The Innovative Finance ISA: What does the new tax wrapper mean for UK SMEs?

This is a guest post by Richard Harwood of Innovative Finance ISA.org.uk

The continued growth in Peer-to-Peer (P2P) lending volumes is showing no signs of slowing and the introduction this week of the new Innovative Finance ISA (IFISA) could go a long way towards cementing the industry’s position as a mainstream source of SME finance.

The AltFi Volume Index, which measures P2P lending volumes across the UK, estimates that a combined £6.3 billion has been lent so far in Britain - prompting many to ask at what point this ‘alternative finance’ sector will become mainstream. Indeed, with new loans now drawing down at circa £100 million per week (approximately one third of which is being lent into the SME sector) some argue that the industry’s days as an ‘alternative’ finance provider are numbered.

Many expect the availability of SME funding to accelerate even further following the introduction of the new IFISA. This tax wrapper sits alongside the traditional Cash ISA and Stocks & Shares ISAs, is available to anybody over the age of 18 and will allow individual lenders to receive tax-free interest on Peer-to-Peer loans.

The IFISA will share the combined annual ISA allowance of £15,240 and, if widely adopted, will provide a vital boost in P2P platform liquidity. Research conducted by the Peer-to-Peer lending platform ThinCats predicts that around 25% of all investors aged 55 and over will give serious consideration to opening an IFISA - more than five times the current (pre-IFISA) uptake of Peer-to-Peer lending by that demographic. Undoubtedly for many would-be lenders, the Government’s decision to introduce the IFISA has effectively rubber stamped the industry as ‘here to stay’.

There is no doubt that the favourable tax status of IFISA-wrapped P2P loans will broaden the appeal of Peer-to-Peer lending for many cash-rich investors, many of whom have thus far merely been observing the sector’s growth, rather than participating in it. The result for SMEs wishing to access this form of debt finance is that we will very likely see P2P platform liquidity materially bolstered over the coming months. Research conducted on behalf of Yorkshire Building Society predicts that some 405,000 IFISA accounts could well be opened, providing up to £6.2 billion of lending liquidity this year, and as much as £8.1 billion from next April.

The most obvious challenge for the P2P platforms in the medium-term will be how they go about maintaining SME borrower creditworthiness standards in the face of piling mountains of IFISA cash. Platform fees are, after all, driven by lent funds rather than unlent funds. Some believe that if the IFISA does manage to raise the industry’s firepower too quickly, operators will be tempted to take on lending opportunities which might not have otherwise been considered appropriate. If credit standards are to be maintained then - all things being equal - investor yields could fall to the extent that the supply of P2P capital exceeds serviceable, creditworthy demand - a situation which could very well trickle through to SMEs in the form of lower overall borrowing costs.

Not everybody shares this enthusiasm however. News of the new ISA was met with less than positive feedback from the independent financial advisor community, which has for the most part made it clear that it does not intend to include the Innovative Finance ISA within its suite of recommended products. Many advisers cite the relatively short track record of the Peer-to-Peer lending sector and the fact that the industry has not yet proven its resilience across a full ‘boom and bust’ economic cycle - the vast majority of Peer-to-Peer lending platforms were founded post-2008, with Zopa being the only major platform to experience the recent recession.

Further, at the time of writing, fewer than 10 Peer-to-Peer lending platforms have successfully obtained full IFISA authorisation from the Financial Conduct Authority (FCA). Heavyweight lenders such as Funding Circle, RateSetter and a number of others are still awaiting the regulator’s green light, and none have been prepared to provide estimates over their IFISA launch dates - although it has been suggested that lenders will be waiting weeks as opposed to months. The main cause of these delays seems to stem from inside the FCA, which is said to have committed only a very small number of caseworkers to deal with the myriad of IFISA authorisation applications submitted over the past year.

Teething troubles aside, over time the Innovative Finance ISA is likely to help cement Peer-to-Peer lending as a mainstream form of investing. In turn, it is likely that P2P lending will have the capacity to become a mainstream source of business finance, providing a vital bridge for SMEs who have historically been neglected at times by the traditional high street lenders. Setbacks and delays in the FCA’s onboarding of IFISA applicants mean that SMEs are unlikely to feel any material impact from the new IFISA overnight, but the Innovative Finance ISA’s impact certainly be felt over time if investor adoption becomes sufficiently widespread.