Are you contemplating on raising funds for your property development project online?!
Two companies of the Grand Designs presenter Kevin McCloud’s property empire have gone into liquidation. These two companies form part of Happiness Architecture Beauty (HAB) eco-friendly housing empire and had attracted huge number of individual returns upto 9% a year – but instead investors are expecting to lose up to 97% of their money.
Worst hit are almost 300 small investors who put £2.4m into a “mini-bond” scheme offered by HAB in early 2017. They were informed that in best case scenario they are expected 74% and in worst case 97% of their invested funds. The investors were given an option to restructure whereby investors would keep their invested funds till September 2024 at the earliest and would also get zero interest until that date. Investors refused the offer and companies filed for liquidation.
With £2.4m mini-bonds of HAB finance and earlier that year London Capital & Finance’s grand £236m mini-bond collapse, FCA has reacted immediately with actions. This article we will talk about how FCA has now removed all the routes to market the mini-bonds and other speculative instruemnts to general public i.e. unsophisticated investor.
New temporary product intervention measures have been introduced regarding the online promotion of speculative mini-bonds to retail investors. The changes came into effect on January 1, 2020, and they are a response to the widespread marketing of speculative mini-bonds to people with little knowledge or experience of this type of high-risk investment.
The changes were made because research indicated that retail investors, who lack the experience and expertise in the investment market, were placing their money into complicated and high-risk investments, and were losing money as a result. Online speculative mini-bonds were never designed to be an investment option for everyday investors, and exist for the finance industry itself.
A speculative mini-bond contains the following features:
- It is usually issued by an unauthorised person, not subject to FCA oversight. This person is usually not covered by the Financial Services Compensation Scheme (FSCS).
- The bonds are unlisted and commonly issued through a special purpose vehicle (SPV)
- They offer a high fixed rate of interest (often 8% or more) to investors who commit to an investment of 3-5 years. Investors have little or no opportunity to sell of transfer the investment before the ned of the 3-5 years.
- The capital is usually used to fund speculative and high-risk activities
- They often involve high costs or third-party payments being made from the proceeds of the bond issuance.
The online marketing of speculative mini-bonds to retail investors is under the spotlight. Of particular concern is the mass-marketing of these bonds which promotes the potential for high rates of return, without explaining the high risk. The promotion also suggests that protection is given to the investor by bodies such as the FCA or HMRC, when it is not.
The new temporary rules apply to unlisted debentures and preference shares where the issuer uses the funds raised to lend to a third party, invest in other companies or purchase or develop property. This is known as speculative illiquid securities.
The changes will affect prospective retail investors in speculative illiquid securities (SIS). The changes will ensure that SIS can only be marketed to sophisticated of high net worth individuals and the promotions will have clearer disclosure of key risks and any costs or fees impacting the product.
Reason for the changes
LCF was the issuer of so-called ‘mini-bonds’ which it stated it used to make loans to corporate borrowers to provide capital for further investment. LCF issued mini-bonds to 11,625 investors, with a value of £237.2m. On 30 January 2019, LCF appointed administrators after the company was assessed to be insolvent. As a result, criminal investigations into LCF began. The changes aim to protect retail investors in the future.
The temporary measures, which will last for 12 months, require the following:
Any promotions for speculative illiquid securities targeted at retail investors to be restricted to sophisticated or high net worth retail investors.
Implementation of a preliminary assessment of the suitability of a security for any high net worth or self-certifying sophisticated investor to whom it is marketed. This ensures speculative illiquid securities are subject to similar marketing restrictions as currently apply to NMPIs (described above).
Any promotion of SIS must include a standardised risk warning, which clearly states that investors may lose all their money and that that these products are high risk,
Explanation that ISA eligibility does not protect consumers from losing their invested money.
Potential investors must be told that costs and charges associated with the security, and any third-party payments made by the issuer that are deducted from the capital raised, should be indicated as a percentage of the capital raised and illustrated as a cash sum.
The new measures will not apply to unlisted debt securities or preference shares issued by companies to purchase property or pay for the construction of property where the relevant property will be used by the company (or a group company) for a general commercial or industrial purpose.
Also excluded are cases where an issuers’ ability to pay interest or repay capital to investors is dependent or heavily contingent on the return generated from the purchase of construction of the
The prevention of widespread marketing of speculative illiquid securities to ordinary retail investors where a promotion is approved or communicated by an authorised firm.
A reduction in the number of retail investors accessing these investments.
Improvement in the quality of promotions provided to eligible retail investors to allow them to make better informed investment decisions based on clearer, mandated risk warnings and disclosure of costs, charges and third-party payments linked to a speculative illiquid security.
Fewer retail consumers investing in these products, and a greater understanding of the risks. This should reduce the likelihood of consumers investing in unsuitable products and potentially experiencing unexpected losses if a product underperforms or fails.
Unauthorised issuers will still be able to communicate financial promotions relating to their products within the scope of the FPO exemptions.
Salience bias induces investors to focus more on the high return of these securities, but to underestimate the associated risks. This is known to be a key driver of harm.
It is hoped that in the future the new regulations will apply to the larger number of UK-based issuers that have speculative bonds listed or trading on exchanges elsewhere in the EEA. These bonds are also promoted to UK retail investors, are similarly complex and pose similar risks. In some cases, speculative listed securities may pose greater risks since issuers raise larger amounts with longer maturities. Issuers have also encouraged holders of previously unlisted SISs to roll over into a listed security that serves to re-finance the same venture and avoids temporary rules restricting their marketing.
Admission to listing or trading may also be used in promotions for such securities to infer greater security and the prospect of a secondary market, although in practice there is still little or no liquidity. This may further mislead retail investors as to the risks involved, particularly in their ability to exit their investment before maturity.
The amendments are intended to ensure that investors are assessed to determine whether they fall within an exemption provided for in the rules (for example, as certified high net worth or self-certified sophisticated investors).
Investors are then subject to a preliminary suitability assessment where required and, finally, a financial product can then be promoted to people who are assessed as eligible.