challenge on Disruptive Business Models, the Breedon Taskforce and numerous approaches to the FSA by business teams seeking either regulatory guidance or authorisation. A 'Financial Innovation Federation' would draw all this knowledge together more tightly, enabling the more cost-efficient iteration of business plans and quicker time to market for responsible, workable, innovative business models.

We considered that the most useful next step towards establishing such a Financial Innovation Federation would be a meeting between the The Finance Innovation Lab, the P2PFA and other interested parties to explore the practicalities.

Enabling The Growth of P2P Finance - Simon Deane-Johns

View more PowerPoint from Simon Deane-Johns

Government Responds To Breedon

The Government has penned a rapidfire response welcoming the Breedon Taskforce report. Broadly, there is support to explore most of the avenues recommended, except the extension to the ISA programme.

While there's no appetite to make formal changes to the tax and regulatory framework necessary to boost alternatives to banks, the good news is that the Government has acknowledged the industry's desire for proportionate regulation, and welcomed the self-regulatory initiative in setting up the Peer-to-Peer Finance Association to "help raise awareness among SMEs and investors and establish industry standards to protect investors and borrowers". The Government has also :

"...allocated £100m of the Business Finance Partnership to invest through non-traditional channels that can reach smaller businesses, which could include peer-to-peer lending as well as mezzanine loans and asset-based finance. The Government will request proposals for investment in May."

However, the Government "is not minded to amend the ISA scheme" by adding new asset classes. Ironically, the rationale for resisting the Breedon recommendation on this front provides the very basis on which it should be accepted. The ISA scheme is too popular and too narrow to be called "safe" and does not efficiently allocate spare cash to people and businesses who need it: 

"ISAs are a successful and popular product - around 45% of the adult population currently holds one – and their relative simplicity and the coherence of the brand are important to that success. ISAs already offer generous reliefs allowing people to invest up to £10,680 each year in a “stocks and shares” ISA without incurring tax on their returns. The range of qualifying investments includes securities issued by companies listed on a Recognised Stock Exchange: this may include companies of a range of sizes. There is also scope for UCITS, NURS and other investment funds that qualify for inclusion in an ISA to invest part of their funds in smaller, unlisted companies. The Government considers that this provides the right balance of risk given the nature of an ISA investment. The proposed changes would complicate the scheme and undermine its core purpose of providing a relatively simple, safe vehicle which encourages people to save."

Small investors' life savings should be placed in many more baskets than this. 

Breedon's 11 Ways To Finance Small Businesses

Following a rapid but inclusive review, the Breedon Taskforce has recommended 11 ways to improve the financing options for the UK's smaller businesses. As a result, the next few years promise a wealth of innovation and competition in the market for SME finance.

The report confirms that net bank lending to smaller businesses will continue to decline due to the banks' own credit problems and the capital adequacy headwind. In fact, the report estimates a funding gap of about £26bn to £59bn for SMEs over the next 5 years, and an overall finance gap of up to £190bn for UK business sector as a whole.

But the Taskforce has found plenty of scope for growth in alternatives, both in the form of new funding sources, as well as more traditional finance options that have developed in countries where banks have not been so dominant.

The most interesting aspects of the report are: 

1. the acknowledgement (in section 4) that the plethora of government interventions to date (EIS, EIG, etc. etc.) have failed to gain traction; 


2. the recommendation (in section 5) for either an extension to the ISA scheme (as also submitted here) or a new 'Enterprise Savings Account';


3. the acknowledgement (in section 5) that the financial regulatory and promotional framework presents barriers for investors and businesses alike (as also submitted here), and that capital controls and limits on unregulated investments are creating a culture of "reckless prudence" amongst regulated financial institutions (section 8);


4. acknowledgement (in section 7) that there is "some sense" in the request by peer-to-peer platform operators for "proportionate regulation, to protect investors and provide confidence" (as also submitted here) but that officials are concerned that "over-zealous regulation would add to costs, destroying the market before it has a chance to gain scale organically;"  


5. the recommendation (in section 7) that the government should lend in conjunction with the private sector via direct finance platforms;


6. encouragement (in section 6) for standardisation to promote the trade in invoices;


7. the recommendation (in section 5) to create an Agency for Business Lending that would "aggregate a large number of SME loans and finance them via the corporate bond markets" - although, presumably, this would have to be designed to avoid the downside of previous shadow banking activity which is unduly complex compared to direct finance (as also submitted here):

Source: Lipstick On a Pig, p.109.

Taxing Bad Debt

In January, I submitted to the Red Tape Challenge on Disruptive Business Models and the Breedon Taskforce a paper explaining how the government could encourage the development of peer-to-peer finance platforms. Since then, there has been some discussion about potential regulatory changes, as well as the basis on which individual lenders might deduct any bad debt they incur on loans to people and businesses before tax (as banks are allowed to do).  

In other words, personal investors/taxpayers should be entitled to a similar tax framework to the one used by the banks they are competing with in the provision of loans. For example, loans via two peer-to-peer (or direct finance) platforms are listed among the rates available today on MoneySupermarket for a personal loan of £5,000 over 3 years to a borrower with an "excellent profile". There are also competitive rates listed from another direct finance platform in the business loans section.

Denying ordinary taxpayers this tax benefit not only discourages them diversifying their investments, but also limits the flow of competitively priced funding for creditworthy people and businesses. It also means, perversely, that your bank can use your cheap ISA cash to compete against you in the lending markets - and gain a tax deduction on any bad debt that you cannot. So the tax rules are both anti-competitive and confer a selective advantage on some players in the personal and business lending markets - a state aid issue.

To allow you to deduct any bad debt from your income before tax, HMRC will no doubt want to know that your loans were made responsibly at arms-length and that there were decent attempts at recovering missed payments. Here are the criteria on which direct finance platforms ensure this: 

1. The platform operator is not a party to the instruments on its platform and segregates investors’/lenders’ funds, so it has no credit/investment risk, no temptation to engage in regulatory/tax arbitrage and derives no benefit from the segregated funds nor any of the tax benefit available to participating lenders;

2. Finance is drawn from many lenders at the outset according to objective criteria, so lenders are competing against each other on price and not merely choosing friends/family members to lend to;

3. Lenders can achieve diversification across many borrowers at the start, removing the need for subsequent costly re-packaging or securitisation;

4. The one-to-one legal relationship between each borrower and lender is maintained for the life of each loan via the same technology platform (with a back-up available), so all the loan data is readily available to participants and for collections/enforcement activity as well as creating an audit trail for tax purposes;

5. The platform operators abide by applicable legislation such as anti-money laundering regulations: HMRC will want to know who the participants are too so they need to be properly identified;

6. The platform operators can provide information on lenders’ income to HMRC to allow them to collect taxes if desired.

 Of course, none of this would be an issue for the ordinary person, if you could simply lend your ISA money via a direct finance platform, instead of having to put in a savings account or in regulated stocks and shares.

Submission on New Model for Retail Finance

Set out below are both the initial summary and my full submission to the Red Tape Challenge and the BIS Taskforce on Non-bank Finance. I'm very grateful to the colleagues who contributed, as mentioned in the longer document.

In its invitation to submit evidence of ‘red tape’ that is inhibiting the development of ‘disruptive business models’, the Cabinet Office notes the example of Zopa, “a company that provides a platform for members of the public to lend to each other, who found that financial regulations simply didn’t know how to deal with a business that didn’t conform to an outdated idea of what a lender is…” 

This paper demonstrates that financial regulation similarly fails to deal with a range of non-bank, direct finance platforms (“Platforms”) that share some of the key characteristics of Zopa’s person-to-person lending platform (see Annex 1). Accordingly, financial regulation is failing to enable the cost efficient flow of surplus funds from ordinary people savers and investors to creditworthy people and businesses who need finance. In particular, as further explained in Annex 2, the current regulatory framework:

• generates confusion amongst ordinary people as to the basis on which they may lawfully participate on alternative finance Platforms (even though some are licensed by the Office of Fair Trading);

• creates legal and regulatory issues that vary greatly depending on the structure of Platform and instrument adopted, particularly where investment is for return, rather than by way of donation (without return) to a good cause. This means that detailed legal advice is needed for any Platform and this is itself a barrier to entry for some schemes which may not pose any significant risk to the public. Platforms may also require a level of regulatory authorisation which may be inappropriate, again considering the low level of risk to the public.

• does not make alternative finance products eligible for the usual mechanisms through which ordinary people save and invest (as explained in Annex 2), and the inability to deduct bad debt before tax and the tax on interest charged to cover bad debt exposes individual participants on Platforms to much higher ‘effective tax rates’ than their applicable statutory rates (see Annex 3);

• discourages ordinary savers and investors from adequately diversifying their investments;

• incentivises ordinary savers and investors to concentrate their money in bank cash deposits, and regulated stocks and shares;

• inhibits ordinary savers’ and investors’ from accessing fixed income returns that exceed long term savings rates;

• inhibits the development of peer-to-peer funding of other fixed term finance (e.g. mortgages and project/asset finance); and

• protects ‘traditional’ regulated financial services providers from competition.

These regulatory failings could be resolved by creating a new regulated activity of “operating a Platform”, for which the best-equipped regulatory authority would be the Financial Services Authority (as replaced by the Financial Conduct Authority). In tandem, or as alternatives, there could be exemptions based on size of investment or risk (e.g. some schemes or platforms may involve minimal investment in what is sometimes a socially useful venture); lesser regulation/authorisation within existing classes of regulated activity (as for small payment services providers or small e-money issuers) ; or the official endorsement of self-regulatory codes (as banks enjoy in relation to the Banking Code, for example). Direct and indirect incentives that selectively favour incumbent banks and investment funds should also be recognised and modified to balance the competitive landscape. Detailed regulatory changes are explained in Annex 4. 

Regulation of the platform would be independent of any regulation that may apply to the type of product offered to participants on the platform (e.g. loans, trade invoices, debentures to finance renewable energy and lending for social projects, as noted in Annex 1). However, exemptions from regulations governing financial promotions and offers to the public could be granted for instruments that are offered on Platforms. 

Proportionate regulation that obliges Platform operators to address operational risks common to all products would also enable economies of scale and sharing of consistent ‘best practice’, and leave product providers and other competent regulators to focus solely on product-specific issues (e.g. consumer credit, charitable purposes). Similarly, participants on such Platforms do not need to be treated as if they are participating in the course of a ‘business’ if the Platform itself meets all the compliance requirements that a business of that kind would otherwise have to meet. 

Given the established nature of the financial regulatory framework and the dominance of incumbent banks in the provision of debt finance to individuals and small businesses in particular, it is unrealistic to assume that new business models will thrive without some alteration to the regulatory framework to enable rapid market entry and to facilitate strong, responsible growth.

Alternative finance briefing paper simon deane-johns 27 01 12

View more documents from Pragmatist.

Red Tape Challenge Submission - Summary

In its invitation to submit evidence of ‘red tape’ that is inhibiting the developmentof ‘disruptive business models’, the Cabinet Office notes the example of Zopa, “a company that provides a platform for members of the public to lend to each other, who found that financial regulations simply didn’t know how to deal with a business that didn’t conform to an outdated idea of what a lender is…” 

Financial regulation similarly fails to deal with a range of non-bank finance platforms that share some of the key characteristics of Zopa’s person-to-person lending platform. Accordingly, financial regulation is failing to enable the cost efficient flow of surplus funds from ordinary people savers and investors to creditworthy people and businesses who need finance. In particular, the current framework: 

1. generates confusion amongst ordinary people as to the basis on which they may lawfully participate on alternative finance platforms (even though some are licensed by the Office of Fair Trading); 
2. does not make alternative finance products eligible for the usual mechanisms through which ordinary people save and invest, exposing lenders to higher ‘effective tax rates’; 
3. discourages ordinary savers and investors from adequately diversifying their investments; 
4. incentivises ordinary savers and investors to concentrate their money in bank cash deposits, and regulated stocks and shares; 
5. inhibits ordinary savers’ and investors’ from accessing fixed income returns that exceed long term savings rates; 
6. inhibits the development of peer-to-peer funding of other fixed term finance (e.g.mortgages and project/asset finance, and even short term funding of invoices); and
7. protects ‘traditional’ regulated financial services providers from competition. 

These regulatory failings could be resolved by creating a new regulated activity of operating a direct finance platform, for which the best-equipped regulatory authority would be the Financial Services Authority (as replaced by the Financial Conduct Authority). Regulation of the platform would be independent of any regulation that may apply to the type of product offered to participants on the platform (e.g. loans, trade invoices, debentures to finance renewable energy and lending for social projects). Proportionate regulation that obliges platform operators to address operational risks common to all products would also enable economies of scale and sharing of consistent best practice, and leave product providers and other competent regulators to focus solely on product-specific issues (e.g. consumer credit, charitable purposes). 

Similarly, there is no reason why products distributed via these platforms should not also be eligible for the usual mechanisms through which ordinary people save and invest, such as ISAs, pensions and enterprise investment schemes.

I'm off to Number 10 today to discuss these issues, and will be submitting a more detailed paper in the coming weeks, both to the Red Tape Challenge and the BIS Taskforce on alternative business finance. I'm interested in any comments you may have.

Alternatives To Traditional Business Funding

Huge thanks to MarketInvoice for the kind invitation to their event at the Cass Business School yesterday. The event really highlighted the gravity of the SME funding situation and the giant leap in understanding that is required of politicians and policy-makers in this area.

Chuka Umunna MP, Shadow Secretary for BIS, gave the keynote, and the panel included Andrew Cave, the Head of Policy at the Federation of Small Businesses, Emmanouil Schizas of ACCA Global, as well as Anil Stocker of MarketInvoice and Andy Ralph, director of a company that has raised significant amounts of invoice finance in the past quarter. 

Chuka gave some useful context:

• All the recent banking industry figures point to a significant contraction in lending to SMEs in the past quarter. Worse, SME Finance Monitor says over half of SMEs applying for overdrafts this year for the first time have been refused, and more than 400,000 SMEs who wanted to apply for an overdraft in the third quarter  didn’t do so – a third because they were discouraged by their bank.
• A recent BACS report also suggests that "half of all the UK’s small and medium sized enterprises are awaiting late payments. On average, each firm is owed £39,000 in late payments, with the total amount owed to SMEs having reached a staggering record figure of £33.6bn."

Less helpful, however, were Labour's proposed solutions to this mess. In summary, notwithstanding his glowing endorsement of MarketInvoice's as a useful private sector alternative to bank finance and the acknowledged need for more non-bank competition, Chuka said that Labour wants:

• Banks to improve local relationship management;
• The government to be more active and directly involved in improving payment and supply chain management;
• To create a new agency along the lines of the US Small Business Administration and Small Business Investment Company programme, whereby SBICs use their own capital plus funds borrowed with an SBA guarantee to make investments in qualifying small businesses - a phenomenal soure of moral hazhard and downright fraud that's been well documented by David Einhorn in his US Senate Committee testimony and the book "Fooling Some of the People All of the Time"; and
• To use government procurement to help SMEs (notwithstanding Labour's notorious reputation for waste in that area).

Perhaps it's beyond his shadow brief, but it was notable that Chuka made no mention of the discussion of alternative regulatory solutions here and in the US, nor the Cabinet Office focus on red tape that inhibits disruptive business models that specifically identifies alternative finance platforms. There was no reaction to the suggestion that alternative payment providers should enjoy the same tax subsidies that banks and other regulated institutions enjoy through ISA/pension allowances and individuals' ability to off-set losses against income. And no thought appeared to have been given to the idea of a clearly defined 'safe harbour' for the likes of MarketInvoice and peer-to-peer platforms from the rules on collective investment schemes and/or arranging deals in investments, to enable them to start up more confidently, quickly and efficiently.

In fact, Chuka's pitch rather underscored his party's role in helping to create our desperate need for alternatives to traditional business funding. Let's hope we see some decent ideas from the opposition in future.

In the meantime, it's down to the participants on MarketInvoice, Funding Circle and CrowdCube and the many angel networks to carry the alternative funding hopes of SMEs.