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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
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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
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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
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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