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City watchdog to permanently ban risky mini-bond ads

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18/06/2020
The financial regulator is proposing to make permanent its ban on the promotion and mass marketing of high interest mini-bonds and illiquid securities.

The Financial Conduct Authority (FCA) is proposing a permanent marketing ban on speculative illiquid securities, including mini-bonds, following concerns that investors aren’t aware of the risks involved.

With headline-grabbing rates in the low interest environment, the FCA added that many investors couldn’t afford the potential financial losses that come with the added risk.

In January this year, it introduced a 12-month promotional ban for ordinary retail investors and the FCA is now looking to make this permanent.

It also wants to bring listed bonds with similar features to speculative illiquid securities within the scope of the ban.

However, as is currently the case, these products can be promoted to those considered ‘sophisticated’ and ‘high-net worth’ – typically earning more than £100,000 or with net assets of £250,000+. Risk warnings will need to be included and costs and payments to third parties that are deducted from the money raised from investors must be disclosed.

Sheldon Mills, interim executive director of strategy and competition at the FCA, said: “We know that investing in these types of products can lead to unexpected and significant losses for investors. We have already taken a wide range of action in order to protect consumers and by making the ban permanent we aim to prevent people investing in complex, high risk products which are often designed to be hard to understand.

“Since we introduced the marketing ban, we have seen evidence that firms are promoting other types of bonds which are not regularly traded to retail investors. We are very concerned about this and so we have proposed extending the scope of the ban.”

The ban will apply to the most complex bonds where the funds raised are used to lend to a third party, or to buy or acquire investments, or to buy or fund the construction of property.

Exemptions from the advertising ban include listed bonds which are regularly traded, companies which raise funds for their own commercial or industrial activities, and products which fund a single UK income-generating property investment.

What are mini-bonds?

While mini-bonds tend to offer attractive interest rates – some up to 8% – they are high risk propositions.

They’re unsecured and non-transferable so you’re locked in until the maturation point, which is often three to five years.

They aren’t subject to the same rigorous regulation as other bond products and aren’t covered by the Financial Services Compensation Scheme (FSCS), so if the issuer goes bust you could lose all your money. Read more: Q&A: What are retail and mini bonds?

The FCA said it is concerned about these products as they often have high upfront or embedded costs and charges, imply capital protection and can be held within a tax wrapper, such as an Innovative Finance ISA (IFISA) or Self-Invested Personal Pension (SIPP). However, many don’t meet the criteria and mislead investors by suggesting the products or issuer has protection or is endorsed by the FCA.

The regulator estimated the average investment in these securities is over £25,000 so a total loss of funds “could have a significant negative impact on individual consumers”.

The temporary ban imposed earlier this year came in the wake of London Capital and Finance (LCF) insolvency in 2019. LCF issued mini-bonds to over 11,000 investors totalling £237m.

‘Dangerous sense of security’

Sarah Coles, personal finance analyst at Hargreaves Lansdown, said: “These specific kinds of mini-bonds are constructed in a way that makes them particularly toxic: they’re fiendishly complicated, so investors struggle to understand the risks involved. At the same time, they have the potential to lose investors all of their money, and they’re called ‘bonds’, which lulls investors into a dangerous sense of security.

“Absolutely everything involves risk – even cash ISAs that risk falling short of inflation. Each investment is a balance of the potential risk and the possible rewards. It’s important that people understand the risks involved, take the ones they’re comfortable with, and steer well clear of anything complex and opaque enough to obscure the risk entirely.”

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