Following a series of high profile mini-bond failures, the FCA has banned the mass marketing of speculative mini-bonds to retail investors from 1 January 2020.

The ban will last 12 months, during which time the FCA plans to consult on making the rules permanent.

Some of the highest profile mini-bond failures recently have included London Capital & Finance (LCF), and Grand Design’s Kevin McCloud ‘HAB’ property mini-bonds, both of which ended in failure, leaving retail investors facing millions of pounds in combined losses.

The FCA said it has seen evidence of a growing number of promotions which are frauds, scams or involve no attempt to meet financial promotion rules. It should be noted the marketing ban does not apply to such frauds and scams because they are illegal in any event.

Mini-bonds are a form of corporate bond which investors buy for a set amount of time in return for a set return. At the end of the period the original capital is repaid. 

One of the issues identified by the FCA is the promotion of unlisted bonds issued by an unauthorised person who is not subject to FCA oversight, and will generally not be covered by the FSCS. While these are securities, if a company raises funds for itself by issuing the debt instrument itself, it does not need to be authorised and it can promote the raise to the exempt categories of the FSMA 2000 Financial Promotions Order (FPO), as long as it follows certain procedures. Exemptions include high net worth individuals and sophisticated investors. 

There are many companies that have worked within these rules successfully for some time, issuing their own unlisted corporate bonds, including big names like John Lewis and Hotel Chocolat. Third parties issuing unlisted bonds for investment into, or the use of other entities, must abide by all of the FPO restrictions applicable to the promotion of securities.

But, the danger, which, according to the FCA, is all too real, is that the FPO restrictions are ignored (deliberately or otherwise) in a high volume of online promotions by a growing number of firms. This exposes retail investors to much higher levels of risk than they realise as, in many cases,  the marketing materials they access are not subject to any minimum standards – not even the usual ‘clear, fair and not misleading’ requirement.

The reality is that these types of promotions have been illegal for many years and the FCA already has the power to intervene where an unauthorised party is breaking financial promotion rules. But one way to circumvent these rules is for unauthorised firms to have their materials reviewed and approved by an authorised firm, allowing them to be distributed to ordinary retail investors.  The responsibility then falls on the authorised firm to make sure the rules are met. 

The new requirements will prevent this although there is scope for a brief ‘race to the bottom’ with promotions approved by authorised firms before 1 January 2020 still allowed to be communicated by unauthorised parties to retail investors. The FCA has, however, warned that the standard of scrutiny applied by authorised firms undertaking these approvals is very much now on its radar and subject to new guidance; “We expect firms that have approved financial promotions for speculative illiquid securities before our temporary rules apply to carefully consider this guidance and, if necessary, withdraw their approval if they cannot satisfy themselves that a promotion is clear, fair and not misleading.”

There has been substantial recent criticism of the Innovative Finance ISA (IF ISA) in the wake of the LCF collapse, including how the FCA suggests in its temporary intervention it can be used to mislead investors:

“Some promotions claim that an investment is eligible to be held in a tax-incentivised ‘wrapper’ (e.g the IF ISA or a SIPP) when it does not qualify, or if it does, the promotion may misleadingly imply that HMRC’s role in overseeing a tax wrapper means the investment is endorsed by government” 

In the case of LCF, the HMRC and FCA authorised IF ISA manager claimed the bonds it was issuing were IF ISA eligible. But they were not, although the regulators did not take action on this until over £236 million had been invested by over 11,500 investors.

Nevertheless, bonds that can be held in an IF ISA must involve a platform that is authorised to ‘arrange deals’ for retail investors and which treats the investors as its clients. As a result, an investor has recourse to both the FOS and FSCS in relation to how the platform arranged the investment, although importantly the bond itself is not covered by the FSCS. 

These platforms have also been subject to the same rules due to come into effect from December for peer to peer lending sites. for several years. This means that, before investing, a potential investor must demonstrate their understanding of the bond they are investing in by passing an appropriateness test and they must be categorised as high net worth, sophisticated, advised or restricted (certifying they will only invest 10% of their investible assets). 

The new rules expressly forbid marketing to restricted investors and since speculative illiquid securities have been added to COBS 9A 2.22, the route of advised, ordinary retail investors to invest in unlisted bonds is now extremely limited:

Advisory firms must be, “satisfied that an exemption is available before recommending an investment subject to a restriction on distribution to a retail client, noting in particular that a personal recommendation to invest will generally incorporate a financial promotion.” Since even approved financial promotions are not to be shown to retail investors from 1 January, unless an adviser is comfortable that they fall into one of the FPO exemptions, such as high net worth individual or sophisticated investor, information about the investment simply cannot be provided and an investment can’t be made.

This seems a little harsh for ordinary retail investors who are interested in and fully understand IF ISA eligible bonds: It means that unlisted speculative securities can only be promoted to, “individual retail investors who have been pre-categorised as either sophisticated or high net worth, and where the product has been initially assessed as likely to be suitable for them.” 

Andrew Bailey, Chief Executive of the FCA said: “We remain concerned at the scope for promotion of mini-bonds to retail investors who do not have the experience to assess and manage the risks involved..

“In view of this risk, we have decided to complement our substantial existing actions with a further measure which will involve a ban on the promotion and mass marketing of speculative mini-bonds to retail consumers. We believe this will enable us to further consumer protection consistent with our regulatory principles and the FCA Mission.”

The FCA said it also intends to launch a communications campaign to improve consumer awareness of the risks of mini-bonds, and will also work with the Treasury on its review into the regulatory framework for the issuance of non-transferable debt securities.

In the meantime, whether these temporary measures will make policing the mini-bond arena any easier and thereby significantly reducing consumer detriment remains to be seen. Whether they have the unintended consequences of restricting the funding source to some legitimate, authorised unlisted bond platforms to such an extent that they go out of business, reducing competition and limiting access to the substantial benefits of the IF ISA, may also be in the balance.

Thanks to Adempi Associates for their assistance with the compliance complexities in this article.

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