Bond No Longer: FCA bans advertising of mini-bonds

December 17, 2019

3 min read

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What's going on here?

The Financial Conduct Authority (FCA) have introduced a one-year ban on the advertising of mini-bonds to retail investors.

What does this mean?

Mini-bonds are a very risky form of investment issued simply as an IOU from a company to an investor. Typically, they are bought by private individuals for between £5,000 and £20,000, and offer high returns of between 8 and 12%. They have recently come under scrutiny because of allegations of fraud and misleading marketing, which has led to the collapse of providers such as London Capital and Finance (LC&F). LC&F raised £237m from nearly 12,000 investors, spending the money on several property and business developments within a 6-month period. Shortly after, however, the FCA froze its bank accounts, LC&F entered administration, and the Serious Fraud Office (SFO) began investigating its directors.

What's the big picture effect?

The FCA has limited powers over companies which issue mini-bonds, since these companies are usually not authorised by them. Generally, this is fine; FCA-authorisation is not needed to issue debt securities such as mini-bonds. However, the FCA does regulate investment services provided in relation to these investments. This includes financial advisors, who must not unlawfully approve, communicate or advise on the sale of mini-bonds. Advisors can promote mini-bonds, but before doing so they must ensure that their marketing is fair, clear and not misleading. This means doing due diligence on the investment, which often contains complex terms and structures. Mini-bonds cannot be directly offered to any investor, either – only to high net worth or sophisticated investors. These are people with £250,000 in assets and who earn over £100,000 annually.

The main issue is the way these mini-bonds are packaged; LC&F, for instance, wrongly advertised them as low-risk Individual Savings Accounts (ISAs). However, there are calls for the FCA to do more. Firstly, the marketing ban only covers mini-bonds which lend to third parties, invest in other companies or develop properties. It does not cover providers who invest in their own activities, such as Mexican restaurant chain Chilango which crowd-funded over £5.7m of so-called ‘burrito bonds’. Adverts offered “free food” and 8% returns when the business was actually losing money. It also used EBITDA (earnings before interest, tax, depreciation and amortisation) as an indicator of financial performance. Only citing EBITDA can shift investors’ attention away from high debt levels and expenses, providing an incomplete picture of financial health. This seems true here: the 12-chain restaurant had £6.9m of debt in October and has just proposed a company voluntary arrangement (CVA). This leaves it one step away from administration and its 1,500 bondholders receiving nothing.

Secondly, the internet is rife with similar mini-bonds being advertised as ‘safe’ investments with protection from the Financial Services Compensation Scheme (FSCS) – which they do not have. The FCA is trying to persuade Internet Service Providers (ISPs), particularly Google, to take down websites more promptly. It is also developing data analysis tools for web scraping to assist in identifying mini-bond promotions.

There is also a case for strictly regulating mini-bonds themselves due to their high risk and cash-flow difficulties. Providers typically invest money into startup businesses or building projects. These are very high-risk, because of their unreliable cash flows or weak asset bases. Only 20% of UK startups remain liquid after just three years, while building projects are frequently hampered by delays and ever-rising costs. In October, mini-bond provider HAB Land was put into voluntary liquidation after failing to raise additional finance. Its 300 investors had put in, on average, £8,000 each for an expected 8% return, yet were told in August that 97% of their money could be lost.

Banning the marketing of certain mini-bonds is a small step in the right direction for the FCA, and builds on its crackdown on unlawful promotions of other investment schemes (see our article on that here). However, with mini-bond providers repeatedly collapsing, a wider and more permanent ban, covering the promotion of all mini-bonds, might be needed.

Report written by Arun Allen

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