Why?
This ban is the FCA’s reaction to a spate of failures by mini-bond issuers, including the notorious failure at London Capital and Finance earlier this year.
Common features of the speculative mini-bond which concern the regulators include:
- The issuer is typically an unauthorised person offering a high fixed rate of interest (8 per cent or more),
- Investors are committed to invest for a period of time (three to five years) with no opportunity to sell or transfer the speculative mini-bond during that period,
- The issuer uses capital raised from retail investors to fund speculative and high-risk activities, and
- Investors are subject to high costs or third-party payments made from the proceeds of the bond issuance.
The FCA’s examination of practices in the mini-bond market has led to the imposition of these temporary measures, in part due to the significant risk of immediate consumer harm. This harm is rooted in the marketing of mini-bonds, which does not satisfy the requirement in COBS 4.2 that promotions should be clear, fair, and not misleading. The FCA has found that the average amount invested in mini-bonds is £25,000 per investor, so there is a potential significant negative impact on individual investors.
Which investments?
The temporary measures do not use the term ‘mini-bond’ but instead target ‘speculative illiquid securities’. Broadly, these are unlisted debentures and preference shares (with a minimum investment of £100,000 or less) where the issuer uses the funds raised to:
- Lend to a third party (that is, a person other than a member of the issuer’s group),
- Buy or acquire investments, or
- Purchase or develop property.
Raising debt finance for other purposes is therefore not subject to the temporary measures.
What is exempted?
The temporary measures are not intended to apply to:
- Speculative illiquid securities issued by companies that intend to purchase property (or pay for the construction of property) where such property is to be used by the company, or a group company, for its own commercial or industrial purposes.
- This exemption does not cover issuances where the ability of the issuer to pay investors is wholly or predominantly dependent on the return from the purchase or construction of such property; this is classified as speculative property investment and would be in scope of the temporary measures.
- Speculative illiquid securities issued by a property holding vehicle to purchase income generating property such as a single UK property or properties within a single UK development.
Although exempt from these temporary measures, both types of unlisted investments above remain subject to the rules for non-readily realisable securities.
The FCA also clarifies that the following arrangements will not be subject to these temporary measures:
- Readily realisable securities (broadly, securities admitted to listing or trading on an EEA exchange);
- Peer-to-peer agreements;
- Securities that fall within the FCA’s non-mainstream pooled investments definition; and
- Securities issued by a credit institution.
What is required?
The temporary measures require the following:
- Promotions of speculative illiquid securities targeted at retail investors must be limited to sophisticated or high-net-worth retail investors. In certain cases, firms will also need to carry out an assessment of the suitability of the speculative illiquid securities for the recipients of the promotions.
- Marketing materials must include prominent disclosure, including:
- A standardised risk warning stating that investors may lose all of their money, that these products are high risk, and that ISA eligibility does not protect consumers from losing their invested money.
- A costs and charges disclosure setting out any third-party payments made by the issuer that are deducted from the capital raised, in the form of a percentage of capital raised and as a cash sum.
- The date on which the promotion was approved.
When?
The temporary measures are to be in place between 1 January 2020 and 31 December 2020. The FCA expects to consult on proposals during 2020 with a view to making permanent rules to apply on or before 31 December 2020.
Comment
The FCA states that it is only addressing unlisted bonds and preference shares as they typically “have no prospect of a secondary market….and do not have a prospectus, unlike bonds or shares admitted to listing on an exchange”. This is a questionable approach as an issuer of unlisted transferable securities may well have a prospectus as this is required if they are to be offered to the public. In addition, the liquidity of many listed bonds is often extremely limited. Firms can apply to the FCA for a waiver or modification if they consider the rules to be unduly burdensome in particular cases.
As always, we would be happy to discuss further any of the issues raised in this alert.
Client Alert 2019-278
