Background to FCA’s intervention on mini-bonds
On 26 November, the FCA published details of a temporary intervention in the market for the sale of retail bonds- so called “mini-bonds”. https://www.fca.org.uk/publications/temporary-product-interventions/temporary-intervention-marketing-speculative-mini-bonds-retail-investors. The purpose of the intervention is to restrict the sale of mini-bonds to retail investors, where the selling activities involve authorised firms. The temporary intervention is effective from 1 January 2020.
According to the FCA’s statement, this intervention has been prompted, at least in part, by the issues highlighted in the administration of London Capital and Finance. In that case London Capital raised significant sums from investors through mini-bonds prior to its administration. However. the FCA highlights its concerns about the wider market for mini- bonds and the issues raised by its investigations into this market. In particular, the FCA notes its concerns at how these bonds have been marketed. Promotions tend to have a strong focus on the returns which may be generated but less focus on high costs and high risks.
The FCA considers the risks to investors sufficiently serious, to introduce temporary restrictions. The rules however apply to cases where an authorised firm is involved in approving the financial promotion or in the sales process. The intervention does not cover cases which currently fall outside the regulatory perimeter. However, the Treasury is currently conducting a review of the wider market which may lead to further statutory intervention.
Timing of the Intervention
At this stage, the intervention is a temporary intervention using the powers under section 137D of FSMA. It is intended that the restrictions imposed will remain in place from 1 January 2020 to 31 December 2020. However, it seems likely that this temporary intervention will be replaced by something more permanent over the next year. The FCA refers to the likelihood that it will introduce more permanent rules for high risk investments next year.
The intervention will not apply to promotions approved by authorised firms for the purposes of section 21 of FSMA, before 1 January. However, the FCA makes very clear the standards that such promotions should meet. It has issued accompanying Guidance clarifying its expectations in this area.
What will the intervention mean?
The intervention will effectively prohibit the marketing of speculative illiquid securities to retail investors involving an authorised firm. A speculative illiquid security is defined to mean a debenture or preference share which:-
- has a denomination or minimum investment of £100,000 or less;
- is issued in circumstances such that the issuer is using the proceeds (i) to lend money to third parties other than a group member; or (ii) to lend to investors in other companies; or (iii) to construct or buy property;
- is not a listed security.
The FCA makes clear that the restrictions will not apply to, and therefore there are excluded from the intervention,:-
- debt securities and preference shares issued by companies to purchase property or pay for construction of property where the property is used by the company or a group company for a general commercial or industrial purpose. However, this exclusion will not apply where the return on the bond is dependent or heavily contingent on the return generated from the property;
- products involving a single UK property or properties within a single UK development, purchased via a holding company with shares and bonds providing a return based on rental income and capital appreciation. Again this exemption will preclude property development activities;
- securities issued by a credit institution or non-mainstream pooled investments (which are already covered by similar rules);
- promotions to high net worth and sophisticated investors subject to caveats outlined below.
The FCA also make clear that the restriction does not apply to unauthorised issuers who rely on exemptions contained within the FSMA Financial Promotion Order 2005. In other words, an authorised person is not involved. The 2005 Order allows unauthorised issuers to market bonds to high net worth and sophisticated investors subject to meeting certain criteria. However, the FCA notes that it is paying close attention to whether the rules applying to unauthorised issuers are being met.
Promotions to high net worth/sophisticated investors
As noted above, the FCA ‘s intervention may not apply to promotions made to high net worth and sophisticated investors (both certified and self- certified). In the case of promotions made to this class, the authorised firm approving the promotion must make a preliminary assessment that the investment is likely to be suitable for that investor. This entails the firm taking reasonable steps to acquaint itself with the client’s profile and objectives. It can then ascertain the likely suitability of the investment.
Where a firm legitimately promotes a speculative illiquid investment in these circumstance, it must ensure the promotion contain prescribed risk warnings. These are detailed in the FCA Rules. Risk warnings must be bold and prominent. The promotion must also properly disclose costs, charges and commissions related to the investment. It must also show how these costs will effect the amount invested.