The Financial Conduct Authority (FCA) has warned that mini-bonds and peer-to-peer loans held within the Isa wrapper are “high risk”.
The warning has been issued following evidence that Innovative Finance Isas (Ifisas) are being promoted alongside Cash Isas despite the latter offering far more protection, as the first £85,000 is shielded by the Financial Service Compensation Scheme even if the bank or building society goes bust.
This protection does not apply to mini-bonds or peer-to-peer loans. Moreover, whereas Cash Isas are relatively risk-free, aside from capital being potentially eroded through inflation, the same cannot be said for the Ifisa.
Those who invest in an Ifisa need to be aware of and comfortable with the additional risks associated with lending directly to companies and individuals.
Ifisas offer returns typically between 3% and 8% a year depending on the risk level – markedly higher than the returns available through Cash Isas.
Given the FCA’s warning it seems that some firms have been trying to take advantage of enticing savers through how they are marketing peer-to-peer, due to savings rates being at historical low levels.
In addition, there has been the recent collapse of a mini-bond run by London Capital and Finance, which promised returns of 6.5% to 8% a year.
It went into administration at the end of January, leaving 11,000 investors at risk of losing most of their money as only 20% is expected to be recovered. The mini-bond was available in the Ifisa wrapper.
A month earlier the FCA told London Capital and Finance to withdraw its marketing material, which it said was “misleading”.
The FCA has been told by the government to conduct an independent review of the way it handled the collapse, which will consider whether the regulator was too slow to act.
These bonds are targeted at small investors, but important distinctions need to be made here.
Retail bonds are tradable on the secondary market (via the London Stock Exchange's Order Book for Retail Bonds, Orb), whereas mini-bonds must be held to maturity. In addition, mini-bonds typically raise smaller amounts and are on the whole riskier.
The FCA says: “Investments held in Ifisas are generally high-risk with the money ultimately being invested in products like mini-bonds or peer-to-peer investments.
These types of investment may not be protected by the Financial Service Compensation Scheme, so customers may lose the money invested or find it hard to get back.
“Anyone considering investing in an Ifisa should carefully consider where their money is being invested before purchasing an Ifisa.”
Responding to the FCA’s warning, Angus Dent, chief executive officer of peer-to-peer business lending platform ArchOver, said the FCA needs to “be as careful with their choice of language as we are with ours.”
He adds: “To insinuate that there’s no chance of getting your money back if you’ve invested it in mini-bonds or peer-to-peer loans is to ignore the £53 million we have returned to lenders when loans have matured.
“To simply write off a market that has lent £9 billion in total lending, by saying that as we’re outside the Financial Service Compensation Scheme – and lenders won’t get their money back – is not helpful advice for investors.
It is likely a knee-jerk reaction to the collapse of the mini-bond run by London Capital and Finance, which simply cannot be compared with the peer-to-peer industry.”
Critics of peer-to-peer lending also argue the industry has yet to pass the test of time, with only one firm currently in the space – Zopa – predating the global financial crisis.
Iain Niblock, chief executive of Orca Money, which offers peer-to-peer portfolios, acknowledges that all the sectors within peer-to-peer (consumer, property and business markets) could be hit by an economic slowdown, and that ultimately the reaction of the end investors will be key to how peer-to-peer platforms fare.
But Mr Niblock is confident peer-to-peer will hold its own, citing that it has strong characteristics, such as being uncorrelated to stockmarkets.
He adds: “Just because most peer-to-peer lenders haven’t been through a downturn that doesn’t mean they aren’t preparing.
"Lenders such as Funding Circle and Landbay have conducted stress tests of their loan books based on Bank of England modelling to see what would happen in various scenarios, and have found investors will still get a decent return, albeit slightly reduced.
“Platforms planning ahead is a good sign, but investors can also get prepared by keeping an eye on default rates among peer-to-peer lenders, doing their due diligence on how stable and secure a provider and its loans are, and building a diversified portfolio.”
This article was first published on our sister site Money Observer