City watchdog issues warning over ‘high risk’ ISAs
Days before the annual ISA deadline, the Financial Conduct Authority (FCA) has said it has seen evidence of IFISAs being promoted alongside cash ISAs, but warned that the two products are very different propositions.
In a statement on its website, the FCA said: “Investments held in IFISAs are high-risk with the money ultimately being invested in products like mini-bonds or peer-to-peer investments.
“These types of investments may not be protected by the Financial Services Compensation Scheme (FSCS) so customers may lose the money invested or find it hard to get back.
“Anyone considering investing in an IFISA should carefully consider where their money is being invested before purchasing an IFISA.”
Sarah Coles, personal finance analyst at Hargreaves Lansdown, said: “There’s a good chance that this announcement has been inspired, at least in part, by the collapse of the mini-bond run by London Capital & Finance.
“This was a highly unusual case, which includes allegations of suspicious transactions, and is currently under investigation. However, in the aftermath of the collapse, the FCA has highlighted the risk that some people may not fully understand their IFISA investments.”
What are Innovative Finance ISAs?
Innovative Finance ISAs are a relatively new type of wrapper available through peer-to-peer lending platforms.
With peer-to-peer lending, savers lend money direct to businesses or individuals.
They hope to get better rates than they would from banks and building societies, while borrowers aim to raise money for themselves or their business without having to go down the traditional bank route.
Savers who are disillusioned with the low rates on cash ISAs may be enticed by the target interest rates on these ISAs, some of which are as high as 6% or 7%.
But IFISAs come with numerous risks compared with cash products. Importantly, they are not covered by FSCS, which entitles customers to compensation of up to £85,000 if an authorised financial services firm fails.
But there are others. Coles said: “They lend money direct to businesses, so there’s no guarantee they’ll be able to pay interest or repay the loans. Many peer-to-peer businesses spread the money between different loans to reduce the risk and run safety net funds to lessen the impact of a failure.
“However, they haven’t yet been through a really tough time, with large numbers of defaults, so we don’t know how they’ll hold up when these safety nets are deployed.”
Despite this she said IFISAs are still a sensible option as a small part of a wider portfolio for some investors as long as they understand the risks and are comfortable with them.
However, she said savers who need a “risk-free home” for their cash should “steer clear”.
The good news for these savers is that the rates on cash ISAs have picked up in the closing weeks of the tax year.
They still won’t blow the lights out, but you can currently earn up to 1.46% in an easy access cash ISA with Yorkshire Building Society, 1.77% by fixing for a year with Shawbrook Bank, and 1.95% with a two-year fix from Charter Savings Bank.