Shortly before Christmas, the Financial Conduct Authority (FCA) issued a temporary intervention order banning the marketing of speculative illiquid securities, often called "mini-bonds", to retail investors. A copy of the Intervention Order can be found here.
In brief, from 1 January, any promotions of what the FCA deems to be "speculative illiquid securities" can only be targeted at sophisticated investors or investors who are high-net worth retail investors.
The Intervention Order will apply for a 12 month period; however the FCA has made it clear that permanent rules will be in place by 31 December 2020.
In this article, we discuss the rationale and impact of the Intervention Order.
What is the rationale behind the FCA issuing the Intervention Order?
One of the FCA's overarching statutory objectives is to protect consumers and the FCA has "significant concerns" about the widespread marketing of speculative illiquid securities to retail investors, especially via online and social media platforms. As a result, there are concerns that such widespread marketing efforts have resulted in retail investors investing in products which do not meet their needs and could result in significant losses.
The FCA has been under pressure to take action and protect retail investors following the collapse of a number of high-profile investment propositions throughout the course of 2019, in particular: the property bonds issued by entities connected with Grand Designs presenter Kevin McCloud; and, the insolvency of London Capital and Finance which collapsed after having issued mini-bonds of an aggregate value of £237.2 million to more than 11,600 investors.
An investment in speculative illiquid securities is inherently high-risk and the granular detail associated with such an investment is difficult for retail investors to understand (if indeed such details are disclosed to investors at all). However, the FCA estimates that, not including those impacted by the collapse of London Capital and Finance, at least 11,000 people may be currently invested in such speculative illiquid securities with an average investment amount of £25,000, evidencing that there is a potential for significant negative impact if such investments subsequently collapse or do not otherwise generate the level of returns expected by investors.
What are the "speculative illiquid securities" which are affected by the Intervention Order?
The Intervention Order specifically relates to the promotion of "speculative illiquid securities", often referred to in promotion materials and the media as "mini-bonds", being unlisted debt or shares that are issued to raise proceeds to:
(b) invest in other companies; or
(c) construct or buy property (except where this property is for the issuer's own commercial or industrial use); and
(d) which has a denomination or minimum investment of £100,000 or less.
The Intervention Order is aimed at "speculative illiquid securities" which typically have the following features:
- the promise of high annual returns often described as "fixed" and starting at 6% to 8% which is well above rates offered by current cash savings products;
- they require investors to invest for a fixed period of at least five years or more with limited scope to sell or transfer their investments during that time without incurring significant exit charges;
- exposure to high-risk, speculative assets that are difficult to value or be readily redeemed, which is a mis-match with the "fixed" high returns;
- those issued by an unauthorised issuer (or an authorised issuer issuing unregulated securities) which usually means there is no protection afforded by the Financial Services Compensation Scheme;
- complex legal structures either in relation to the product or between the issuer and the promoter of the investment;
- high-upfront or embedded costs and charges; and/or
- misleading financial promotions which:
- focus primarily on attractive headline returns;
- imply capital protection or other features such as diversification or asset-backed;
- do not disclose costs and charges; or
- use the role of HMRC in overseeing tax wrappers (i.e. ISA eligible) to imply oversight or endorsement by the government.
- focus primarily on attractive headline returns;
Who will the Intervention Order impact and what should you do?
The Intervention Order applies widely and will expressly impact:
(b) authorised firms that approve or communicate promotions relating to speculative illiquid securities; and
(c) firms that:
(ii) arrange deals in investments; and
(iii) deal in investments on behalf of clients.
Clearly, if you are an issuer of, or firm involved in the issue of, speculative illiquid securities, then you needed to have ceased marketing and promoting such securities to retail investors by 1 January 2020.
Going forward, any promotions of speculative illiquid securities should only be made to sophisticated and/or high-net worth investors and issuers should be prepared to be able to evidence to the FCA that systems and controls are in place to ensure that promotions are, in fact, only made to such investors.
In addition, all marketing materials should be reviewed to ensure that they do not include any misleading claims (for example, if the securities are marketed as being asset-backed then they need to be actually backed by realisable assets) and must also prominently include:
- a risk warning stating that:
- investors may lose all of their money
- that the securities are high-risk; and
- even if the securities are ISA-eligible, this does not protect investors from losing all of their invested money; and
- disclosure of the costs and charges setting out any third-arty payments to be made by the issuer out of the monies raised from investors in the form of a percentage of capital raised and a cash sum
What if I am issuer of non-speculative illiquid securities?
Whilst the Intervention Order does not apply to the promotion of:
(b) peer-to-peer agreements (such as equity or debt crowdfunding):
(c) debt or shares that fall within the FCA's non-mainstream pooled investments (NMPI) or non-readily realisable securities (NRRS) definitions: or
(d) debt or shares issued by a credit institution,
it should be noted that the promotion of each of the above to potential investors is governed via separate UK law, regulation and/or FCA rule.
If you are an issuer of debt or shares which are not speculative illiquid securities, then whist the Intervention Order may not directly impact you, it does evidence the FCA's willingness to uphold its objective to protect consumers. As such, a review of your marketing materials and investment processes and procedures is advised to ensure that it complies with current applicable laws, regulations and/or FCA rules.
How we can help
FCA issued a call to action on 21 January 2020, encouraging firms to consider their approval of Financial Promotions under S21 of the FSMA and by asking firms to notifying instances of approval directly to the FCA.
In conjunction with our Regulatory Consulting team, DWF is able to assist firms in identifying the types of activity that fall within the intervention and to diagnose whether any of the instruments that your firm advises upon or arranges are subject to the intervention.
We can work with you to analyse how you should approach the implementation of the new measures and the call to action, with reference to the type of clients dealt with by your firm. This could involve:
- reviewing your approval of financial promotions, whether you have approved promotions on behalf of you own firm, or another unauthorised person;
- considering your approach towards investor categorisation and due diligence;
- working through, in detail, the considerations to be applied to your current or retrospective business activity;
- planning the steps you can take to revise your current and future activities, and;
- reviewing your advisory proposition and processes around promotions.
We have experience of working with previous segments of the financial services sector who have previously been impacted by previous regulatory interventions, such as the issuers of Contracts for Differences and we can help ensure that your business and clients are minimally impacted by the FCA intervention.
Please contact us for further assistance.