The Innovative Finance #ISA

The Treasury has announced the details of its commitment to extend tax-free Individual Savings Accounts (ISAs) to include peer-to-peer loans from 6 April 2016, effectively adding a third basket for your nest eggs. The enabling regulations will be published later this year. In the meantime, the government is also consulting on adding certain 'crowd-investment' instruments to ISAs in due course.

From April 2016, there will be a new "Innovative Finance ISA" in which individual investors will be able to hold P2P loans (formally known as 'article 36H agreements' in article 36H of the FSMA (Regulated Activities) Order 2001, and "P2P agreements" in the FCA's Handbook).

Advisers will be able to advise on P2P loans within the scope of their existing FCA advisory authorisation.

For ease of administration, each P2P lending platform is likely to become the ISA Manager for the Innovative Finance ISA that covers P2P loans agreed on its platform. 

P2P platforms (and other relevant ISA managers) will not be required to enable customers to sell their loans or to move their loans to another platform. But platforms may, if they wish, facilitate the sale of loans on their own secondary markets (as some do already) and enable the transfer of the cash proceeds to another ISA manager - indeed customers must be able to withdraw un-lent cash withdrawn within 30 days. However, it won't be possible for you to transfer only part of the money you subscribed in that tax year.

The different rules for P2P loans mean that they won't qualify for Junior ISAs or Child Trust Funds, which are less flexible than adult ISAs.

At Last: ISAs Go To Work!

Readers of this blog will be familiar with my rants on ISAs. So you can imagine my delight that the Chancellor has finally announced an the extension of the scheme:

"To further increase the choice that ISA savers have about how they invest, ISA eligibility will be extended to peer-to-peer loans, and all restrictions around the maturity dates of securities held within ISAs will be removed. The government will also explore extending the ISA regime to include debt securities offered by crowdfunding platforms."

In addition, from 1 July 2014 ISAs will be reformed into a simpler product, the ‘New ISA’ (NISA), with an overall limit of £15,000 per year. You will be able to hold cash tax-free within your Stocks and Shares NISA (if your provider allows it). And you'll be able to ask NISA providers to switch your money between cash-NISAs and Stocks and Shares NISAs.

As explained here, these changes offer a huge boost to the real economy, because savers will be able to lend their 'dead' savings directly to each other and to small firms to help fill the funding gap left by the banks. At the same time, savers will improve the value of their investments, not only by diversifying into a new asset class, but also one that provides a decent return.

Hats off to the government and the Treasury for putting in the work to turn this situation around.

Why Our ISAs Don't 'Work'... Yet.

The Treasury consultation on expanding the ISA scheme provides a fresh opportunity to put our savings to work and boost economic growth at the same time.

What's wrong with ISAs?

The “Individual Savings Account” (ISA) rules encourage us to put £11,280 a year into bank cash deposits and a limited list of regulated bonds and shares by making the returns tax-free.

Last year the Treasury estimated that about 45% of UK adults have an ISA, with a total of £400bn split about equally between cash and stocks/shares.

But in 2010 Consumer Focus found that cash-ISAs were only earning an average of 0.41% interest (after initial ‘teaser’ rates expire). They also found that 60 per cent of savers never withdraw money from their account; and 30 per cent see their ISAs as an alternative to a pension. 

Yet the banks don't use this cheap £200bn very wisely. In fact, only £1 in every £10 of the credit they create is allocated to firms who contribute to economic growth (GDP) and 60% of new jobs. In other words, lending to businesses is just not our banks' core activity, even though we also guarantee their liabilities. They earn more by financing consumption and speculation in financial assets. They've even taken £9.5bn under the so-called "Funding for Lending" scheme, and lent even less than before...

So we need the ISA scheme to encourage people to put their ISA money - and the country - back to work.

That means adding alternative asset classes that provide a decent return by financing the real economy, such as those generated on peer-to-peer lending and crowd-investment platforms.

Why hasn't this been done already?

The Treasury has previously resisted calls to do this on two occasions over the past few years. Their defence has been that ISAs are popular, simple to understand, relatively low risk and peer-to-peer platforms are not regulated (see here at para 14 and here at page 13).

But on neither occasion did the Treasury acknowledge the risks posed by the huge concentration of ISA cash in low yield deposits. Or the potential benefits of enabling savers to make some of those funds available to consumers and small businesses at lower cost and far higher returns - especially given that peer-to-peer default rates have proved to be very low.

The regulatory concern also appears to have been misplaced. Banks have clearly demonstrated that regulation affords no guarantee that consumers will be treated fairly. And peer-to-peer platforms, which are already partly regulated by the Office of Fair Trading, have been requesting broader regulation for several years. As a result, the Treasury has begun consulting on plans for more comprehensive regulation by the new Financial Conduct Authority from 2014.

All of that means the latest consultation on adding new assets to the ISA scheme is a golden opportunity to convince the Treasury to let us put our savings to work. 

Let's not miss it.

Submission To Parliamentary Commission on Banking Standards

In the interests of transparency, I've embedded below my submission to the Parliamentary Commission on Banking Standards.

Submission to commission on banking standards sdj 08 02 13 final from Simon Deane-Johns

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.