Andrew Jackson, head of collections and recoveries at Funding Circle, explains why the Small Business, Enterprise and Employment Act 2015 is good news for SMEs.
When Stanley Kubrick’s 2001: A Space Odyssey opens with Also Sprach Zarathustra, trumpets rise over an emerging timpani roll, and the sun reveals itself magnificently from behind a planet, pouring light into the darkness of space. This is exactly how small businesses should feel when they read the access to finance section of the Small Business, Enterprise and Employment Act 2015.
It is little wonder that access to finance is the first part of the act, since it carries such huge potential for small and medium-sized enterprises in the UK. Under this part, traditional lenders will be required to provide cash-flow information to credit agencies, and to refer their rejected customers to other finance platforms for additional lending.
As we leave a long night of recession, this act shines a light on fairer competition, democratisation of finance, and gives small businesses more choice.
Sharing of credit data
All businesses need a bank account. And where banks provide banking facilities, they are able to collect information on the cash flows of their customers in real time. This information has not been shared widely by the banks, and even where it is shared, there is not equal access to it for alternative finance providers.
Section 4 of the act requires banks to provide data from holding current accounts to credit reference agencies. Credit reference agencies use this information to shape their credit ratings and introduce new metrics, which will enable alternative lenders to build their own innovative and sophisticated credit models. Correctly assessing the credit-worthiness of businesses will help these finance providers to avoid higher default rates, improve their own profitability, and build credibility as they become more established in the financial infrastructure of the UK.
Customer referral to finance platforms
Many small businesses seeking finance approach only the 4 largest banks. In small and medium-sized businesses, the rejection rate is around 50%, even though many of these businesses are viable. The reasons for rejection may simply be because the bank has already reached the top of its concentration of lending to that particular business sector or region. However, there are challenger banks and online marketplaces with different business models that would be prepared to lend to these businesses.
Section 5 of the act requires certain banks to refer their customers to finance platforms if they refuse to provide funding. Under the regulations, traditional banks will be required to share information with certain platforms where those businesses agree. This will give those businesses more options to find the most appropriate form of finance for their business needs, and quickly, too.
In order to support the provisions described above, the act also provides for certain functions to be conveyed to the Financial Conduct Authority, and to extend the remit of the Financial Ombudsman Service (FOS), so that a complaint may be made to FOS about a designated credit reference agency or finance platform.
It’s too early to say how these provisions will be implemented, since in essence they give the Treasury power to make regulations to carry out the purposes of the act. The draft regulations have not yet been published and, as always in law, the devil is in the detail. The hope is that through consultation, plain English drafting, pragmatic thinking and commercial policy making, more small businesses will be able to access the finance they need to grow as a result of this legislation.
Improving access to finance and encouraging investment
These changes mark the beginning of a wider legislative shift which sees the government increasing the opportunity for challenger banks and online marketplaces. Such a shift includes the following exciting developments, which aim to improve the process for getting finance to small businesses, and encourages individuals to invest in small businesses through marketplaces:
- Deeds of priority: for many alternative finance providers, a unique selling point is speed of access to finance. This has been hindered in the past by banks delaying processing deeds of priority or waivers. The Budget 2014 confirmed the new agreement by the major banks to process most requests for a deed of priority or waiver within 7 working days, and for each bank to provide standardised documentation to simplify the process.
- The LISA (lending ISA): the Budget 2014 referred to ISA eligibility being extended to peer-to-peer loans. Positioned between the cash ISA and the shares ISA, a lending ISA will create attractive returns with less volatility, and the same level of liquidity as the current ISA products. Whether through a single platform with a hugely diversified product, or through a third party provider, this opens up a huge reserve of potential investment in small businesses in the UK in 2016.
- Offsetting losses: in the Autumn Statement 2014, George Osborne proposed bad debt tax relief on peer-to-peer loans. From April 2015, investors no longer have to pay income tax on their gross return (before any losses). Instead, they are only required to pay tax on the net return (after losses), which will significantly improve overall returns.
- No tax on £1,000 of interest: the Budget 2015 confirmed that a new personal savings allowance would be introduced. This means that the first £1,000 of interest in any tax year will be tax free (or £500 for higher rate savers). This was extended to peer-to-peer, or marketplace, lending. It is a further boost to the sector and will encourage more people to lend to small businesses through online marketplaces.
The Small Business, Enterprise and Employment Act 2015 is the first step that codifies in law the opening up of finance opportunities for small businesses in the UK. In this new dawn, it is in the best interests of the UK’s business community to land in a place where individuals control their investments, strong values such as transparency and fairness drive financial decision-making and, ultimately, we all find ourselves in a better financial world.
About the author
Andrew Jackson is head of collections and recoveries at Funding Circle, a leading marketplace that focuses exclusively on small businesses and which facilities direct borrowing from a wide range of investors. To find out more, visit the website or follow on Twitter @fundingcircle.