When we look back, 2015-16 will be seen as the watershed moment: when peer-to-peer (P2P) lending and crowdfunding made the big time, transitioning from quirky innovation to a respected alternative source of finance and investment opportunities.
The government has clearly been persuaded of the potential benefits of so-called alternative finance – especially as a means of bridging the funding gap for SMEs. For the most part, it has embraced the sector with open arms, and signalled intent to do what it can to support its continued development. Yet it is also (rightly) concerned with balancing this against appropriate measures to ensure that investors are protected.
Confirmed in George Osborne’s post-election Budget, the Innovative Finance Isa is the first concrete step in bringing alternative finance into the mainstream. Due to be introduced in April 2016, it will allow consumers to lend up to £15,000 a year tax free, via loan-based platforms, to individuals and businesses.
It’s a welcome move. But the announcement also reflects the government’s softly-softly approach. The new Isa will be separate to cash and stocks and shares Isas, and comes with distinct features. It will be far less liquid than its traditional cousins and, like stocks and shares Isas, it will not be covered under the Financial Services Compensation Scheme (FSCS). This shows recognition of P2P crowdfunding as a distinct asset class, with a unique risk profile.
And it is clearly a test run. The government will simultaneously be running a consultation on extending the Isa to more complex debt securities and equity offered on platforms to raise capital for businesses. This will likely come to pass – once authorities are assured of their appropriateness.
Should all go to plan, we will probably see the government follow up with further measures to support the sector. One particularly beneficial move – originally mooted in last year’s Autumn Statement – would be to allow lenders to offset losses accrued via P2P investments against their taxable income. Many crowdfunding investments are already eligible for such tax breaks, where the business in question qualifies for the Enterprise Investment Scheme (EIS), or its more generous sister, the Seed Enterprise Investment Scheme (SEIS). Extending this out to all crowdfunding investments would be a natural next step.
CROWDFUNDING IN 2020
The coming three to five years will be a bedding-in period for the industry, as investors get used to the space and the Financial Conduct Authority (FCA) learns how best to manage its growth in the interests of both investors and business. Given its novelty, the consumer enthusiasm we’re currently seeing will continue. A levelling off will come, however, as more and more default rates get published, investors come to a more sober understanding of the sector’s risk-reward profile, and a natural equilibrium is established. We know defaults are relatively high for SMEs in general, and there’s no reason why crowdfunding should prove an exception to this.
At the same time, platforms will continue to develop their offering as the sector matures. In the short term, we can expect them to start offering their own pre-packaged Innovative Finance Isas to capitalise on the new rules. They will also begin to compete on “investor safety” features (we have already seen certain platforms introduce “reserve funds” and other measures). Crucially, we will see platforms come together to agree industry standards and definitions regarding, for instance, default rate calculations. As it stands, there is little consistency across different players, making it difficult for consumers to properly assess risk and select between platforms – this needs to change.
The sector’s growth will also carry implications for the wider financial ecosystem. Already, specialist funds dedicated to crowdfunding investment have started springing up. This will be a major growth area in the funds industry as crowdfunding becomes established. Many investors will want exposure (for diversification, as much as anything else) without having to pick their own investments.
The P2P model is already transforming other industries (Uber and Airbnb spring to mind). There is no reason why it shouldn’t have a similarly revolutionary impact on the funding landscape. By 2020, alternative finance will simply be a part of the financial furniture.
STAT OF THE WEEK
Powered by Crowdnetic, this crowdfunding information dashboard pulls data from major platforms, showing hundreds of fundraises in real-time. We feature one compelling statistic each week
In London, there are currently 64 companies crowdfunding.
Between them, they have so far raised £9.9m