DBS

34 it back to cash. This differs from the withdrawal and transfer rules that are in place for other ISA investments, where there is a guarantee that it will be possible to withdraw or transfer the investment within 30 days. FSCS – NOT EVERYTHING IS COVERED There are two types of FSCS protection that can apply: Deposit Protection: The FSCS defines deposits as “money placed in a bank or similar institution to earn interest or for safe-keeping” as ‘client money’. This could apply to funds which are being held prior to being invested by an investment manager, or possibly platform. The assumption is that, in most cases, the entity holding these funds will be FCA authorised and investment based crowdfunding sites are required to deposit these funds into a segregated client account with an appropriately authorised banking entity. So, when this client money is being held by a bank and the platform through which it was to be invested fails before actually investing the funds, the FSCS would protect the funds up to the value of £85,000. Likewise, if the bank holding the funds failed, the same would apply. Investment Protection: Once funds are invested, investment protection may come into play. This would apply in the event of some fault in the advice or regulated activities of an authorised adviser or DBS platform; authorised platforms hosting debt based securities offers must comply with the rules on financial promotions, so that they are ‘fair, clear and not misleading’ 66 . Any fault in the approval of a financial promotion, or as a result of an individual making an inappropriate investment as a result of the platform not complying with its duty to ensure the appropriateness of the investment, may allow an investor to claim compensation from the FSCS. But this would only apply if the authorised adviser or DBS platform was unable to pay such compensation, e.g. it had gone out of business. The FSCS may be able to pay up to £50,000 investment protection compensation per claim, per individual, if all of the following criteria are met: the advice firm must have been authorised by the appropriate regulator to do so at that time; the investor must have lost money as a result of the advice given; the firm (or its principals) must no longer have sufficient assets to meet claims for compensation. It’s important to note that authorised P2P platforms are not covered by FSCS investment protection and neither are self-promoted DBS which involve no FCA authorised entities. Nevertheless, FSCS investment protection does not mean that an investor would be in a position to claim compensation, simply because an investment failed, for example, as a result of one of the disclosed risks. Since the FSCS generally only covers business conducted by firms authorised by the UK regulators, the parties issuing these types of securities (as opposed to the platform arranging the deal) are often not covered by the Financial Services Compensation Scheme. RISK OF ISSUER DEFAULT The risk that a company will not be able to make timely payment of interest or principal is default risk. But with additional risk, comes additional yield – certainly higher than conventional bonds and also higher than most equities, with lower levels of volatility. But quantifying the level of risk can be very difficult, particularly where smaller companies are concerned, where little track record may be available. Larger, corporate and retail bonds and gilts might benefit from a credit rating by specialised agencies which are intended to estimate this risk. However, this analyst community is very limited in the crowdfunded DBS market, although it has been available since mid 2016 through Moody’s involvement with Crowdcube, for which it provides a Probability of Default (POD) tag for crowdfunded bonds. This metric is prominently listed on the investment documentation and Crowdcube describes it not as a risk rating, but rather as “an approximate measure of the credit-worthiness of the issuer”. 67 This could be a useful development in assisting advisers and investors and further investigation suggests that Crowdcube’s crowdfunded bond offerings with a POD of 0.5-0.7% occupy a similar risk of default range as the peer to peer lender, Funding Circle’s, A+ risk rated loans. And they offer investors a similar return, at 8% and 7.7% p.a. respectively. In the A+ category, Funding Circle has an “estimated annual bad debt” of 0.6%. This is indicative of just how low the risk in DBS can be, although in August 2016, the Crowdcube average POD was 3.3% 68 . Nevertheless, the POD calculation only measures the risk of default within 12 months of the last financial accounts, which could be almost a year out of date and, outside Crowdcube, the onus is usually on the investor, adviser or their intermediary to judge the borrower default risk. But the best platforms will provide due diligence that makes this task much more straightforward; platforms such as Downing Crowd, Rockpool and Triple Point Advancr, for example, commission independent reviews of their DBS. Clearly, the risk of borrower default is higher for an earlier stage, smaller entity than a larger, corporate body because of the statistical realities of the failure rate of young companies with fewer resources. Consequently, due diligence to ensure, as far as possible, that the issuer is in a position to meet all “DBS may suffer a liquidity constraint but the illiquidity premium provides more than adequate compensation for most investment scenarios.” – Jake Wombwell-Povey, Goji