ISA qualifying investments: consultation on whether to include investment based crowdfunding

Transcription

1 Consultation Response ISA qualifying investments: consultation on whether to include investment based crowdfunding September 2015 About Co-operatives UK Co-operatives UK is the network for Britain s thousands of co-operatives. We work to promote, develop and unite member owned businesses across the economy. From high street retailers to community owned pubs, fan owned football clubs to farmer controlled businesses, co-operatives are everywhere and together they are worth 37 billion to the British economy. The internationally recognised definition of a co-operative is as follows: A co-operative is an autonomous association of persons united voluntarily to meet their common economic, social, and cultural needs and aspirations through a jointlyowned and democratically-controlled enterprise. 1 Opening remarks The vast majority of co-operatives in the UK incorporate under the Co-operative and Community Benefit Societies Act (2014) as co-operative societies or community benefit societies. In this response we consider the implications of expanding ISA eligibility to include debt and equity securities issued by these societies. Most co-operative and community benefit societies are SMEs with no access to RSEs. 2 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 ISA eligibility were to be extended to the debt and equity of co-operative and community benefit societies offered on crowdfunding platforms. The key points we make in answering questions 1 to 7 can be summarised as follows: Extending ISA eligibility in the way being considered would enhance existing opportunities for SME co-operative and community benefit societies to crowdfund debt finance, and to a lesser degree equity finance as well (see answers to questions 2 and 7) There are some restrictions on how co-operative and community benefit society equity could or should be held in ISAs, but these are existing responsibilities for societies and the Financial Conduct Authority (FCA), and For more on the size and makeup of the co-operative economy see our open data explorer:

2 2 would not impose additional burdens on ISA managers or HMRC (see answer to question 2) The legal and regulatory framework for co-operative and community benefit societies provides significant built in protections for the investing public when it comes to some equity, and financial promotions regulations apply to all other equity and debt securities offered by societies (see answer to question 3) The regulated nature of the co-operative and community benefit society legal forms means they are unlikely to be misused as vehicles for aggressive tax avoidance (see answers to questions 1 and 5) 1 Do you agree with the proposed principles for assessing whether to extend ISAs to equity and debt securities offered via a crowdfunding platform? Please provide any comments as appropriate. 1.1 We agree with these principles. 1.2 In relation to the third principle it should be recognised that supporting investment in co-operative and community benefit societies through ISAs would constitute value for money for the exchequer because of the attendant social value, particularly through building self-reliance that proactively reduces further demands on the state. 1.3 Also relevant to the third principle, the FCA scrutinises co-operative and community benefit societies at registration and after to determine mutual or community purpose. This is done in such a way as to make it is very difficult for these legal forms to be misused a shell vehicles for aggressive tax avoidance. 1.4 In relation to the fourth principle, it should be noted that while there are additional rules for how co-operative and community benefit societies can raise capital (see answer to question 2), it would only ever be the responsibility of the societies themselves and the FCA to uphold these, with no additional complexity for either ISA managers or HMRC. 2 Specifically, could respondents provide views on the key characteristics of: Crowdfunding platforms; Debt-based securities offered via a crowdfunding platform; and Equity-based securities offered via a crowdfunding platform? 2.1 We limit our remarks to the special characteristics of co-operative and community benefit societies and the debt and equity they can offer through crowdfunding platforms, within an assessment of the potential benefits and challenges presented by ISA eligibility. This assessment covers three types of

3 3 stock and share ISA: direct self-investment, indirect self-investment, and managed funds. Securities offered by co-operative and community benefit societies 2.2 Co-operative and community benefit societies issue a unique form of equity called withdrawable share capital. This risk capital cannot be traded and confers no right to a dividend, though it can under certain conditions be withdrawn by the member at par value. Interest can be paid as a percentage of shareholding at a fair compensatory rate and societies must actively ensure rates they pay do not exceed what is necessary to attract and retain capital. This is patient relatively illiquid capital that can deliver steady long term returns on investment rather than capital gain. The law limits individual holdings in a society s withdrawable share capital to 100,000. Because withdrawable share capital offers limited returns, is non-speculative, and forms just one part of an engaged, participative and democratic member relationship, it is issued outside of financial promotions regulations (for more on this see our answer to question 3). 2.3 Co-operative and community benefit societies can also issue a rarely used transferrable non-withdrawable form of share capital. These confer no right to a dividend and again interest is paid as a percentage of shareholding at a fair compensatory rate. Societies must actively ensure rates they pay on this capital do not exceed what is necessary to attract and retain capital. There is no statutory limit on individual holdings in this capital. Public offers to investment in this capital are subject to financial promotion regulations. 2.4 Co-operative and community benefit societies are also able to issue a wide variety of debt securities including bonds, loan stock and debentures. In the past societies have offered these securities to existing members, to other stakeholder groups close to the co-operative, and to investors more broadly. Any public offering of these securities is subject to financial promotion regulations. Investment in co-operative societies 2.5 Investment in co-operative societies is intrinsically linked to their special member-owned purpose-driven nature. The purpose of a co-operative society must be to meet a common need or aspiration of its members, who democratically own and control the enterprise. 2.6 In many co-operative societies members pool financial resources to meet their common needs or aspirations by purchasing shares, upon which interest can be paid as a percentage of shareholding at no more than is necessary to attract and retain capital. Members who invest in their co-operative do so to support its development while also hoping to receive a steady long term return

4 4 on investment. Depending on the purpose of the co-operative this is usually a very direct and democratic form of social investment. 2.7 In a co-operative society membership must be based on a common need or aspiration being met, and this relationship must be more than that between an investor and a business. This is set out in the Co-operative and Community Benefit Societies Act (2014), and enforced through FCA regulatory policy. It is this membership rather than holdings in equity that give rise to co-operative ownership and control, with voting rights and charges over residual assets always being equal between members, regardless of their holdings in equity. 2.8 Yet even within these arrangements in practical terms the rights of equity holders mean that member ownership and equity interact in a complex way. For this reason co-operatives in the UK are only allowed to issue a minority of their equity to investor-members. Investor-member shares must be distinct from standard member equity and must have curtailed voting rights to retain member control. Consequently indirect investment in the equity of a cooperative society is a sensitive area because it distances equity holders from the co-operative; making it harder to determine whether investors are also members and how much equity is held by investor-members. Investment in community benefit societies 2.9 Community benefit societies are best understood as a member owned democratic form of social enterprise. Members invest in their community benefit society in order that it will better deliver its community benefit, while also hoping to receive a steady long term return on investment. Again there is a clear rule that returns on investment must not exceed what is necessary to attract and retain capital. This is a very direct and democratic form of social investment. As in a co-operative society interest can be paid as a percentage of shareholding at a fair compensatory rate In a community benefit society returns on investment must always align with and never take primacy over fulfilment of its community purpose. This is enforced through FCA regulatory policy. So while there is not necessarily the requirement for a co-operative member relationship in these investments, the motivations of investors, the use of capital, and returns on investment, must always align with the community purpose, and so again indirect investment in these societies has some sensitivities to be managed. Interaction with crowdfunding platforms 2.11 In recent years communities have made increasing use of withdrawable share capital to pool resources in co-operative and community benefit societies in the form of community shares. Community shares have been instrumental in allowing people to invest in, own, and control local assets and services ranging from pubs and shops, to renewable energy schemes, transport, and

5 5 infrastructure. Community share offers have been at the forefront of social investment crowdfunding through platforms such as Mircogenius and Ethex. The Community Shares Unit (CSU) estimates that more than 50,000 members have invested over 60 million in community shares since There are also examples of societies listing debt securities on crowdfunding platforms. 4 Co-operatives UK sees significant potential for more societies to access investment in this way, particularly where they are able to demonstrate ethical credentials or social impact. Direct self-investment ISAs and co-operative societies 2.13 Where an ISA allows the holder to choose specific securities to invest in, including hypothetically co-operative society debt and equity listed on crowdfunding platforms, the opportunities are broad So long as the co-operative society can verify legitimate membership of the ISA holder through the ISA it would be appropriate for a member of the co-operative to invest in and hold equity through this ISA A co-operative society could also offer a minority of its equity as investormember shares on a crowdfunding platform and these could be purchased and held by anyone through a direct self-investment ISA It would also be appropriate for both members and investor-members of a cooperative society to buy and hold debt securities issued by a co-operative on a crowdfunding platform through a direct self-investment ISA. Indirect self-investment ISAs and co-operative societies 2.17 Where an ISA holder has a choice of investment funds to pick freely from but cannot choose securities directly, the opportunities for co-operative societies are more limited A co-operative society could offer a minority of its equity as investor-member shares on a crowdfunding platform and these could be purchased by investment funds that any ISA holder could then choose. This presents opportunities both for ethical and social investment funds, and for ethical and social investment ISAs It would also be appropriate for investment funds to buy co-operative society debt securities listed on crowdfunding platforms, and for these funds to be chosen by any ISA holder. Again this presents opportunities both for ethical and social investment funds, and for ethical and social investment ISAs. 3 Community Shares Unit 4 See Greenwich Leisure s 2013 bond offer on Ethex:

6 It would not be appropriate for a co-operative society to issue any of its standard member equity to investment funds via a crowdfunding platform. Manged ISAs and co-operative societies 2.21 Where the stocks and shares ISA is managed on behalf on the holder the opportunities and restrictions in relation to co-operative societies set out in paragraphs 2.16 to 2.20 apply in exactly the same way. However there is perhaps additional scope for managed fund ISAs to be calibrated towards ethical or social investments and to be branded as such The table below displays what is and is not appropriate for ISA investment in co-operative societies, as it has been described in paragraphs 2.13 to Direct self-invested ISAs Indirect self-invested ISAs Manged fund ISAs Member equity Investor-member equity Debt securities Existing member Yes Yes Yes General investor No Yes Yes Existing member No Yes Yes General investor No Yes Yes Existing member No Yes Yes General investor No Yes Yes Community benefit societies 2.23 All forms of stock and share ISA present broad opportunities for community benefit societies listing debt and equity securities on crowdfunding platforms As membership of a community benefit society does not necessarily require a co-operative relationship as described in paragraph 2.7 there are no restrictions on who can invest in its equity and no distinctions between members and investor-members However the degree of directness in the investment could be a factor in the ongoing governance and mission of the society. It could become problematic for the good governance and overall mission of a community benefit society to have significant portions of its equity held by investment funds rather than directly by citizens. Modern community benefit societies tend to work best when owned and run by a group of engaged members who have a real stake in its communal economic and social impact alongside any financial returns. Withdrawable share capital 2.26 Government should also take account of how the basic characteristics of withdrawable share capital could interact with ISAs. There is never an absolute right to withdraw of shares and societies will generally impose conditions on withdrawal that are appropriate to their business needs. For example a lengthy notice period may be required before a withdrawal can be actioned. Shares are also often issued on the condition that they cannot be withdrawn for a number of years, especially earlier on in the life of a society. If

7 7 the business circumstances require it societies may also temporarily suspend withdrawals entirely or above a certain amount Withdrawable share capital therefore offers varying limited degrees of liquidity most appropriate for members committed and engaged in their co-operative or community benefit society. Such circumscribed exit could also be acceptable to self-directing ISA holders and fund managers oriented towards patient long term investment, especially when these have ethical and social objectives. This patient long term return on investment lends itself to ISAs Even when oriented towards social and ethical investments, we still expect most self-directing ISA holders and fund managers to be more distanced from a society and its purpose, and therefore more prone to withdrawing capital based on narrow financial calculations. This poses potential risks for societies. For co-operative societies the risk is reduced by only being able to have a minority of their equity held in this way. We believe it would be prudent for community benefit societies to take similar precautions This notwithstanding it s important to remember that these are complexities to be managed by societies rather than ISA managers or HMRC It would be possible for societies to issue a class of withdrawable shares specifically aimed at the ISA market with blocks on withdrawal running for many years, thereby providing long term capital for themselves and greater clarity in exit horizons for self-directing ISA holders and fund managers. Transferable share capital 2.31 In some respects transferable shares may be more appropriate for engaging with the ISA market. These provide permanent capital thus greatly reducing concerns about commitment of investment and its implications for capitalisation. However, while they offer greater liquidity for investors in theory, in practice this may not be the case. No secondary market currently exists for these securities and there is regulatory uncertainty as to what forms of share transfer are permissible, making them less attractive to most self-directing ISA holders and fund managers. However, it is possible that expanded ISA eligibility would act as a catalyst for secondary markets to develop. 3 Do debt-based securities and equity-based securities offered via a crowdfunding platform meet the protect the consumer principle? Would any additional safeguards be required if these securities became eligible for ISA? Please explain your answer. 3.1 Again we limit our remarks to securities offered via crowdfunding platforms by co-operative and community benefit societies. Withdrawable share capital: exceptions and protections

8 8 3.2 Opportunities to invest in the withdrawable share capital of co-operative and community benefit societies are not governed by financial promotions regulations. Neither societies nor crowdfunding platforms are subject to FCA regulation and authorisation for the purposes of a share offer. However this should not be read as an absence of consumer protection; rather protections here take a different form. 3.3 There are many instances where members hold withdrawable share capital without any kind of public offer taking place, most notably in agricultural cooperatives and consumer societies. When such societies ask existing engaged members to contribute capital by purchasing withdrawable share capital this is very different from a company inviting the public to invest. 3.4 Community shares are a different proposition. Inviting non-members in a community to pool capital in a venture clearly has some of the characteristics of a public offer, but there are still some crucial differences. The co-operative or community purpose of societies, their democratic ownership and control, and the unique characteristics of withdrawable share capital, all provide built in protections for consumers and are subject to regulation by the FCA under the Co-operative and Community Benefit Societies Act (2014). 3.5 By law co-operative and community benefit societies are driven by mutual and community purposes that align with but cannot be superseded by generation of financial returns. Holders of withdrawable share capital must be engaged members for whom significant motivations must include meeting their common needs and aspirations or delivering a community benefit. The FCA assesses societies at registration and after to ensure these conditions are met. 3.6 In order to ensure these conditions are met interest paid on shares must be actively limited to what is necessary to attract and retain capital, and rates paid cannot be driven by profits. This too is subject to FCA scrutiny and necessarily leads to steady long term returns on investment of a more moderate nature. In divorcing share interest from profit sharing a risk that consumers will be promised high returns based on unfounded projections of profitability is removed. 3.7 Furthermore because withdrawable share capital cannot be traded there are no possibilities for speculative capital gain. This further reduces possible total returns on investment and removes another risk that consumers will be promised high returns based on unfounded projections. 3.8 A final protection arises from the democratic power exercised by members of co-operative and community benefit societies. By law these must be democratic businesses in which each member gets one vote, regardless of how much they invested, and to whom decision makers are accountable. Holders of withdrawable share capital are informed and empowered insiders whose collective interest it is difficult to undermine.

9 9 3.9 In summary three interlocking protections for consumers: mutual/community purpose, democratic member empowerment, and limited non-speculative return on investment, are all regulated by the FCA under the Co-operative and Community Benefit Societies Act (2014), and allow members to pool capital in societies outside of financial promotions regulations. Community Shares Handbook and Standard Mark 3.10 In recognition that community share offers have some of the characteristics of other public share offers the Community Shares Unit (CSU), working with the FCA, HM Treasury, the Charity Commission, and the sector, has developed an extensive body of best practice. This work, consolidated in the Community Shares Handbook, provides comprehensive practical guidance on how societies using community shares can comply with the Co-operative and Community Benefit Societies Act (2014), with a very strong focus on consumer protection. 5 The CSU also operates a Community Shares Standard Mark which it awards to share offer documents that meet its best practice criteria. 6 The Mark is set to form an important part of the consumer protection framework around community shares, and this could be extended to any arrangements for ISAs. Transferable share capital and debt securities 3.11 Transferable share capital and debt securities offered by co-operative and community benefit societies on crowdfunding platforms are subject to the full financial promotions regulations. 4 How far are debt-based securities and equity-based securities offered via a crowdfunding platform already subject to the safeguards set out above? Please explain your answer. 4.1 The Co-operative and Community Benefit Societies Act (2014) is already in force and the FCA is active in enforcing it, with a strong focus on consumer protection. Financial promotion regulations applying to transferable share capital and debt securities are already in place. The Community Shares Handbook and Standard Mark are already in place. 5 What additional safeguards, if any, would be needed to ensure that debt and equity securities offered via a crowdfunding platform are not susceptible to tax avoidance if made eligible for ISA?

10 Due to FCA scrutiny of co-operative and community benefit societies at registration and after it is very difficult for these legal forms to be misused as shell vehicles for aggressive tax avoidance. The requirement for societies to actively limit share interest and the prohibition against profit sharing based on investment also make these legal forms unappealing for tax avoiders. 6 Are there types of debt security offered via a crowdfunding platform that respondents believe will not be covered by the Personal Savings Allowance? Please provide examples. 6.1 No comment 7 Do respondents feel there is a compelling case for extending ISAs to equity offered via a crowdfunding platform in addition to existing tax reliefs? 7.1 The equity of co-operative and community benefit societies in early development is sometimes eligible for Enterprise Investment Scheme (EIS), while debt and equity issued by early stage community benefit societies is alternatively eligible for Social Investment Tax Relief (SITR) as well. While this support is extremely valuable, especially for community share offers, it covers only one part of societies development. 7.2 Once societies are firmly established they tend to rely on reinvested surplus, reserves, bank loans, and in some cases retained member capital. It is healthy for societies to diversify sources of capital where they can, particularly to prevent over-gearing. For this reason some outside investment in the form of both equity and debt can be appropriate for more established societies. We see enormous potential opportunities for societies to benefit from recent trends toward greater public participation in equity investment through crowdfunding. These businesses are particularly well placed to attract ethical and social investors, as well as investment by people whose needs they meet. 7.3 There is a strong case for extending ISAs to society equity offered via crowdfunding platforms as this will support people and communities to save while at the same time investing patiently in enterprises that meet their needs. This is something already being developed to great effect through Community Investment Funds in the Canadian province of British Columbia. 7 We think similar financial frameworks should be established to serve communities in the UK. 7

11 11 James Wright, Policy Officer Co-operatives UK Holyoake House Hanover Street Manchester M60 0AS