Mr Christopher Woolard
Interim Chief Executive
FCA Head Office
12 Endeavour Square
London E20 1JN

1 June 2020

Dear Mr Woolard

Temporary intervention on the marketing of speculative mini-bonds to retail investors

We are writing in respect of the temporary intervention by the FCA on 26 November 2019, which imposed a number of additional temporary provisions into the Conduct of Business Sourcebook of the FCA Handbook (the “Temporary Rules”). These temporary measures will expire on 31 December 2020 and we want to submit our contribution to the consultation on the permanent position that will be adopted following this date, having advised a number of companies on the issuance of IFISA qualifying bonds to raise funds for the purposes of money lending.

In the preamble to the Temporary Rules, a number of valid concerns were raised relating to the marketing of “speculative illiquid securities” to the retail market and the relative lack of regulatory oversight by the FCA. As identified, these were contributory factors that led to the FCA’s intervention against London Capital & Finance Plc (“LCF”) and its subsequent administration. However, this only tells part of the story.

It has been widely reported that there were inherent structural issues that ultimately led to the demise of LCF. Matters such as the transferability or otherwise of the shares go beyond the mere marketing of the fund and these issues would have made the offering unsuitable for any investors, irrespective of their wealth and investment expertise. Indeed, there is a criminal investigation ongoing in respect of the individuals involved with LCF. Whilst the Temporary Rules have restricted the marketing of mini-bonds and similar products to those more able to interrogate the detail and understand the risks, they do little to drive up the overall quality of the offering.

It is clear that since the Temporary Rules came in to force on 1 January, the economic outlook has changed considerably; the UK economy is now most likely in a recession and a number of viable and profitable businesses face extinction, particularly in the SME sector. It goes without saying that these companies are the lifeblood of the economy up and down the country, and many of which are in high growth sectors, yet continue to struggle to secure the funding they need from high street banks. We believe that now is the time to take firm and decisive action to revive the economy by providing vital liquidity to these companies.

Mini-bonds and IFISA qualifying bonds present an innovative solution to the current problem by creating pools of capital that can be lent under a defined investment policy to SMEs and other businesses, without contributing to the Treasury’s £180bn debt pile or adding systemic risk to the banking system. At the end of 2017-18 the market value of Adult ISA holdings stood at £608 billion, almost all of which is in cash ISAs (44% of the market) and Stocks and Shares ISAs (55% of the market). We believe some of this money can be deployed more effectively, benefiting investors and the economy as a whole. In our view, adding a few basic hurdles that inhibit the less scrupulous operators from entering the market will revive the IFISA market and result in products that are suitable for a broad cross-section of investors.

Some options that the FCA may consider appropriate are as follows:
 
1. Retained Profits Reserve – although the bond issuer company is thinly capitalised, it must partially subordinate the participation rights of directors and shareholders to the rights of bondholders until a retained profit reserve (fixed as a percentage of the outstanding bond capital and accrued but unpaid interest) has been established sufficient to cover a measure of loss from poor performance.  We have incorporated these provisions into a number of our IFISA bond documents already, typically on the basis that a reserve of 5% of the outstanding bond capital and accrued but unpaid interest but this could be higher.

2. Sponsor equity minimum requirement – at present, the only requirement under the Companies Act 2006 is that a public company is capitalised as to £50,000, of which £12,500 must be paid up.  This is in practice a very low bar and does little to deter the less scrupulous operators from setting up a public company and raising bond monies.  If a minimum equity capitalisation requirement is introduced for any vehicle raising funds for the purposes of money lending, this would significantly increase the sponsor’s exposure to the risk and should encourage more careful lending decisions. Alongside this, it would be prudent to impose a cap on the level of fees that may be extracted by the operator of the issuer (whether in the form of advisory fees, management fees or otherwise), thereby incentivising operators to have a greater interest in the residual profit of the issuer. This combination of carrot and stick we believe will encourage a sensible and sustainable lending policy.

3. Listing – The temporary FCA rules include a specific exemption where securities are readily realisable.  This includes securities that they are admitted to official listing on an exchange in an EEA State.  We would suggest that this is expanded to include more straightforward “technical listings” on smaller exchanges outside of the EEA, such as The International Stock Exchange. The additional upfront background checks together with the ongoing reporting and disclosure obligations should, so adds an additional layer of protection for investors and will shine an unwanted light on the offering by any unscrupulous operators.  Indeed, we note that the TISE Rules for example have enhanced disclosure requirements where securities are offered to the retail market. This approach would also allow a bond issuer to cultivate connections with IFAs who will only propose investments in listed products, thereby opening the market to a broader range of investors.

4. Discretionary Fund Management – We appreciate that the FCA may want to retain a degree of direct supervision over the sector and one way this can be achieved is through a discretionary fund management requirement. This works by an authorised person offering a spread of returns with different investment maturity, interest rates and level of risk.  It would then engage with IFAs, who would instruct a discretionary fund management arm of the authorised person to select a portfolio of bonds that match the investor’s profile and investment ambitions.  The IFISA bonds and other securities caught by the Temporary Rules will be marketed by authorised persons to retail investors, through IFAs (who qualify as professional clients) rather than the investors becoming clients directly. This would keep the responsibility for undertaking suitability tests with the IFAs, who are the most qualified to do so.   

We would be delighted to discuss these options with you further.

Yours sincerely

Roger Blears & Christopher Spencer

CC. Mr Andrew Bailey, Governor, Bank of England
The Rt. Hon. Dame Elizabeth Gloster DBE, PC, Chair of the independent investigation into the regulation by the Financial Conduct Authority of London Capital & Finance Plc