DBS

21 “Investing in crowdfunded bonds and debentures gives ordinary people real choice and control over their money and how it is invested for the long term.” – Bruce Davis, Abundance to get a project underway, before other lenders are comfortable with becoming involved. They are also popular with short property development projects where a defined stage – e.g the acquisition of land or completion of refurbishment – signals a clear exit point at which either the asset is sold and facilitates repayment of investors’ capital, or it is possible to refinance and investor capital can be repaid. If we turn to a different type of term, the bond or debenture contract or the loan note may include covenants; that is, terms for the debtor by way of an agreement between the issuer and the investor that ensure the company will not behave recklessly with the investors’ money. These might include limitations to the amount of debt the firm can take 19 , restrictions on the size and timing of dividend payments and the maintenance of minimum levels of working capital. Or, a Security Trustee could be appointed as a function of a fixed or floating charge, who would prevent the sale of assets for less than market value or who has the ability to seize company assets on behalf of bondholders if they feel the company may be at risk of defaulting on the DBS. Another consideration could be the limiting of executive pay so that directors who are also shareholders do not borrow money to reward themselves at the expense of the company and its creditors. The terms of the covenant should be fair to the investor, without undue bias in favour of the issuer and advisers should be aware of what they are and how they could potentially affect the investment. TYPICAL RATES OF RETURN At the lower end of the scale, our research has found UK debt based securities offerings with a 4% annual interest rate. Whilst still a decent return in the current environment, this is relatively low for the asset class, although it’s important to note that there are some strong risk mitigators available that can act to lower the level of risk. These include: High value asset backing Security ranked as senior debt, ahead of all other obligations of the borrowers Short term (as low as 1 to 3 years) Secure underlying income streams (i.e fixed government subsidies) Transferability Access to secondary market At the other end of the scale, rates of up to 25% can be found, but of course, they are likely to have a much higher risk rating because they include far fewer, if any, of the risk mitigators. This would allow a worst case scenario of locking in investors for the entire term of the bond or debenture and, in the event of default of the issuer, total loss of the investors capital. In return for this, investors should expect to receive a higher yield and it is up to advisers and investors to decide if the yield on offer is sufficient to justify the risk. Unlike P2P lending, one indicator of the risk of investing is usually not available to DBS investors – the underlying interest rate the borrower is paying. Nevertheless, some DBS platforms are now publishing their bond books, showing the borrower rate. The most commonly quoted crowdfunded DBS yield to investors is around 6-7%. LEGAL AND REGULATORY STATUS: CROWDFUNDING PLATFORMS Crowdfunded bonds, loan notes and debentures are defined by Article 77 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 as Instruments creating or acknowledging indebtedness. In the UK, the crowdfunding regulatory framework also applies some bespoke rules to equities and debt securities – transferable and non- transferable. These are classified as non-readily realisable securities. From a crowdfunding perspective, this includes equity products and crowdfunded DBS. In broad terms, the FCA has focused on two types of crowdfunding: loan-based crowdfunding platforms, through which people and institutions lend money to consumers or businesses in the expectation of a financial return through interest payments and repayment of capital over time; and investment-based crowdfunding platforms, through which people invest in non-readily realisable shares or debt securities issued by businesses. The FCA sees these different types of crowdfunding platforms as two distinct markets to be subject to largely separate regulatory regimes. The regulator views loan-based crowdfunding (P2P lending) as posing risks to its objectives, particularly in relation to consumer protection, whereas the investment-based crowdfunding sector is considered to pose fewer issues, at least in relation to regulation (if not in relation to investment risk) 20 . It seems that, as P2P matures, the FCA is reconsidering the light touch regulation that it has applied to P2P since 2014, with the stricter regulatory regime which applies to DBS providing a more robust framework from the risk perspective. The FSMA 2000 requires platform operators to become authorised by the FCA in order to conduct regulated activities. Regulated activities associated with the crowdfunding of securities transactions will include one or more of the following, which are in Article 25 of the Regulated Activities Order: