Written by Harvey Jones, Personal Finance Editor at the Daily Express.
Peer-to-Peer lending (P2P) has won over many sceptics since the first platforms appeared a decade ago, but there appears to be a glaring exception. New research suggests that one key group remains doubtful: independent financial advisers. Just 18% would either put their own money into P2P or have already done so, according to a study by the Yorkshire Building Society.
More than four out of five IFAs surveyed believe their clients don’t understand P2P lending rules. They were concerned about consumers’ low levels of understanding of the potential risks of P2P, which is not covered by the government-backed Financial Services Compensation Scheme (FSCS). This caution might have been understandable five or six years ago, but it looks increasingly odd today, as P2P becomes an established business model. More than £1.74 billion was invested last year, up from £666 million in 2013, as investors cast aside their early suspicions to seek a far higher return than they can get on cash.
To a degree, IFAs are right to be on their guard. They know clients are cautious, having been stung in the past by too-good-to-be-true investment offerings. And they understand that many will be worried by the lack of FSCS protection, which is a nice warm comfort blanket for savers.
Stiff regulation by the Financial Conduct Authority has taught advisers to be instinctively cautious. Before dismissing P2P as too risky, IFAs need to understand how it works and the efforts many platforms have made to manage risk. Many P2P lending platforms have built up their contingency funds, to cover any losses following default. Wellesley & Co also runs its own provision fund, which currently stands at a hefty £1.84 million (and rising). And of course the leading P2P platforms are also regulated by the Financial Conduct Authority.
P2P lenders further reduce risk by spreading savers’ money across over large numbers of borrowers, to reduce the damage if any single one defaults. They also carry out stringent credit checks on loan applicants, to ensure they only accept high-quality borrowers. Better still, savers can dip their toes into P2P waters, starting from as little as £10 or £100, depending on the platform. Once their confidence – and their adviser’s confidence – grows they can start to save larger amounts.
Advisers rightly understand that P2P is riskier than leaving money in the bank. Savers’ capital is at risk and their interest payments are not guaranteed if a borrower defaults.
With different platforms running different models, advisers have to understand how much risk each one presents. Many of the new band of higher-risk crowdfunding sites act as investment angels backing business start-ups, and both advisers and their clients must understand what they are getting into.
But if the Yorkshire’s findings are accurate, IFAs are arguably too cautious, and need to take a second look at P2P.
The concept of P2P lending is sufficiently established to stake its claim to a place in a balanced portfolio, offering higher potential returns than cash, but with less volatility than stocks and shares. From April next year, it looks set to break into the mainstream, with the launch of the new Innovative Finance ISA, announced by Chancellor George Osborne in his emergency Budget in July.
Even the most sceptical IFA can’t ignore that. The Yorkshire’s research shows that nearly half of advisers expect interest in P2P to grow sharply once it is eligible for the tax-free allowance. The prospect of earning between 4% and 6% a year free of tax will be too attractive to go unnoticed by IFA’s clients.
Advisers who continue to dismiss P2P out of hand may have some hard questions to answer from increasingly eager clients. The decision to recommend P2P will largely depend on factors such as the client’s existing portfolio and personal attitude to risk.
But advisers can’t make that decision until they know exactly how much risk P2P presents. That may be less than they think, when balanced against the potential rewards.