DBS

35 “When investing for yield, investors look for a simple solution that delivers security and attractive returns; managed by a provider with extensive sector experience.” – James Cranmer, Triple Point of its financial responsibilities must be very thorough. Obstacles to this may include patchy access to accounting information (particularly, as is likely, where the issuer is a non-listed company) and, for offers below the sterling equivalent of €5 million (as per EU regulations), the full information required in a prospectus is not obligatory and hence may not be provided. In spite of this, the information memorandum must still comply with all of the relevant financial promotional rules and be approved by an FCA authorised entity as adhering to the “clear, fair and not misleading” stipulation. However, even where a debt based security is underwritten by the company’s assets, there may not be a guarantee that these will be sufficient to cover all debts in the case of it encountering choppy waters. This is where realistic asset valuation and a sensible loan to value ratio are crucial. As with many other investment types, portfolio diversification is the key to successful DBS investing. Diversification can be achieved across multiple elements including platforms, underlying assets, investment maturities and size and stage of issuers. RISK OF PLATFORM GOING OUT OF BUSINESS There is clear acknowledgement in the crowdfunding industry that collapse of one or more of the well-known platforms due to malpractice presents a high risk to growth. And the same would be true of those platforms which service the crowdfunded DBS we are discussing here. The FCA refers specifically to this risk in relation to loan based crowdfunding in its Interim feedback to the call for input to the post-implementation review of the FCA’s crowdfunding rules: “The possibility of a high-profile platform failure is seen by firms as the biggest risk to the ongoing viability of the sector.” 69 It’s partly for this reason that loan based crowdfunding sites are required to have in place arrangements to continue the administration of repayments if the platform goes out of business. To do this, a platform may have an agreement with a third party backup service provider – the most usual option. Platforms offering DBS which can be held in an IFISA are required to do more than simply match bond, loan note and debenture issuers with investors. They are also involved in receiving and distributing investment related payments to investors. In real terms, this means that any collapse of the platform could potentially impact the payment of interest and capital from the issuer to the holders of the DBS. Nevertheless, where that is the case, in the event of the platform ceasing operations, the investors still have their legal rights (through their original agreement with the issuer) to continue to receive interest and repayments. However, unlike P2P lending platforms, there is no legal requirement to ensure that arrangements are in place to facilitate ongoing services for receipt and distribution of interest and capital repayments. So, although investment based crowdfunding rules differ from those that govern P2P lending, it is clear that the collapse or closure of an investment based platform which administers a crowdfunded DBS issue could cause substantial problems. That said, there are positives; any funds held by the platform on behalf of the bond, loan note or debenture holder, e.g. funds ready to be loaned or to be paid as interest or repayment, at the insolvency of the DBS platform, are subject to the FCA Client Money rules which stipulate that they must be held in a ring-fenced account, separate to the assets of the platform. As a result, they should still be considered as belonging to the holder by any party brought in to distribute the assets to creditors of the platform. In addition, assuming the platform is FCA authorised, FSCS deposit protection would apply up to £85,000 per investor. Additionally, some DBS platforms and IFISA managers, appoint or act as a security trustee – charged with taking security over assets so that in the event that a DBS issuer defaults on the loan, it has the right to step in to recover investors’ money. Whilst this service is usually in place to offset difficulties if the issuer defaults, where the security trustee is a third party, and where receipt and distribution of interest payments, as well as registrar duties are undertaken by independent parties appointed by the platform, it is possible that they would continue to do so in the absence of the platform. This is dependent on the specific investment documentation. Nevertheless, all authorised IFISA managers are required to treat investors for whom they arrange DBS investments as their clients. This means that the platform will be aware of who the investors are and must act honestly, fairly and professionally in accordance with the best interests of its client (the client’s best interests rule (COBS 2.1)). To date, there have been no high profile DBS platform failures , whereas there have been failures of self-promoted bonds that have resulted in meaningful losses. See page 12 of this report. THE EFFECT OF INTEREST RATES The appeal of debt instruments can be very sensitive to interest rate movements, especially those which are longer dated. The risk is that market interest rates, particularly risk free rate ones such as bank deposits, may become relatively more favourable than the coupon rate. The longer the maturity of the bond, the greater the risk that rates will change, hence the