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Consultation Response Draft legislation: Innovative Finance Individual Savings Account and debt based crowdfunding September 2016 1 Summary of position The draft legislation should be amended to make debt securities listed on electronic platforms by co-operative and community benefit societies eligible for the Innovative Finance ISA There is nothing in the form, function or regulation of society debt securities listed on electronic platforms that makes them less appropriate for Innovative Finance ISA eligibility than company and charity debt securities Not making these amendments will result in significant and much needed opportunities being missed to: - increase choice for socially and ethically conscious savers - encourage growth in crowdfunding by societies - diversify finance and investment options for societies 2 Introductory remarks 2.1 We have been very supportive of government’s direction of travel in relation to the Innovative Finance ISA. This is mainly because we have seen significant and much needed opportunities to develop new investment streams for the UK’s co-operative and community benefit societies (collectively referred to as ‘societies’). We are therefore extremely disappointed that government has decided not to make society debt securities listed on electronic platforms eligible for the new Innovative Finance ISA. 2.2 In this paper we set out why society debt securities listed on electronic platforms are appropriate for Innovative Finance ISA eligibility, and how amending the draft legislation to provide this eligibility would enhance the legislation’s performance against its stated policy objectives. 2.3 Co-operatives UK provided a detailed and supportive response to the July 2015 public consultation on qualifying investments, with a distinct focus on society securities.1 We are disappointed HM Treasury has not seen fit to 1 http://www.uk.coop/sites/default/files/uploads/isa_qualifying_investments_consultation_on_whether_to_include_investment_bas ed_crowdfunding_-_co-operatives_uk_consultation_response.pdf 2 include the sector in more detailed consultation on the subject of society eligibility. We also find it problematic that since July 2015 government has not published anything specific in relation to society eligibility, with its policy decision in this regard being signalled only by omission at this late stage. 3 Society debt security appropriateness 3.1 There is nothing in the form, function or regulation of society debt securities, that makes them less appropriate for Innovative Finance ISA eligibility than company and charity debt securities. The rationale for disadvantaging businesses incorporated as societies in this way is thus very unclear. 3.2 It is essential government recognises that debt securities issued by societies but listed and promoted on electronic platforms are regulated under the UK’s financial promotions regime to the same degree as securities issued by companies and charities. While there are some varying exemptions to the financial promotions regulations for society debt securities, these do not extend to the activities of third parties, such as crowdfunding platforms. This is a fundamental consideration in determining appropriateness. 3.3 It is also important to consider that in July 2015 government amended ISA regulations to make society debt securities listed on RSEs eligible for ISAs, creating equality with company listings.2 Government is now assured that the consumer protections governing crowdfunding are adequate to extend ISA eligibility from RSE listed to electronically listed company and charity debt securities. Given that these same consumer protections apply to electronically listed society debt securities, it should be just as appropriate to extend ISA eligibility for these from RSE listings to electronic platform listings. 3.4 Government should also note that society debt securities are fully transferrable as per section 102A (3) of FSMA 2000. There are no legal, regulatory or functional obstacles arising from the society legal form. Indeed there are examples of societies listing transferrable debt securities on recognised stock exchanges (RSEs).* 3.5 Similarly, there are examples of transferable society debt securities being listed on crowdfunding platforms without legal, regulatory or functional obstacles.** 4 Policy objective: choice 4.1 Extending Innovative Finance ISA eligibility to debt securities issued by societies would certainly increase choice for savers, whereas limiting savers’ 2 http://www.legislation.gov.uk/uksi/2015/1370/pdfs/uksi_20151370_en.pdf For example the Co-operative Group, a registered co-operative society, has issued transferrable ‘euro bonds’ on an RSE unimpeded (https://www.uk.coop/sites/default/files/uploads/attachments/capitalfinance_0.pdf) * ** For example see Greenwich Leisure’s 2013 bond offer on Ethex: http://www.gll.org/b2b/pages/32 Draft legislation: Innovative Finance Individual Savings Account and debt based crowdfunding 3 choices to investing in some forms of business but not others obviously reduces choice. The question is whether that limit on choice is justified by other considerations; in part 3 above we argue that it is not justified. 4.2 The massive success of community shares (public investment in society equity) in recent years suggests that there will be significant demand among certain savers for ISA investment in many types of society, and especially in those societies with a demonstrable social or ethical purpose and impact. The Community Shares Unit (CSU) conducts market analysis. Even using the most conservative estimates for the last two years based on what has been reported directly to the CSU, the community shares market has raised almost £60 million in the last five years, with upwards of £20 million invested in 2014 alone.3 This in itself is not an inconsequential figure, but when set in the context of the wider social investment and alternative finance sector, this is particularly illuminating. Community shares now comprises over 10 percent of the overall annual social investment market and is the second largest form of ‘crowdfunding’ in the UK.4 We see no reason why there would not be similar public appetite for ‘co-operative and community ISAs’. 4.3 Crucially ISA eligibility could be about far more than ‘regulated social investment.’*** There are a wide variety of co-operative businesses that might not meet the official definition of a social enterprise but which still command significant public support, most notably employee-owned co-operatives and consumer co-operatives. There are 17.5 million members of co-operatives in the UK.5 This represents a huge group of savers who are supportive of co-operative Values and Principles, and who may like at least some of their savings to be invested in co-operative businesses. International research on co-operative capital finds that when supportive savers are given more opportunities to support co-operatives they tend to take them.6 4.4 Savers who would like the opportunity to invest in societies through the Innovative Finance ISA will be denied that choice by the legislation as currently drafted. 5 Policy objective: growth in crowdfunding 5.1 To date societies have contributed significantly to the development of crowdfunding through the huge success of community shares (see paragraph 4.2 above). However, the prospect of extending ISA eligibility to society debt 3 Community Shares Unit (2015) ‘Inside the Market Report June 2015’ 4 Ibid *** investment in regulated social enterprise: community benefit societies, community interest companies and charities 5 http://reports.uk.coop/economy2016/ 6 http://ica.coop/sites/default/files/352_ICA_Coop_Capital.pdf Draft legislation: Innovative Finance Individual Savings Account and debt based crowdfunding 4 securities presented exciting opportunities to develop other co-operative investment models in the crowdfunding space. 5.2 We know that crowdfunding works well when investors can connect with the business or idea. This is why social and ethical crowdfunding has been particularly successful. Meanwhile, due to their Values and Principles co-operatives tend to find investors supportive of, or with a stake in, their activities particularly appropriate. Thus co-operatives in the UK and elsewhere in the world have identified crowdfunding as a particularly promising source of investment.7 5.3 There is growing interest among employee-owned co-operative societies in crowdfunding investment from a supportive public, taking inspiration from some high profile successes.**** The possibilities presented by the Innovative Finance ISA had particularly caught the attention of many of these businesses. These co-operatives are especially limited in how much equity they can raise from member-employees and how little they can give away to outside investors. Debt-based crowdfunding from supportive savers has thus been identified as particularly attractive for these businesses. 5.4 The decision to exclude society debt securities from the Innovative Finance ISA will deter what we believe would be significant co-operative activity in this area. 6 Policy objective: competition and diversity in the financial sector 6.1 Government should be in no doubt that many societies, and co-operative societies in particular, are in need of more diverse and tailored finance streams. Extending ISA eligibility to include their debt securities would provide a basis for innovative and beneficial diversification. Not doing so will certainly not increase competition or diversity for these businesses. 6.2 Recent international research has found that mechanisms which allow supportive savers to invest in co-operatives over the long term are an essential component in the successful financing of thriving co-operatives.8 6.3 We have reason to believe that beyond the challenges faced by all SMEs, societies are particularly disadvantaged by biases in the financial services system. They can find it harder to access corporate finance because they are poorly understood by lenders. Lenders can be unfamiliar with their mutual ownership models, uses of capital and corporate purposes. A lack of familiarity with the society legal forms can be additionally problematic. Indeed 7 https://coopseurope.coop/resources/news/eu-commission-releases-report-cooperative-working-group-fostercooperatives%E2%80%99 **** 8 For example Unicorn’s crowdfunding from customers to by its premises: http://www.unicorn-grocery.coop/history.php http://ica.coop/sites/default/files/352_ICA_Coop_Capital.pdf Draft legislation: Innovative Finance Individual Savings Account and debt based crowdfunding 5 entrepreneurs in many sectors tell us it is harder as a society to access debt finance, particularly project finance for significant capital investment and growth. This is frustrating because there is nothing inherent in the society legal form that should impinge on lenders’ decisions. By way of an example, we are aware that at present it is Funding Circle policy not to provide finance to societies. 6.4 As a group of businesses co-operative societies are particularly underserved by government policy to support enterprise finance. Because during start-up co-operative societies are extremely limited in the extent to which they can offer equity to external investors, most cannot benefit from the UK’s venture capital schemes. Also, full-risk equity investors in societies get five times less support from the exchequer than full-risk equity investors in PLCs.***** And furthermore co-operative societies are excluded from many social investment initiatives, including Social Investment Tax Relief and finance streams from the Access Foundation, Big Society Capital and Big Lottery to name just a few. 6.5 Societies looking to grow also face additional challenges to other SMEs because they are restricted in how much equity they can offer to external investors without ceding ownership and control. 6.6 More generally the mutual and communal purposes of societies tend to make some forms of external investor and investment more appropriate than others. 6.7 Because of the above we assert that more than any other group of businesses in the UK, societies need the increased competition and diversity ISA eligibility would bring. 7 Distortive impacts, lost opportunities 7.1 If, without good reason, government supports savers to invest in one group of businesses but not in others it will be a distortive and damaging intervention. Exclusion from the Innovative Finance ISA will further disadvantage the society legal forms, which are already underserved legislatively and in business policy. Not only will this further penalise existing mutual businesses but it will help force sub-optimal choices onto entrepreneurs who might otherwise choose the society legal form. 7.2 Most societies are SMEs with no access to RSEs. The growth of crowdfunding has therefore presented a major opportunity for them to diversify sources of capital and raise finance from a broader public. These opportunities would be significantly enhanced if Innovative Finance ISA eligibility were to be extended to them. Even comparatively large societies will be negatively affected by being excluded without good reason. Societies that would otherwise have ***** As a result of getting Personal Savings Allowance rather than Dividend Allowance Draft legislation: Innovative Finance Individual Savings Account and debt based crowdfunding 6 been big gainers, such as employee-owned co-operative societies, stand to be among the biggest losers. 7.3 We urge government to reconsider the appropriateness of society debt securities in light of our points in part 3 and amend the draft legislation to extend eligibility for the Innovative Finance ISA accordingly. Draft legislation: Innovative Finance Individual Savings Account and debt based crowdfunding