Taking Reasonable Steps with Mini-bonds
Mini-bonds are under the regulatory spotlight. David Boyhan delves into what mini-bonds are and what can be learned from recent failures in the market.
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The collapse of London Capital & Finance (LCF) has put mini-bonds under the regulatory spotlight. Questions have been raised over the FCA’s oversight of this market and the Treasury has now weighed in to review how mini-bonds should be governed.
What exactly is a mini-bond?
There is no official definition of a mini-bond, but it is generally a bond built from illiquid debt securities and issued to retail investors. Offered with a relatively high interest rate over a set term, typically by smaller firms and start-ups, mini-bonds appeal to clients seeking a decent return on their investment. As mini-bonds generally cannot be traded and must be held until maturity, they are a high-risk option. If the bond issuer fails, then consumers can lose all of their capital.
Fallout from LCF’s demise
While the FCA waits for the findings of an independent inquiry into the collapse of LCF, it’s certain that some of the firm’s customers were considerably harmed. The FCA has taken action to clarify some of the risks in the mini-bond market and it is likely that the regulator will bolster the supervision of this sector. So, it’s important that firms take proactive action now. This applies to:
- Firms that have sold mini-bonds historically
- Firms that are currently active in this market
LCF entered administration owing £236m to more than 11,000 investors”
Lessons to learn
Mini-bonds can help provide income for customers and can also provide diversification. However, as the LCF situation has proved, these are higher risk investments and the potential for customer harm is significant.
Firms should first understand the size of their mini-bond population. Once this is established, consideration should be given to the historic and current sales process for these products. How are mini-bonds marketed? Are there direct offer financial promotions? If so, are they marketed to the right types of investors? Are the appropriateness tests adequate? How is suitability assessed and what is the process for ongoing reviews?
Mini-bonds are some of the latest higher risk products drawing attention. Therefore, it’s crucial that firms undertake reasonable steps to ensure that their processes are in line with imminent regulatory expectations.