FCA temporary intervention on the marketing of speculative mini-bonds and preference shares to retail investors

 New guidance on the requirements which apply to firms approving financial promotions

The FCA has today introduced intervention measures for 12 months from 1 January 2020 which will restrict the promotion of unlisted debentures and preference shares where the capital raised will be lent to a third party, invested in other companies or used to purchase or develop property.

The measures are being introduced to ensure that financial promotions relating to speculative illiquid securities are not communicated to ordinary retail investors. The FCA’s conduct of business rules (COBS) are therefore being amended to restrict firms approving or communicating financial promotions in relation to speculative illiquid securities which are addressed to or are disseminated in such a way that they are likely to be received by a retail client, subject to certain exemptions.

The new measures will not apply to unlisted securities where funds raised will be used to buy or construct property for an issuer’s own commercial or industrial purpose; or will be raised by an investment vehicle to invest in a single UK-based property. The new measures do not apply to promotions approved by authorised firms before 1 January 2020.

For the purposes of the new rules a speculative illiquid security is defined as a debenture or preference shares which has a denomination of £100,000 or less and which has been issued or is to be issued in circumstances where the issuer or a member of the issuer’s group will use some or all of the proceeds of the issue directly or indirectly for one or more of the following purposes: the provision of loan finance to third parties; buyin g or acquiring investments; buying property or an interest in property or paying for or funding the construction of property.

The FCA believes that the risks associated with speculative illiquid securities are often similar to unauthorised collective investment schemes (UCIS) where the likelihood of investors receiving interest and capital repayments often depends on an issuer achieving pooled returns from lending to or investing in other third parties or property usually involving a high degree of speculation and risk. Significant costs and charges or third-party payments deducted from the amounts raised by an issuer can also make the feasibility of achieving promised returns even more challenging. Most retail clients cannot easily understand or assess such risks.

The promotion of these investments will shortly be restricted to individual retail investors who have been pre-categorised as either sophisticated or high net worth and where the product has initially been assessed as likely to be suitable for them. Specific risk warnings and disclosures of any costs or payments to third parties that are deducted from the money raised by an issue will also be required in any financial promotion of such investments.

A debenture or preference share is not a speculative illiquid security where one or more of the following exemption applies:

• The issuer or a member of the issuer’s group uses or purports to use the proceeds of the issue for the purpose of buying property or an interest in property or paying for or funding the construction of property where, in either case, the relevant property is or will be used by the issuer or a member of the issuer’s group for a general commercial or industrial purpose which it carries on;
• The ability of the issuer to pay any coupon or other income and/or capital at maturity is wholly or predominantly liked to, contingent on, sensitive to or dependent omna return generated as a result of the matters referred to in (1);
• The debenture or preference share is issued or to be issued by a credit institution, a non-mainstream pooled investment; a readily realisable security (i.e.admitted to the official list maintained by the FCA or a comnpetant authority in another EEA State); or
• The debenture or preference shares is a P2P agreement.

 

The FCA believes that unauthorised issuers currently follow one of three approaches to marketing;

• a communication which is not approved by an authorised person but is lawful because it falls within one or more exemptions in the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (SI 2005/1529) (“FPO”).

The FCA claims that FPO exemptions do not generally enable marketing to the general public via the internet as an unauthorised issuer seeking to promote its securities only to high net worth or sophisticated investors within the FPO will need to have in place processes to ensure these promotions are only addressed to such persons.

The FPO only requires that an issuer should believe on reasonable grounds that the recipient of a communication should be a certified high net worth or self-certified sophisticated investors. Therefore, with the appropriate gateway criteria on a website which allows a recipient of a communication to confirm that they are indeed so certified or to certify their status on the basis of an appropriate fact find questionnaire, in our opinion, such processes will be in place and should satisfy FCA requirements.

 

• a communication approved by an authorised firm subject to FCA rules for non-mainstream pooled investments (NMPIs)

NMPIs include a unit in a UCIS.

A company which issues debentures is not a UCIS because it falls into the exemption for bodies corporate in Article 21 of the Financial Services and Markets Act 2000 (Collective Investment Schemes) Order 2001 (SI 2001/1062).

NMPIs include a security issued by a special purpose vehicle, other than an excluded security. The material part of the definition of a ‘special purpose vehicle’ is that it is a body corporate explicitly established for the purpose of securitising assets and whose sole purpose is the issuance of designated investments (which would include debentures) or redeeming or terminating or repurchasing the same.  An ‘excluded security’ includes a security whereby the issuer’s ability to fulfil its payment obligations to the investor are wholly or predominantly linked to, contingent on, highly sensitive to or dependent on the performance of or changes in the value of (amongst other things) shares or debentures provided the shares or the debentures are not themselves issued by special purpose vehicles.

A corporate body which raises capital by the issue of shares or debentures, capital which it then uses to lend to a third party, or to invest in the shares or debentures in another company, will be a company issuing excluded securities because it will rely on payments received from its borrowers or investee companies to fulfil its own payment obligations.

Conversely, if a company issues debentures or shares in order to raise capital to purchase or develop property those debentures and shares will not fall within the exemption for excluded securities.

Accordingly, in our opinion, the NMPI rules are only potentially relevant to property purchasers or developers and are not at all relevant to moneylenders. Even then, given that the purposes of a property purchaser or developer will include the purchase and development of property in our opinion, the NMPI rules are also unlikely to apply here because the issuer will not meet the ‘sole purpose’ criteria for qualification as a special purpose vehicle (and the same might also be said of an issuer whose purposes include the running of a money lending business).

It is the effective extension of the NMPI rules which constitutes the temporary measures being introduced by the FCA. See ‘So what is new?’ below.

-a communication approved by an authorised firm which is subject to FCA rules for non-readily realisable securities (“NNRS”)

The NRRS rules are such that the terms and rates of a product can be broadly advertised provided the promotion does not include an immediate invitation to invest. Consumers can however register interest to receive a direct offer financial promotion.

The definition of what is a direct offer financial promotion has always been vague, perhaps deliberately so. Opinions differ, but wehave always takenthe view that such a promotion is not caught by the rules if the promotion omits an application form (e.g. oneappended to the promotion). This interpretation now seems to be endorsed by the FCA by their own confirmation that a communication is not a direct offer financial promotion if it does not include an immediate invitation to invest.

 

So what is new?

1. Any financial promotion of speculative illiquid securities targeted at retail investors must be restricted to sophisticated or high net worth retail investors.

 

An authorised firm must not communicate or approve such a financial promotion where it is addressed to or disseminated in such a way that it is likely to be received by a retail client (COBS 4.14.2).

This restriction does not apply to the following:

• certified high net worth investors; individuals who meet the requirements (annual income of £100,000 or more excluding pension withdrawals or net assets of £250,00 or more excluding primary residence, loans secured on it, and retirement benefits) or a person legally empowered to make investment decisions on their behalf  and where the authorised firm considers it is likely to be suitable for that individual based on a preliminary assessment of the client’s profile and objectives;
• certified sophisticated investors; individuals who meet the requirements (a certificate signed within the last 36 months by an authorised person that the individual understands the risks and where the individual has signed a prescribed certificate in the last 12 months) or a person legally empowered to make investment decisions on their behalf;
• self-certified sophisticated investors; individuals who meet the requirements (where the individual has signed a prescribed certificate in the last 12 months) or a person legally empowered to make investment decisions on their behalf andwhere the authorised firm considers it is likely to be suitable for that individual based on a preliminary assessment of the client’s profile and objectives; and
• excluded communications

 

The requirement for a preliminary assessment of suitability does not extend to a full suitability assessment, unless advice is offered, but requires the firm to take reasonable steps to acquaint itself with the client’s profile and objectives to ascertain whether the investment is likely to be suitable for that client (“Modified Suitability Assessment”).

A financial promotion may not be sent to a restricted/every day investor as this is not one of the permited exempt categories of receipient under the new rules.

A financial promotion to professional investors is allowed as this would fall within the category of an excluded communication.

 

2. Firms will also need to carry out a preliminary assessment of the suitability of a security for any high net worth or self-certifying sophisticated investor to whom it is marketed (e.g. considering a client’s profile and investment objectives). This is to ensure that speculative illiquid securities are subject to similar marketing restrictions as currently apply to NMPIs.

 

3. Any marketing material indicating benefits of speculative illiquid securities must also include prescribed specific and prominent risk warning disclosures disclosure including (COBS 4.14):

 

• a standardised risk warning which clearly states that investors may lose all their money, that these products are high risk and that ISA eligibility does not protect consumers from losing their invested money;

 

• costs and charges associated with the security and any third-party payments made by the issuer that are deducted from the capital raised which should be indicated as a percentage of the capital raised and illustrated as a cash sum; and

 

• the date on which the financial promotion is approved.

 

Options from 1 January 2020

It is likely that the rules of what constitutes a financial promotion, that is an invitation to invest in or engage in an investment activity, will be restrictively interpreted. Therefore, communications made before it is known whether or not an investor falls within one of the prescribed permitted categories of recipient will need to be generic in nature and not designed to be either an invitation or an inducement (“Preliminary Communications”).

Where a financial promotion is to be issued an issuer taking advantage of the FPO it will need to believe on reasonable grounds that the recipient of a communication should be a certified high net worth or self-certified sophisticated investors. This will require appropriate gateway criteria on a website which allows a recipient of a Preliminary Communication to confirm that they are indeed so certified or to certify their status on the basis of an appropriate fact find questionnaire, before they receive the FPO exempted financial promotion.

Where a financial promotion will not be issued under the FPO but will be approved by an authorised person, the authorised person will need to operate the same gateway criteria and additionally also undertake the Modified Suitability Assessment.

Alternatively, an issuer might seek to admit its debentures to the Official List maintained by the FCA in the UK or to the Official List maintained by Euronext Dublin. As such, the debentures would constitute readily realisable securities and would therefore fall within one of exemptions set out in COBS 4.14.18(3) and so would not constitute a speculative illiquid security. We have recent experience of listing debentures with Euronext Dublin having completed the Dublin listing of the £100m bond issue platform for Engenera Green Bonds plc on 23^rdOctober 2019.

Alternatively, and perhaps as an interim measure pending listing, financial promotions might be restricted to authorised financial advisers with an invitation for the financial adviser  to instruct a discretionary fund manager who will treat thefinancial adviser as its agent professional client in accordance with COBS 2.4.3 so that, in selecting a portfolio of bonds,  it is the financial adviser who undertakes a prior suitability assessment of his client before communicating the financial promotion to the client.

Please do not hesitate to speak to either me, Frank Daly, Adam Lawrence or Christopher Spencer as regards any queries arising from the above. We would be delighted to advise.

 

Yours sincerely

Roger Blears

 

Roger Blears | Senior Partner | RW Blears LLP

29 Lincoln’s Inn Fields, London WC2A 3EG

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