The downfall of London Capital & Finance (LCF) has raised some uncomfortable questions for the various authorities involved, but also helped demonstrate the attraction of the Innovative Finance ISA (IF ISA).

When the bond platform was told by the Financial Conduct Authority (FCA) to cease marketing its unlisted bonds, the stage was set for one of the alternative finance industry’s largest meltdowns. Within months LCF had gone into administration.

Cut to a few months later, and four of the officers of LCF are under investigation by the Serious Fraud Office and the FCA has launched an investigation into the failings of the firm. But, LCF and its executives are not simply cowboys who have recently come to the attention of the authorities by taking wild potshots in a completely unregulated context.

LCF had been authorised by the FCA since 2016, and the company and individuals in its senior leadership had various FCA authorisations. Furthermore, LCF was registered with HMRC as an authorised ISA Manager for Innovative Finance ISAs.

With thousands of retail investors facing the reality of losing the majority of the combined £236 million invested, much is being made of the failure of the bonds. Administrators Smith and Williamson (S&W) have told bondholders to expect to lose around 75% on their investment and there is also speculation that the majority of the money invested was going to just a few companies, most of which were related to LCF’s founder.

Under normal circumstances, bonds failing would not necessarily point to fraud, or in fact, any illegality. The reality is that investments fail and in the world of unlisted corporate bonds, companies regularly and entirely lawfully, establish bonds to fund their own activities. 

In fact the issue that brought LCF to the notice of the authorities was the eligibility of their bonds for the IF ISA. According to LCF’s marketing, they were. However, in reality, they were not. As a result, not only did investors lose out on the potential tax savings on any profits, but also a raft of consumer protections that are built in to the IF ISA qualification criteria.

For a start, for an unlisted bond to be held within an IF ISA, it must be transferable, giving some opportunity for liquidity. The requirement for the involvement of a party with the FCA permission to arrange deals in investments, and for that entity to treat the investor as its client, offers the investor FCA regulatory protections and recourse to the Financial Ombudsman.

None of this is required of a corporate entity that sets up and sells its own loan notes.

The regulator has come in for criticism for being slow to act, and the Treasury has an ongoing investigation into the FCA’s handling of the situation. The LCF affair also raises questions about HMRC’s monitoring of ISA managers.

It also serves as a reminder to investors and advisers to conduct thorough due diligence on any investment they make beyond the marketing (including through alternative finance), as well as appreciate the benefits an IF ISA can bring beyond tax savings.