The Innovative Finance Isa has so far proven to be something of a damp squib, but from this week it expands to include a whole new asset class — crowd bonds.
Until now, this tax-free individual savings account has only been able to hold peer-to-peer loans. This kind of lending matches those who are prepared to lend their savings to interest-paying borrowers through a website. The peer-to-peer lender arranges the loan but — unlike a bank — does not take balance sheet risk.
The Isa has not really taken off because none of the major peer-to-peer lenders — including Funding Circle, Zopa and RateSetter — have yet been fully authorised by the financial regulator, something that has to happen before they can have their loans held in Isas.
The only innovative finance Isas to have been launched have come from a handful of smaller, less well-known lenders. From Tuesday, however, investors will be able to hold debt securities within the wrapper, including debentures (essentially, asset-backed bonds) issued by crowdfunding companies, which some are calling “crowd bonds”.
What exactly is a crowd bond?
A “crowd bond” is a bond issued by a company or charity and sold to investors by a crowdfunding company — they are usually secured against the company’s assets. The crowdfunder should be authorised by the Financial Conduct Authority to “arrange deals”, they should have done their homework on the company offering the bond, and they should give you — the investor — a test to make sure that you understand the risks attached to your investment. The bonds themselves will usually be issued by relatively small, unlisted companies.
This sounds a lot like a mini-bond . . .?
There are some crucial differences. Whereas mini-bonds are non-transferable, crowd bonds can be sold to other investors. However it’s important to remember that crowd bonds are still unlisted investments and there is no developed secondary market, so while the crowdfunder might help you sell your bond to another investor it is best to assume that you will have to hold the bond to maturity.
The other big difference is technical, but important. Mini-bonds tend to be issued by unregulated companies which are only allowed to market their bonds to retail investors with the help of a second, FCA-regulated company. That company will check that the advertisement (or “offer document”) for the bond is “clear, fair and not misleading” — but there is no set amount of due diligence they must carry out.
Once consumers have invested in the bond they are not considered “a client” of the FCA-regulated company — so that company has no responsibilities towards them and no incentive to make sure that the investment is a good one. That is not the case with crowd bonds — the regulator considers you a customer of the crowdfunder, and investors can report the crowdfunder to the financial ombudsman if they have been negligent in carrying out due diligence on the bonds.
Am I covered by the Financial Services Compensation Scheme if things go wrong?
Yes and no — mostly no. Your money is at risk and if the bond defaults you will lose it, there will be no FSCS compensation. However, if the regulated crowdfunder goes out of business because a fraudulent bond leads to investors suing, investors in the fraudulent bond can claim up to £50,000 in compensation.
What sort of things can I invest in and what are the returns like?
Bonds have so far been issued by care homes, hydroelectric power stations, solar farms, wind farms and pubs. The bonds usually offer fixed returns of between 4 to 7 per cent. Existing bonds have been issued in a range of maturities, between 5 years and 19 years.
Is this different from peer-to-peer lending?
Yes. With a peer-to-peer loan you will probably be lending to multiple consumers or small businesses, rather than issuing one large loan to one business. This means you’ll get better diversification in your portfolio with P2P loans — although they are generally unsecured.
The peer-to-peer lender will have carried out credit checks on the borrowers. It’s been argued that as the peer-to-peer lender isn’t doing any lending itself it isn’t incentivised to make sure the loans are high-quality. The lenders argue that as they earn fees on arranging loans, it’s in their interests to arrange high quality loans to maintain customers.