On 18 June 2020, the FCA published a consultation paper on high-risk investments, announcing its intention to permanently ban the marketing of mini-bonds to retail investors. This followed a temporary ban on the mass marketing of speculative mini-bonds to retail customers from 1 January 2020 until 31 December 2020. Earlier in 2019, mini-bond provider London Capital & Finance had gone bust, owing £237m to over 11,000 bondholders after customers were promised returns of 6.5%–8%on their investment.

What are mini-bonds and why have they caused trouble? Paul Alexander, local partner in the Milan office of law firm White & Case, explains the issues.

What are mini-bonds and when were they first introduced?

In a UK context, the term 'mini-bond' usually refers to an unlisted and illiquid debt security marketed to retail investors. The UK market for such securities took off in 2010, following the financial crisis, when some banks didn't have sufficiently strong balance sheets to lend to small and medium-sized companies. Those companies borrowed directly from investors instead.

How were mini-bonds able to be issued as non-authorised instruments?

Under the current regulatory regime in the UK, a business does not have to be regulated by the FCA to issue mini-bonds. As the securities are unlisted, no prospectus is prepared, and there is no compensation under the Financial Services Compensation Scheme for investors who incur losses.

Therefore, the only regulatory involvement relates to the marketing of securities under UK financial promotion rules. Prior to the introduction of the ban, an invitation or inducement to buy or sell a mini-bond was permissible if made or approved by a firm that was authorised by the Prudential Regulatory Authority (PRA) or the FCA and fulfilled criteria of clarity, accuracy and risk disclosure.

Now, firms are prohibited from making or approving promotional communications to retail investors regarding speculative illiquid securities, whether or not they fulfil the criteria described above.

Has the FCA ban faced any legal challenges?

In principle, the FCA's approach is logical because it is trying to prevent the sale of high-risk financial products to retail investors. The FCA definition of speculative illiquid security refers to debentures (including bonds) and preference shares whose proceeds are used to finance third parties, acquire investments or property or fund construction of property. Exemptions are made for companies raising funds for their own activities or raising funding for a single UK property investment.

However, it is never easy to specify what it is that makes an investment ‘speculative’, so there may be some low-risk products that retail investors are prevented from buying – whether property related or otherwise – and also high-risk products that fall outside the scope of the ban.

Following the FCA's announcement of its intention to permanently ban the marketing of mini-bonds to retail investors, who can these products be marketed to?

About the expert

Paul Alexander is a UK qualified lawyer with 18 years of experience advising on high-profile debt, equity and equity-linked transactions. Paul's practice covers stand-alone bond issues for investment grade and sub-investment grade issuers, MTN programmes, issues of hybrid securities, liability management exercises, project bonds, convertible and exchangeable bonds and initial public offerings.

Paul has been based in Milan for a number of years, and his extensive track record representing underwriters and companies in capital markets deals in Italy has given him a deep understanding of the complex issues related to the domestic market. Paul is recognised as highly regarded by IFLR1000 2020 in DCM and ECM and is recommended by The Legal 500 2020 in DCM.

There are a number of exemptions from the financial promotion regime set out in the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, for example, where products are marketed to investment professionals, high-net-worth companies and unincorporated associations. In addition, the new rules specify that securities can be marketed to individuals who have been pre-categorised as either sophisticated or high-net-worth individuals and where a suitability assessment has been conducted.

Any marketing material describing the benefits of speculative illiquid securities must include specific risk warnings and details of costs and charges. The FCA has also proposed extending the scope of the ban to those listed securities that are not regularly traded on an exchange, to prevent regulatory arbitrage.

Do you feel the FCA was adequately supervising the firms issuing the bonds? Despite the firms being authorised, the products were unauthorised and there's a lot of potential to mislead here.

According to news reports, there are two early examples in 2015 of mini-bond issuers collapsing in the UK and the bonds issued being worthless. These were Secured Energy Bonds and Providence Bonds.

However, the losses were small compared to the London Capital & Finance collapse in 2019, in which investors lost approximately £237m.

There is a criminal investigation underway and the outcome will likely reveal the nature of the interaction between London Capital & Finance and the FCA prior to December 2018, when the FCA ordered the firm to withdraw its promotional material regarding the mini-bonds.

Meanwhile, the FCA says that since April 2019, it has assessed over 550 cases of financial promotions that appeared not to have complied with the FCA rules, so this has clearly become an area of focus more recently.

There is always a balance to strike between facilitating corporate funding by retail investors and ensuring that those retail investors are adequately protected. Appropriate disclosure and risk warnings are always important, as is maintaining a distinction between simpler and more complex structures, where a level of financial knowledge and experience should be obligatory for potential purchasers. According to the FCA consultation paper, since London Capital & Finance, there have been two subsequent collapses of firms marketing mini-bonds. These are Basset & Gold and Blackmore Bond, which have both gone into administration. In total these three firms led to approximately £300m of losses across the £1.4bn UK market for speculative illiquid securities, hence the urgency of their recent actions.

Any views expressed in this publication are strictly those of the author and should not be attributed in any way to White & Case LLP.