Advising on Innovative Finance ISAs and peer to peer agreements (P2P agreements)

Following proposals by HM Treasury the ISA regulations have been amended to allow peer to peer agreements to be held in an ISA wrapper. They will be known as an ‘Innovative Finance ISA (IFISA)’. 

This means that providing advice on an IFISA or P2P agreement will be a regulated activity. As a result, the FCA published CP16/05 in February 2016 to reflect the new rules in this area, which was swiftly followed up by the Policy Statement – PS16/8 published 21 March 2016.

The first thing to confirm is the FCA do not require firms who deliver independent advice to consider investments into P2P agreements when making a personal recommendation nor do they require advisers to hold any specific qualifications in this area. It is up to the firm to define and assess competency. However the adviser must have a level four qualification.

From 6 April 2016 all firms that have the permissions for the regulated activity of ‘advising on investments’ will automatically have their permissions varied to include the ability to advise on P2P agreements. Firms would have already received an email from the FCA confirming this and giving the firm the option to remove this permission if they want. If firms wish to remove this permission they have until 6 October 2016 to remove the permission by the simplified form that the FCA has emailed out to firms without any charge being incurred.  After this date, to remove this permission will involve using the Connect system and there will be a charge. If the firm does not have the permissions for these types of products then the agencies of such agreements cannot be transferred to the firm. The firm will also need to make it clear to clients whether advising on any existing P2P agreements will be included in their reviews or not. If the firm does intend to review existing plans, albeit not advise on new arrangements, then the firm will need the relevant permissions and the advisers must be competent to review and advise upon such contracts.

On a positive note, firms who already have the permissions for advising on investments will not see any impact on the regulatory capital requirements that they need to hold. However, we do recommend that firms notify their PI insurer of their intention to advise in this area.

If firms do decide to hold the permissions to give P2P advice then they will also need to make sure they have good record keeping on these products as there will be specific reference to them in the GABREL returns completed by firms.

Payment or receipt of commission for recommending a P2P agreement is banned. However, as is the case at the moment, unadvised sales can still receive commission.

In terms of giving the advice itself the overriding requirement has not changed. COBS 9.2.1 R states:

(1) A firm must take reasonable steps to ensure that a personal recommendation, or a decision to trade, is suitable for its client.
(2) When making the personal recommendation or managing his investments, the firm must obtain the necessary information regarding the client's:
1. (a) knowledge and experience in the investment field relevant to the specific type of designated investment or service;
2. (b) financial situation; and
3. (c) investment objectives;
so as to enable the firm to make the recommendation, or take the decision, which is suitable for him’.

However the FCA has updated the COBS rules for P2P agreements (which will include IFISAs). COBS 14.3.7A G states:

‘Examples of information a firm should provide to explain the specific nature and risks of a P2P agreement include:
(1)  expected and actual default rates in line with the requirements in COBS 4.6 on past and future performance;
(2) a summary of the assumptions used in determining expected future default rates;
(3) a description of how loan risk is assessed, including a description of the criteria that must be met by the borrower before the firm considers the borrower eligible for a P2P agreement;
(4) where lenders have the choice to invest in specific P2P agreements, details of the creditworthiness assessment of the borrower carried out;
(5) whether the P2P agreement benefits from any security and if so, what;
(6) a fair description of the likely actual return, taking into account fees, default rates and taxation;
(7) an explanation of how any tax liability for lenders arising from investment in P2P agreements would be calculated;
(8) an explanation of the firm's procedure for dealing with a loan in late payment or default; 
(9) the procedure for a lender to access their money before the term of the P2P agreement has expired; 
(10) an explanation of what would happen if the firm fails, including confirmation that there is no recourse to the Financial Services Compensation Scheme’.

PS16/08 provides more guidance. It confirms that COBS 4 requires that all communications are fair, clear and not misleading. As a result they do not consider it necessary to specify that firms have to explain how IFISAs differ from other types of ISA, (although it may be appropriate for firms to do so in some communications i.e. depending on the client’s knowledge and experience). 

They do expect firms to provide a sufficient explanation of the tax position so that customers can understand their tax obligations and the potential impact if a P2P agreement, held in an IFISA wrapper, is not repaid. 

The paper also confirms that ‘firms should disclose the procedure for, and tax consequences of, cashing in or transferring an IFISA from one ISA manager to another’. For example this would include the fact that transfers can only be made once outstanding loans have been repaid as cash, held in the client money account, and provide an indication of the time this is expected to take.

What is key is that the paper states that the FCA expects firms to provide appropriate information before the business is transacted, so that the client is able to make an informed decision about investing. We believe this would include the issuance of suitability reports prior to the application form being signed.

The paper again confirms that the FCA rules set out situations where firms can place reliance on other persons. It states ‘It is generally reasonable for a firm to rely on information provided to it in writing by an unconnected authorised person or a professional firm, unless it is aware, or ought reasonably to be aware, of any fact that would give reasonable grounds to question the accuracy of that information’. 

However advisers must form their own opinion of the risk of any investment and advise their clients based on this opinion. If an adviser is unable to form an opinion based on the information available, then the correct response is not to advise the client to invest in that product. 

Any client receiving advice P2P agreements will have recourse to FOS in the event of a disagreement with the firm and if the advising firm is out of business, the client will be able to refer their complaint to the FSCS.

Therefore, firms need to decide whether they intend to advise in this area and if so ensure they have the relevant systems and controls in place to do so.