Mini-bonds: The FCA crackdown
On 1 January 2020 the Financial Conduct Authority (FCA) implemented a ban on the marketing of "mini-bonds" to retail investors. This action follows the high-profile collapse of London Capital & Finance in January of last year, which left 11,600 investors in a precarious position after £237 million in mini-bonds were marketed to the public and promised a return of 8% interest rates.
The FCA's ban focuses on speculative mini-bonds where the funds raised are used to lend to a third party, invest in other companies or purchase or develop properties. They are known as non-transferable debt securities (NTSDs) as they are not listed on any exchange, making them illiquid and difficult to dispose of on a secondary market. The ban does have a number of important exemptions, which include listed mini-bonds and issues by companies looking to raise funds for their own activities (other than lending, investing or purchasing property) or to fund a single UK property investment.
Crucially the ban is designed to protect retail investors, which is a non-professional class of investor that invests their own funds via a personal account. They are considered unsophisticated and do not always have the tools at their disposal to properly research their investments, understand the risks involved, and may be drawn in by unrealistic and attractive rates of return. The FCA also saw several issuers attempting to falsely promote their mini-bonds as having ISA status – the risk to retail investors is compounded by the upcoming ISA season at the end of the tax year raising demand for lucrative investments.
The ban does not affect the promotion of mini-bonds to "high net worth individuals" or those that are sophisticated. The FCA has definitions for both sophisticated and high net worth investors:
- Sophisticated investor – an investor who has sufficient knowledge and experience of relevant investments, and has attested that they understand the risks involved and significant risk of losing all their investment. This can either be assessed by a firm, or can be self-certified.
- High net worth investor – an investor who has an annual income of £100,000 or more, or has net assets of £250,000 or more, excluding the value of their main residence, insurance rights or benefits, or withdrawals from pension savings (unless this is used to provide an income in retirement), and who also signs a declaration acknowledging the high-risk nature of the investments, the possibility of losing all their funds, and that they could seek professional advice.
It should therefore be of utmost importance to firms involved in promoting mini-bonds that they comply with the regulations set out by the FCA and ensure that they check that their promotions are restricted to eligible investors only.
Over the next year the FCA plans to overhaul the regulation concerning speculative mini-bonds so as to best protect all investors, ensure that consumers are aware of the risks involved in these investments and provide a robust framework for firms operating in this market.