A time for change: addressing new priorities for a better world
1 July 20
1 July 20
Last week, the FCA announced a proposal to make its ban on the marketing of speculative illiquid securities to retail investors permanent and with a wider scope. We welcome the decision. Speculative illiquid securities, which includes speculative mini-bonds, come in a wide variety of shapes and sizes and have bamboozled retail investors with slick marketing and the prospect of enticing returns. We believe the proposal correctly emphasises the vital role of financial advisors in assessing the suitability of investments and undertaking robust due diligence of the manager and the trade on behalf of clients.
Mini-bonds are illiquid debt securities. They are essentially an IOU issued by a company (the issuer) to an investor in exchange for a fixed rate of interest over a set period of time. At the end of this period, the investors' money is due to be repaid.
The higher returns offered by mini-bonds are often a reflection of the higher risks when compared to other types of investments. These risks reflect a number of things, from the fact that the bonds are usually issued by early stage companies or companies that find it difficult to raise money from the bank or from other institutional investors (which are therefore considered riskier businesses) to the fact that they can’t readily be converted into cash or sold on. If the business fails, investors may get nothing back. They pay a higher level of interest than bank accounts exactly because they are more risky investments. Mini-bonds are not like savings accounts. There is normally no protection from the Financial Services Compensation Scheme (FSCS) if the issuer is unable to repay investors’ capital. This means that, if the mini-bond issuer fails, an investor could lose all of their money.
Such investments are certainly not for everyone, as those who suffered losses in the collapse of mini-bond issuer London Capital & Finance (LCF) earlier this year discovered.
But mini-bonds can be a legitimate way for companies to raise money. Just because some providers of mini-bonds have failed, does not mean that the entire industry is not fit for purpose. Like other financial instruments, mini-bonds also come in different shapes and sizes. It’s understandable that the FCA banned the marketing of “speculative mini-bonds” to retail investors of “speculative mini-bonds”, where the funds raised are used to lend to a third party, invest in other companies or purchase or develop properties. That said, they can still be marketed to "sophisticated investors", who declare themselves able to understand the risks, or high net-worth individuals who are better able to bear potential losses with an annual income of more than £100,000 or net assets of £250,000 or more.
This highlights the essential role of a financial advisor in assessing suitability of investments and undertaking research.
The role of the financial adviser is to understand the knowledge, the financial situation and objectives of their client. A good adviser will conduct the necessary due-diligence on behalf of their client, including the experience and financial strength of the investment manager, whether the manager’s interests are aligned with the investors or whether they get paid irrespective of the success of the product. Many retail investors are bamboozled by slick marketing and the prospect of enticing returns. A financial adviser, through experience and a healthy degree of cynicism, will insist on robust answers before recommending any type of investment, including mini-bonds, to his clients.