FCA announces temporary intervention on the marketing of speculative mini-bonds to retail investors

The FCA have announced today (26 November) that they are temporarily banning the promotion of high risk speculative mini-bonds to retail consumers. Please see the FCA Paper here for full details.

They have also published separate guidance on the requirements which apply to firms approving financial promotions under the FCA’s rules (available here). The FCA expects firms to apply this guidance with immediate effect.

When will the ban apply?

The ban will apply from 1 January 2020 to 31 December 2020.

NB. The temporary rules will not apply to promotions approved before 1 January 2020, which can still be communicated by an unauthorised person on or after 1 January 2020. However, the FCA expects that relatively few promotions approved prior to 1 January 2020 will continue to be communicated by unauthorised persons post 1 January, because of the FCA’s ongoing scrutiny of firms’ compliance with the financial promotion rules and the practical time-limited nature of financial promotions approvals, which will likely require new promotions to be approved after 1 January (and therefore will be subject to the new ban).

What client types will the ban apply to?

The ban will apply to all retail investors aside from sophisticated or high-net worth retail investors (as defined in the new rules). Where products continue to be marketed to high-net worth or sophisticated investors, the promotions will have to clearly state the risks to consumers of losing all their investment and fully disclose all costs or third-party fees (i.e. include a specific risk warning).

What products will the ban apply to?

“Speculative illiquid securities”, defined as unlisted bonds and preference shares with a denomination or minimum investment of £100,000 or less, where the issuer uses the funds raised to lend to a third party, invest in other companies, or purchase or develop property (otherwise known as ‘speculative mini-bonds’). The FCA has some guidance on its website for consumers on mini-bonds (available here):

• Mini-bonds typically offer high returns and this reflects the much higher risks involved compared to other types of investments.
• A mini-bond is essentially an IOU issued by a company (the issuer) to an investor, in exchange for a fixed rate of interest over a set period of time. At the end of this period, the investors’ money is due to be repaid.
• There is no legal definition of a ‘mini-bond’, but the term usually refers to illiquid debt securities marketed to retail investors.
• The return on investors’ money entirely depends on the success and proper running of the issuer’s business. If the business fails, investors may get nothing back.

The Temporary Intervention Paper also outlines features of speculative mini-bonds:

• They are usually issued by an unauthorised person who is not subject to FCA oversight or covered by the FSCS;
• They are unlisted and often issued through an SPV;
• They offer a high rate of fixed interest if investors commit for a period of time, with little or no opportunity to sell early;
• They involve an issuer using the capital raised to fund speculative and high-risk activities; and
• They often involve high costs or third party payments.

What products are not covered by the ban?

Companies using unlisted securities to buy or construct property used for their own commercial or industrial purpose and investment vehicles that only invest in a single UK-based property are not covered by the ban. The ban will not apply to a business raising debt or equity capital for its own purposes, or for a group entity, as long as this activity falls outside of those activities listed above. Credit institutions are also excluded. Readily realisable securities, peer-to-peer agreements and NMPIs are also not caught by this temporary ban.

What is changing in the FCA Handbook?

A new section will be introduced in COBS 4.14. The measures require:

• Any promotions for speculative illiquid securities targeted at retail investors to be restricted to sophisticated or high-net worth retail investors. Firms will also need to carry out a preliminary assessment of the suitability of a security for any high-net worth or self-certifying sophisticated investor to whom it is marketed.
• Any marketing materials must include specific and prominent disclosure including:
  • A standardised risk warning which clearly states that investors may lose all their money, that these products are high risk and ISA eligibility does not protect consumers from losing their investment money.
  • Costs and charges associated with the security and any third-party payments made by the issuer that are deducted from the capital raised, as a percentage of the capital raised and as a cash sum.
  • The date on which the promotion was approved.

The FCA have also introduced definitions of ‘income generating property’, ‘property holding vehicle’ and ‘speculative illiquid security’ (see COBS 4.14.17).

Why are the FCA applying this ban?

They have significant concerns with the widespread marketing of these products, particularly online, despite them being high risk and difficult for most retail investors to understand. They have seen many examples of poor quality financial promotions for speculative illiquid securities targeting retail, which they believe gives rise to a significant risk of consumer harm and requires immediate action (without allowing for a consultation period). Some promotions suggest that the FCA / HMRC offer protection or endorsement of these products, others claim that the investment is eligible to be held in a tax-incentivised wrapper – all of which could be misleading. A specific example they have called out is London Capital and Finance (which collapsed early this year).

Will this affect my firm?

These measures will effect:

• issuers of speculative illiquid securities;
• authorised firms that approve or communicate financial promotions relating to speculative illiquid securities;
• firms who offer services in relation to these products such as:
  • investment advice;
  • arranging deals in investments;
  • dealing in investments on behalf of clients;
• companies receiving funding from issuers of speculative illiquid securities; and
• law firms and other professional service providers to issuers or firms.

What are the next steps?

If you are an authorised firm that approves / communicates financial promotions you will need to consider the revised guidance on approving financial promotions under the FCA’s rules (available here). The FCA expects firms to apply this guidance with immediate effect.

You will also need to consider if you fall into any of the categories listed above and if these speculative illiquid securities are being promoted to retail investors. It is possible to apply for a waiver or modification of these rules if you consider them to be unduly burdensome or that they do not achieve their purpose. However, the FCA has explicitly stated that they may not be able to consider and approve this before 1 January.

The FCA will consult on whether to apply the ban on a permanent basis in the first half of 2020.

Please let us know if you would like to discuss any of the above in further detail.