FCA Takes â€˜Nuclear Optionâ€™ To Ban Sale Of Minibonds To Retail Investorswritten by Bella Palmer
The UK’s Financial Conduct Authority (FCA), the financial services regulator, has taken the decision to ban the promotion of minibonds to retail investors. Minibonds are a kind of unregulated debt instrument most commonly issued by young, growing companies to fund further expansion. Investors essentially loan these companies their money against a fixed interest rate paid over a pre-defined period of time, which can be anything between 2 or 3 and 10 years or longer.
The investment return comes in the form of the ‘coupon’, or interest rate, which is paid periodically, usually quarterly, bi-annually or annually. When the bond matures, the investor should also receive back their initial investment. Unlike regulated corporate bonds that can be traded over an exchange, minibond issuers don’t have to have an up-to-date credit rating by one of the major ratings agencies.
That makes minibonds a riskier investment than corporate bonds as investors are left relying on the bond issuer’s ongoing ability to make coupon payments and then return their original investment, without the benefit of insight into their finances that a ratings agency provides. To compensate that, minibonds tend to come with attractive coupons of at least 6% or 7% and often higher.
The FCA has come to the conclusion that the direct promotion of minibonds offering high coupons to retail investors is too risky to be continued to be allowed. The regulator believes that many retail investors accept bond investments as very low risk and often do not properly appreciate the higher risk nature of minibonds.
The risky nature of these investments has recently been highlighted by a number of scandals. The highest profile was the collapse of minibond company London Capital & Finance earlier this year. The company had attracted £237 million from 11,652 small, private investors who now face heavy losses.
The conclusion has now been reached by the regulator that, at least before a clear set of stricter rules on exactly how minibonds can be promoted to smaller individual investors can be formed, they should be excluded from the retail market entirely. That will happen without a consultation – which has led to the decision being described as the ‘nuclear’ option. The restrictions will come into force from January and last for 12 months. During that period the FCA will conduct a consultation aimed at reaching a decision on whether the decision should remain as permanent – or a new set of rules on the promotion of minibonds to the retail market introduced.
However, one risk, and one the FCA is aware of and conceded exists, is that banning the promotion of minibonds could make the problem worse by placing existing issuers in difficulty by cutting off their option to raise additional capital that way. It commented:
“If an issuer of a bond is already under financial pressure and our measures increase this, they may be less likely to meet interest payments or repay capital to investors. As this is likely to primarily reflect existing weaknesses in an issuer’s business model, we do not think our measures cause harm directly, but may contribute to losses occurring sooner for some investors.”
However, with growing evidence that the incidence of minibond offers that could be considered frauds or scams is increasing, the FCA believes that price is one worth paying. Especially if it prevents more investors from losing money.
Minibonds sit in a grey area of financial services regulation. The securities themselves are not regulated, but the FCA is responsible for making sure they are marketed appropriately and only by regulated firms. Successful minibond investments, where the issuer is able to meet their commitments, can also offer very good returns in exchange for a heightened level of risk. The sticking point is whether retail investors are taking on the level of risk they are with a good awareness and understanding of what could potentially go wrong.
This article is for information purposes only.
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