Are P2P platforms ready for Innovative Finance ISAs?

A guest post by Jake Wombwell-Povey 

With the Innovative Finance ISA (IF-ISA) launching in April 2016, peer to peer investing is set to become even more attractive to retail investors allowing them to invest up to £15,240 tax free.  If we consider that the majority of P2P investors are higher-rate tax payers, and that P2P investors, on average, seldom invest more than the ISA threshold, P2P lending is set to become practically tax-free for the majority of investors.

This is not only a huge boon for P2P platforms chasing funding, but also a fantastic development for SME financing where net lending to SMEs remains negative.

Some context

Firstly, it is worth considering a few key ISA facts to put the tax wrapper into context. In the tax year to April 2015:

• Investors invested £79bn into ISAs (£61bn in cash; £18bn in stocks)
• This equates to a total of 13m ISAs (10.3m cash; 2.7m stocks)
• The average ISA subscription was £6.1k (£5.9 cash; £6.6k in stocks)
• The average P2P investor lends somewhere between £6.5k (Zopa) to £8k (Funding Circle)

I've been tracking the sentiment surrounding IF-ISAs since the Chancellor first announced he was considering making P2P available for inclusion in ISAs in April 2014.  On reflection this was a brave, entrepreneurial and innovative move. The Chancellor would have known that, not only would ISA's tax-shield, and therefore improve returns (mainly to the benefit of existing investors), but the ISA stamp, a kind of government imbued mark of credibility, would attract new and typically more risk averse investors to the sector.

At the time, although the industry was helping to fill a critical funding gap, it was less established and only just being covered by interim regulation. As a result many platforms’ boards were undoubtedly underweight in financial services expertise compared to the levels they currently boast.

The opportunity  

18 months ago, many of the platforms I spoke to were talking ambitiously about how they were going to capture a large portion of the c.£79bn that investors 'subscribe' into ISAs every year.  I think we can agree that, bearing in mind platforms are set to originate somewhere close to £3bn in 2015, the industry would struggle to deploy anything more than 5% of this amount, assuming of course it is drip-fed to platforms over the year (in reality, ISAs are typically highly seasonal around tax year beginnings and ends).

The good news is that the conversations now permeating the sector are more mature. They are focused on how efficient and soundly promoted IF-ISAs can offer retail investors' genuine choice, and how the funds secured through IF-ISAs will play just one part of a platform's funding mix.

Estimates released in recent weeks have suggested a huge range when it comes to the number of new IF-ISA investors that will participate, with some estimates suggesting anywhere up to 405,000.  This is obviously a big increase on the c.121,000 investors that the P2PFA suggests are currently participating. 

Not only is the number of new investors uncertain as we look forward to April 2016, but so is the type.  Will they be more risk-averse, cash ISA savers tempted by decent returns or risk-seeking, stocks and shares ISA investors looking to maximise their tax planning? To me, this is the most interesting aspect of the new IF-ISAs.

The challenges

On the potentially obvious assumption that IF-ISAs will attract a large amount of funds to flow into the sector, such an influx will present a challenge to platforms to find enough loans.

Assuming this new breed of tax-incentivised, retail investor is more risk averse, we can also conclude this increased supply of loans will equally need to be low risk and prime. This, in itself, presents a significant marketing and PR challenge for platforms. Institutions may have to be hung out to dry for a month or two and underwriters ready to re-sell a large stock of high-grade loans to satisfy investor demand.

The other big risk for the industry at large is managing the process and the expectations of new entrants to truly whisk these new investors off their feet.  It would be wise to assume that many new investors will drip feed a small amount of money in at first, see how the process works, before potentially warming to P2P as an asset class and gradually increasing their investment.

With this in mind, making the process straight forward, on-boarding investors promptly, providing sufficient high-quality loans, and managing the messaging to these investors will be important to ensuring that these long-term, traditionally ‘sticky’ funds remain in the P2P sector for the long term.

The investor on-boarding challenge is not one to be underestimated…be prepared!

Author Bio: Jake Wombwell-Povey is the co-founder and Managing Director of Goji, an investment platform focused on the peer-to-peer sector.  From April 2016, Goji will be launching an Innovative Finance ISA platform where Goji, as the IF-ISA plan manager, will be working with a number of P2P businesses to provide them with IF-ISA capability.  The Goji platform is being built by the team who built Monitise.  For more information, contact Jake on [email protected]