News analysis: Positives and pitfalls of peer-to-peer

In its summer Budget, the government confirmed it will launch a new version of the ever-popular tax wrapper in April 2016, which will allow for up to £15,240 to be invested in the peer-to-peer (P2P) sector.

The P2P marketplace has already experienced strong growth, almost trebling in size last year to more than £1.3bn, though that is far below the £57bn squirreled into cash and shares ISAs, according to numbers from Yorkshire Building Society.

New figures from the sector’s trade body, the Peer-2-Peer Finance Association, shows that more than £500m of new consumer and small business loans have been provided by peer-to-peer platforms since April, the fastest rate of growth yet. Cumulative lending by the sector now stands at £3.15bn.

The burgeoning industry, which matches lenders with borrowers, has risen on the back of the combination of lousy rates of return being offered by cash accounts and consumers having greater difficulty in getting personal loans from their banks.

By going to a P2P firm, both borrowers and lenders can cut out traditional financial institutions. The unique selling point is that while borrowers can enjoy lower rates of interest, lenders can in turn achieve far higher rates of return than they would receive from deposit accounts.

Importantly, borrowers go through a credit-check process and subsequently receive risk ratings, which in turn lets them know at what sort of rates they can borrow at. Lenders, on the other hand, can opt to lend to higher-risk peers for greater rates of return or instead they can offer loans to more solid bets for more modest yields.

The sector has had no significant blow-ups as of yet, but research from Yorkshire Building Society shows that fewer than one in five, or 18 per cent of financial advisers, have or would invest their own money into peer-to-peer lending schemes.

The survey highlights that advisers are most concerned about consumers’ low levels of understanding of the potential risks involved. It found 82 per cent of respondents believe customers do not understand P2P lending rules.

Crucially, P2P is not covered by the Financial Services Compensation Scheme. As such savers could lose capital as well as interest, while also facing restrictions on withdrawing money. Notably, earlier analysis from the building society had found only 42 per cent of savers knew about the FSCS and, of those, 60 per cent were unaware they had no FSCS protection.

Looking at the survey results Andy Caton, executive director at Yorkshire Building Society, comments: “Investing in P2P can offer strong possible returns but people need to be fully aware of the possible risks and costs involved. It is clear many financial advisers have concerns about consumers’ understanding and are unwilling to invest their own money in P2P despite the potential returns.”

The reluctance from advisers to invest their own money in P2P becomes magnified when it comes to clients’ money.

Martin Bamford, managing director of advisory firm Informed Choice, who has personally used P2P platforms in the past, admits he has no plans to start recommending them as cash proxies to clients.

He says: “If people view P2P as a cash substitute, that is where the danger could lie. It really needs to be treated as a separate asset class. Cash rates and bond yields are very low but if an investor is getting 5 to 6 per cent for a P2P loan, they need to understand the level of yield on offer equates to the level of risk present.”

Chase de Vere chartered financial planner Patrick Connolly takes a similar view and would like to see more consumer protection in place before he would consider P2P properly. But he admits he cannot see that happening in the short term.

“We do not use P2P but we are looking at it. I can see the attraction given the rates on offer and some people have done well out of it. Our main concerns are that it is not covered by the FSCS and, as the market grows, there could be a dilution of quality. It is a fledgling market and we have not seen it perform during more tricky times,” he says.

However Yorkshire’s study ultimately shows advisers are braced for increased interest from clients. In fact, nearly half of those surveyed (45 per cent) believe interest in P2P will grow as the new savings rules come into effect and 20 per cent have already seen an increase in enquiries from clients about investing in P2P over the past 12 months.

Wealth manager Whitechurch Securities is not currently recommending P2P but its managing director Gavin Haynes says the group is researching it. He adds: “It is a growing area and we may change our minds by next April. The key factor is the lack of protection, given there is no backup from the FSCS. It ultimately comes down to a risk-versus-reward issue.”

But while advisers are reticent, fund managers appear more bullish on the sector. Earlier this year F&C Investments’ co-heads of multi-manager Rob Burdett and Gary Potter snapped up a position in P2P Global Investments, an investment trust that specialises in P2P loans in the corporate sector, after it released more shares into the market.

Other groups that have also bought into the trust at the time include Ruffer, City Financial and Woodford Investment Management.