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FCA consultation on a permanent ban on promoting "minibonds" to retail investors

19/06/2020

At a glance

In November 2019, FCA used statutory powers to impose a temporary ban on the promotion of “speculative illiquid securities” to retail investors. This followed a year that saw London Capital & Financial fall into insolvency, along with increasingly trenchant criticism of promotions of various retail investments with wholly inadequate disclosure of the risks involved.

FCA is now consulting on making the ban permanent:  proposals can be viewed here. A link on the page this launches will take you through to the actual consultation document. Responses are solicited up to 1 October and FCA will be formalising the relevant rule changes before the end of 2020. Head of Financial Regulation Daniel Tunkel, and Solicitor Alex Heron consider the ban in more detail below.

The problem in a nutshell

It has hitherto been very straightforward for a company to issue its own debt instrument (the term “minibond” has become popular, so we’ll use it from here on). The company needs no regulation to issue the minibond, and provided that it is raising cash that falls within exemptions from the Prospectus Rules, the offer is just a regular financial promotion. It has always been possible for an FCA-authorised person to approve the promotion for an unregulated issuer. Quite an industry has developed around this. But FCA has been calling out various approving firms for poor performance. These firms are the interface with regulatory compliance if the bond issuers are not themselves regulated; and a lot of instances have arisen where approving firms have just not taken their roles and responsibilities seriously. The result: retail investors ploughing into poorly described investments that they stand little chance of fully understanding and many of which carry significant concealed risk.  FCA had to intervene. Amendments to the Financial Services and Markets Act 2000 made during the Coalition Government provided a framework for this Product Intervention (which has been in force since the start of 2020). Now the Regulator seeks to make this permanent.

Temporary becomes permanent

The temporary intervention needed no consultation, but formal rule amendments must be consulted on. Hence the issue of FCA CP 20/8. This is worth reading in full, but we will summarise the salient aspects here.

Speculative illiquid securities

There is quite a detailed definition. In essence, though, the new and expanded definition:

  • Covers debt instruments and preference shares;
  • Applies to these where the proceeds for subscription are intended for real estate investment, whether directly or via some intermediate company; and
  • Now will apply to listed bonds and shares where the nature of the listing is such that it does not really provide true liquidity.

Blanket ban on retail distribution

FCA takes the view that these securities cannot be promoted to what the draft rules at one point (without elaboration) describe as ordinary retail investors. This is defined not in itself but by reference to the exemptions then provided.

Certified High Net Worths etc. 

Promotion to certified HNW investors, certified sophisticated investors and self-certified sophisticated investors is still permitted. These terms are defined in the draft rules that will form the new chapter COBS 4.14 to be added to the FCA Handbook. These are not on all fours with the way these expressions are defined in the Financial Promotion Order. For example, with the certified HNW investor, while the test is still £100,000 minimum gross income before tax in the preceding fiscal year, this won’t count income withdrawn from a pension prior to retirement. (This, incidentally, aims directly at a specific abuse where FCA determined that a lot of retail investors were being coaxed into premature withdrawal of pension money to put into speculative minibonds.)

But marketing rules will still apply even here

The provisions in COBS 4.14 will require that even where a promotion is made to a certified HNW investor or the like, there are to be very prominent and bluntly worded risk warnings added to the promotion to indicate, for example, that the investor can lose all his money, that the product is far higher risk than a savings account, and that an ISA wrapper does not protect the money from exposure to risk.

Provisional conclusions

There really isn’t that much harm in these types of investment being limited to certified HNW investors. The rules with respect to restriction on promotion and product risk warnings are attended by the usual requirements for assessment of investor appropriateness and suitability as well, and all of this points to a cleaner and better-run industry. There remains the usual value judgment as to whether these minibonds are inherently more or less risky than, say, an EIS investment, which is highly speculative but currently open to retail investors without restriction.  But these rule changes are about stamping out abuses intrinsic to the investments affected, rather than drawing comparisons of this sort.

Where does this leave bridge and development finance?

We add this as a concluding section. This is not considered in the FCA proposals chiefly because it cannot be. FCA can only regulate what falls within regulation to begin with, and anything that is intended to extend the scope of regulation requires an Act of Parliament. There is a significant industry in the UK of unregulated bridge finance arranging. Various models are used for this, and if correctly operated, all can continue to work outside of financial regulation. The basic premise is that lending is not regulated (leaving aside consumer credit and regulated mortgages), and to make it so would require legislation. So arranging for persons to lend to a borrower can be structured to avoid regulation, and broadly, none of the FCA proposals here change any of this.  Clearly, different bridge finance businesses operate different models. Any who are concerned they may fall into regulation are welcome to contact us for a discussion and review.

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Daniel Tunkel
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Alexandra Heron
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