DBS

33 From a risk standpoint, debt based securities have been described as sitting between P2P loans and equity. The graphic below from the OECD gives an interesting perspective on how asset backing can lower the risk profile. INVESTMENT RISKS IDENTIFICATION AND MANAGEMENT ASSET-BASED FINANCE ALTERNATIVE DEBT HYBRID INSTRUMENTS EQUITY INSTRUMENTS • Asset-backed lending • Factoring • Purchase Order Finance • Warehouse Receipts • Leasing • Corporate Bonds • Securitised Debt • Covered Bonds • Private Placements • Crowdfunding (debt) • Subordinated Loans / Bonds • Silent Participations • Participation Loans • Profit Participation Rights • Convertible Bonds • Bonds with Warrants • Mezzanine Finance • Private Equity • Venture Capital • Business Angels • Specialised Platform for Public Listing of SMEs • Crowdfunding (equity) RISK / RETURN + - ILLIQUIDITY Crowdfunded DBS are classed as not readily transferable. This is a result of FCA regulation which classifies them as a ‘non-readily realisable security’ (NRRS). Crowdfunded bonds and debentures are generally transferable, loan notes can be, and any of these which are also IFISA eligible are always transferable. Investors should ensure this is the case by checking the terms of the debenture or loan note. Even if they are transferable, these debt based securities are not listed on regulated stock markets, and there is no consolidated market for them. Consequently, in the absence of the quoting of a price to buy and sell 63 , they are difficult to value independently. That said, the platform or company may offer broking services or even to buy back DBS before maturity; the offer to buy back DBS is usually at the discretion of the issuer. This is generally permitted only at certain defined junctures, often the anniversaries of issuance. There may also be a penalty attached to early redemption, particularly within the first year or two of the bond’s lifetime 64 . It’s also possible, although not common, for an early repayment clause to be written into a loan note agreement, whereby investors can require early repayment stipulating a notice period to the issuer. In one case, the notice period was six months and, whilst six months is certainly not immediate, it does provide some liquidity certainty, which is enhanced by the fact that the issuer is a PLC with a significant asset base providing security. It’s worth noting, though, that the option to buy back a crowdfunded bond may not always be positive for the investor, as, unlike institutional bonds, the crowdfunded bond issuing company can do this at parity before the term ends. Institutional bond issuers are only able to do so at a higher price. As a result, should the crowdfunded bond issuer decide that it no longer wants to pay out a coupon to investors or finds better financing elsewhere, there is typically no uplift to the investor to compensate for the interest payments that would otherwise have been paid during the remaining term. Unless there is an early repayment charge built in, this means that while bondholders share all the potential downside – losing their investment if a firm goes bust – they aren’t guaranteed to enjoy all the potential upsides 65 . Generally, crowdfunded DBS have limited liquidity, although secondary markets do exist – with nearly half of the DBS platforms we have identified providing them for their clients. So, although liquidity is a concern, products do exist which offer liquidity features and careful research can certainly unearth them. However, the mere existence of a secondary market does not mean that it will be deep enough to guarantee an exit when investors want it at what they judge to be a fair price. Although, some sites provide more information to make this judgement easier, compared to others. The current liquidity difficulties extend to the Innovative Finance ISA because there is no guaranteed 30 day liquidity for money which has been lent and is yet to be repaid. This means investors may only have 30 day access to any cash held within the IFISA (such as interest payments) depending on how quickly it is possible to sell the DBS at an acceptable price and bring The risks listed below apply to all of the types of debt based securities this report considers, unless specifically mentioned. SOURCE: OECD