Debt and equity crowdfunding differ greatly in risk profile
IFISA

The Innovative Finance ISA debt vs equity conundrum

The announcement of the Innovative Finance ISA (IFISA) was a landmark day for the peer-to-peer lending industry, with it being confirmed at Summer Budget 2015 that consumers would be able to hold peer-to-peer loans within this new account and benefit from tax-free returns on the interest paid by borrowers.

Interestingly, it had already been confirmed more than a year earlier that P2P would be included within the ISA framework, and the lingering question related purely to implementation – seemingly a toss-up between whether it would fall under the existing Stocks & Shares wrapper, or if a new ISA geared specifically towards lending via peer-to-peer would be created.

As such, the creation of the IFISA, which opened the door for inclusion to other forms of alternative finance, was something of a middle ground; albeit one leaning considerably more to the positive, given that platforms had been granted their wish of being detached from Stocks & Shares investments.

A dark lining in a silver cloud

However, the one very small drawback on an otherwise momentous day was the danger of P2P lending being interspersed with other forms of innovative investment not homogenous in risk profile, and thus muddying the waters for consumers trying to decide on both the optimal way to build their portfolio, and to ultimately get the most out of this new third-way ISA.

Even within peer-to-peer lending itself, there are significant differences between lending to consumers (as is the case with a platform like ours) and lending to businesses. The latter typically offers greater potential in terms of returns, but also carries a greater level of risk. But given that both fall under the umbrella of P2P lending - or ‘debt crowdfunding’ as it has also been questionably labelled – they have naturally taken their place within IFISAs together.  

However, more confusing – and potentially perilous – would be the inclusion of equity crowdfunding within IFISAs. This is another kettle of fish altogether in which the investor acquires shares in fast-growing companies with the expectation that these companies will continue to grow and provide a suitable exit route at a later stage in the business. Investing in SMEs is inherently more risky both in terms of the risk to your capital and in terms of liquidity - or lack thereof.

Clearly, there are ever-greater risks associated with this which bear little or no resemblance to those when lending through peer-to-peer. To their credit, HMT announced at the Autumn Statement that equity-based crowdfunding has not yet received the green light for IFISA, although they also made clear that there would be an ongoing consultation with the industry to explore the case for its inclusion.

If this were to eventuate, it could set an alarming precedent for the future of the IFISA, and open the door to further ‘misfits’. Again, it is not our place to decide what deserves a place in the ISA framework and what doesn’t. But as experts in our specific field, we are well-placed to point out that such equity-based investments bear far more likeness to Stocks & Shares than they do P2P lending. Platforms like ours are different in structure to equity-based products, different in the risks and rewards offered, different in liquidity and flexibility, and different in the way we are regulated.

Look after the IFISA!

Perhaps it was wishful thinking on our part to expect a Lending ISA, catered exclusively for peer-to-peer lending. Indeed, to create a different type of ISA for every form of investment is wholly unrealistic. However, what we don’t want to see is a situation arising whereby consumers are unable to compare apples and apples within the new IFISA, and, potentially to their detriment, end up with capital and/or interest losses as a result of a misunderstanding of the risk profile of their investments.

Let’s hope sanity prevails, and that the IFISA ‘club’ remains exclusive to appropriate debt-based products. Experts predict that the P2P lending sector will swell from £3bn to £50bn within the next few years as a result of the Innovative Finance ISA, and it is our belief that consumers will enjoy the ride. But this should be a ride in which the risks are clearly communicated, easy to understand, and not fudged by the presence of other entities in the same melting pot which are fundamentally dissimilar.

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Michael Todt

Mike joined Lending Works in early 2015 with a background in marketing and journalism. Having long held a passion for economics, he is now the chief contributor to the Lending Works blog, and regularly writes about all things peer-to-peer lending, fintech and personal finance.