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Too hot to handle: Industry shies away from P2P as capital shortfall exposed

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Deep distrust of peer-to-peer lending from “battle weary” pension providers is holding back the market, but is this sensible protection or are clients potentially missing out on valuable returns?

Sipp firms and advisers remain sceptical as Money Marketing research reveals the wide of variation in attitudes to cash buffer funds in the event of loans defaulting.

Likewise, the Government’s failure to resolve an issue around HMRC’s connected party rules are blocking the development of a functioning market.

But some smaller providers have jumped at the opportunity, forging partnerships with P2P companies amid claims the industry is being overly cautious.

Advisers’ reluctance to consider P2P means the asset class is likely to be pushed direct to consumers, so could non-advised clients be left exposed?

Capital hole

P2P loans rose to prominence a decade ago as banks tightened credit conditions in the wake of the financial crisis.

Now a firmly established market – with the likes of Ratesetter, Zopa, Lending Works and Funding Circle lending billions – the Government has signalled its intent to boost the number of investors further.

Firstly it launched the Innovative Finance Isa which since April has allowed returns on P2P investments to grow tax free. More recently, as revealed by Money Marketing, the Treasury has held talks with the pension industry over bringing the asset class within the scope of Sipps.

Ratesetter – which provides loans to both individuals and companies – has set up partnerships with Sipp firms such as London & Colonial, Greyfriars and European Pension Management.

Ratesetter business development manager Ceri Williams says: “We have a fundamental desire that within five years people will be as comfortable as buying consumer loans as they are buying equities.”

However, the pension industry has deep concerns over the market, not least the capital being held by P2P platforms.

Money Marketing research shows the cash platforms’ set aside to cover bad loans varies enormously.

While Zopa and Ratesetter hold £12.9m and £17.6m respectively against loans worth £2.8bn, Lending Works has just £325,000 set aside and Funding Circle holds nothing at all. A Funding Circle spokeswoman explains the rationale.

She says: “A provision fund introduces new risks; it either has too much money in it which means investors aren’t earning the return they could be, or potentially not enough if losses increase significantly.

“Our investors diversify their lending across hundreds of businesses instead to manage risk.”

The FCA regulates crowdfunding and P2P providers and does have capital requirements for fully-authorised firms. Currently this is the higher of £20,000, rising to £50,000 from April 2017, or a tiered amount as the value of loans increases, from 0.2 per cent of the first £50m to 0.05 per cent of any balance over £500m.

Firms holding interim permissions are not subject to the requirements until they become fully authorised. However, the regulator does not require the existence of provision funds, it is left to firms to decide.

Battle weary

The Treasury’s attempts to bring P2P into Sipps has been met by silence from an industry left “battle weary” by years of scandals centred on unsuitable investments.

James Hay head of technical support and Amps chairman Neil Macgillivray says: “Small, bespoke Sipp providers will probably look at it, but more mainstream firms will be rather more cautious. Sipp firms are becoming battle weary, which is a shame because Sipps used to be about innovative investments and ways to get finance for clients’ businesses.

“The issue of holding P2P is just too onerous, but these are the times we are living in. Sipps used to give choice but that has unfortunately been tainted by bad investment choices and providers now will just not have the appetite to go down that route.”

HMRC’s ‘connected parties’ rules have been a major barrier for providers. Under existing legislation it is possible for a pension scheme to offer commercial loans provided these are not made to scheme members, ex-members or anyone connected with them.

However, in practice a pension scheme may be unable to determine whether an individual is connected to a member or ex-member.

Hargreaves Lansdown head of retirement policy Tom McPhail says: “There’s strong industry and consumer appetite to allow access to P2P investments through Sipps but the industry is concerned about connect party transactions and so the majority of Sipp providers are not accommodating P2P loans within their products.

“We would like to do it, but we don’t feel comfortable at the moment. The issue has been raised and the Government are listening.”

Talbot and Muir head of pensions technical Claire Trott says the bigger problem is around client understanding what they are investing in.

She says: “You’ve got numerous levels of risk you could be going into, so we need to look at whether we have the right protections in place to make sure you haven’t got low risk investors going into high risk P2P. It’s about being the gatekeeper

It’s very difficult for us, we’ve always said we should not be monitoring what people invest in unless it is going to cause them tax charges but if there is not a regulated adviser they will come back to the Sipp provider when it goes wrong and we need to distance ourselves from that.

She adds: “It does feel a bit smoke and mirrors and people say it is like investing in cash but it’s not, you are lending money and people may or may not pay it back.”

Like cash, but better

But Ratesetter’s Williams says there is an “inevitability” about P2P’s place within pension portfolios.

He says: “Because we sit between cash and stocks in terms of the risk profile, but still making an investment, it is a bond proxy. People do have to take on risk but we mitigate it to such an extent in a Sipp wrapper when people are just looking for income, they are not looking for double digit returns they want solid investment-grade returns.

“There’s an inevitability about how well this would look in a wrapper. I’ve got one myself and it provides me with unbelievably good compound growth.”

London & Colonial offer Ratesetter’s loans, which are made up of unsecured consumer loans; secured professional property developers; and SME commercial lending – to their Sipp customers, both advised and directly.

While Williams thinks the growth will be in the direct market, L&C head of product and business development Adam Wrench says at the moment this is “not actively marketed”.

He says the firm is “relaxed” over others’ concern P2P could breach connected parties regulations and believes loans have a big role to play post pension-freedoms.

He adds: “We sit this fitting very nicely with drawdown. With cash deposits not producing much of a return we feel being able to invest in third party loans which provide higher returns can be used to underpin drawdown. We don’t expect it to be used for all of the funds, but as part of a broader strategy.

“Advisers are sometimes a bit slow to adopt to changes in demand but ultimately market demand has pushed back. It’s just a matter of time – the more advisers hear from clients wanting to invest and get more information and how they can benefit, they will get their processes and heads around this – including in terms of compliance.”

ThinCats claims to be the first P2P platform to enter the pensions market. Investors can save through a Sipp administered by SIPPclub for £350 plus VAT a year. They must self-certify as “experienced investors” and confirm they do not need advice.

Founder and chairman Kevin Caley says: “One of the unique advantages of peer to peer lending in a SIPP is that as well as being used to preserve and grow capital it can also be used to provide a regular monthly income.”

He says the ThinCats Sipp allows withdrawal at about 8 per cent a year without eating into the fund value.

“This is at least twice the income that can be expected from other investments and quadruple the income from an annuity.”

In addition to fears about the sustainability of loan books and contravening HMRC rules, Sipp firms are put off by the potential for P2P is increase their own capital requirements. The loans are classified as non-standard assets due to their illiquid nature.

However, SSAS firms are not subject to capital requirements and provider Whitehall also has an arrangement with Ratesetter.

Director Richard Mattison says: “You can argue the SSAS is the right vehicle for non-standard investment types, because it is a standalone scheme. If a problem occurs with one SSAS no other SSAS is affected, Sipps are one big scheme with lots of members. If something goes wrong with a few the whole thing can collapse like a house of cards. That’s why the FCA had to intervene.

Mattison says P2P can work within HMRC rules, adding: “We feel we have built in enough protection to make this work.”

Adviser views

Syndaxi Chartered Financial Planners managing director Robert Reid says:

I have been part of some research in this area and the vast majority of advisers will not touch it because the level of risk is not quantifiable. The sensible firms these days will not push something unless there is proper recognition of the typical investor, which ties in with Mifid II where suitability is key. Advisers wants to know if they sell something, what characteristics do clients need to have for an investment to be suitable. This will slow down P2P advised sales, but there is a head of steam for those firms going direct.

M Thurlow & Co senior partner Blair Cann says:

We have had a few enquiries on P2P but the problem is most of our clients are financially conservative and this is a high risk investment. The number of clients who we classify as ‘adventurous’ is very low. I disagree entirely with anyone who says P2P is cash-like – it is high risk.

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Comments

There are 7 comments at the moment, we would love to hear your opinion too.

  1. Who would blame any adviser from avoiding this.

    How many times in the past has the FSA/FCA suddenly decided that investments were in fact ‘toxic’ after the event.

  2. Why is this even a topic? P2P starts out thinking about defaults – hardly a convincing way to begin an investment proposition.

    Pensions and investors are not banks. Current low interest rates are the driver for these flaky investments which in the main are not covered by the FSCS. If I’m going to lend anyone any money I would want collateral – just like the banks.

    Anyway the whole proposition is based on lending to those who are not good enough to get a bank loan, so why should an individual wish to fish in this murky pool?

    I leave you with a quote from Warren Buffet: “Just about the only way a smart person can go broke is to borrow money”. And don’t we have quite enough debt in the UK without encouraging more?

  3. With P2P, who assesses the loan in terms of creditworthiness or credit history.

    Who takes a hit if it goes wrong.

  4. I was in Building Societies when they thought they could take the banks on at their own game. Wonder if P2P will turn out better than that did……..?

  5. Actually Harry I totally disagree with your comment that the “whole proposition is based on those who are not good enough to get a bank loan”.
    I have used P2P lending myself as a customer, when I was looking to buy a car. I do high mileage and prefer low mileage used to new, especially as the high mileage makes any type of Personal Contract or Purchase deal ridiculously expensive.
    The problem with all the bank loans is that the really low rates require you to borrow at least £7,500, and the trade-in value, cash, and cost of the replacement car meant I only wanted to borrow £5k. So I went to ZOPA, and because I am a good risk, I got a loan at a rate at least 2% lower than most of the banks would offer.
    Having said that, I wouldn’t, as an adviser, recommend one to a client at the moment as there is too much regulatory uncertainty.
    Oh, and by the way, given the first line of your post, does that mean you never recommended a Fixed Interest fund to any clients, as don’t most of the managers of those funds start by thinking about defaults?

  6. @ Kevin

    I really don’t wish to be unkind, but as a successful Financial Adviser I find it hard to credit that you have difficulty self funding £5k.

    And yes if I recommended fixed interest at all in recent times (very rarely) I was very picky indeed and in any investment climate fixed interest never made up more than 15% of a portfolio and no one fund more than 5% maximum.

  7. William Watling 16th June 2016 at 5:49 pm

    Interesting! I invest in RateSetter & FundingCircle generating between 3% for 30 day rolling notice up to 8% for fully secured property development short term (<18 months) loans. My FundingCircle portfolio has returned 9.5% net of losses & charges. Because of the buoyant secondary market on both platforms I can get at my money within days (most of the time) if needed. I've got 600+ loans (max £25) so if a few default my net return might be 7.5% instead of 9.5%. What you lend to can cover unsecured personal lending up to fully secured bridging loans with 'first loss' cover. So if you compare unsecured P2P to credit cards then according to Bank of England & Liberum data the 'avg net return is 6.4% p.a.', with "No year with negative returns in at least 16 years"; that's even during a major stress test of the 08/09 credit crunch!

    We therefore need to be careful about stating P2P is "more risky than …" the sharpe ratio & industry data vs equities, bonds, etc doesn't agree. Many funds actively supported by advisers from major product providers for retirement income in drawdown use derivatives, fx swaps, commodity futures, etc. Is that more or less risky? Are you happy to advise on a fund in drawdown with 10%-15% vol p.a. to get 4%-5% median return & 'pound cost ravaging' risk vs a proportion of a portfolio with nil vol p.a. generating avg 6.4%?

    All the platforms I know take u/w their borrowers v seriously – this is critical to their long term success. Some of the platforms also invest their own money in each loan so u/w is as important to them as their retail investors.

    This is an evolving market with 96 firms registered for FCA regulation to be allowed to offer IFISAs. It serves a broad church of borrower from individuals to SME to property developers, some unsecured, some fully secured, some with provision funds, some without. I'd urge advisers not just to write it off, or you may find clients go direct!

    See https://intelligent-partnership.com or AltFi.com for training, daily data, market reports, etc.

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