London Capital & Finance, Mini-bonds, Regulation, Unregulated; it’s all a load of bonds.

If the London Capital & Finance mini-bonds disaster tells us anything, it’s that the FCA (‘the regulator’) simply cannot keep turning a blind-eye and allowing unregulated bonds and other investments to be offered to retail investors.

The regulator knows full well the definition of a retail investor under Mifid and there should be a blanket ban of ANY unregulated investments being offered outside of this definition, says Mr Bond

However, Mr Bond believes that this alone does not address the situation bought about because of the financial crisis (‘GFC’) of 11-years ago for both borrowers and investors, which is two-fold:

• Many banks simply pulled out of servicing SME businesses leaving them seeking alternative sources of finance, examples of this have been P2P lending, and mini-bonds. The true regulated alternative, the London Stock Exchanges Order Book for Retail Bonds (‘ORB’), has become a source of frustration for investors and issuers alike.
• Since the GFC interest rates tumbled and have remained at historically low levels. This has led investors to search for yield, and clever marketing combined with ‘high’ coupon levels have tempted many individuals to try investments such as mini-bonds.

Before we continue, let’s be clear there is no such investment as a mini-bond per se.

‘let’s be clear there is no such investment as a mini-bond per se’

By definition, a bond is a fixed income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental) that is listed on a stock exchange.

The listing provides the regulation, either directly through the exchange in the example of the UKs NEX Growth Market, or via the UK Listing Authority (a part of the FCA) in the case of the ORB.

And, listing such as NEX and the ORB should be used. These are regulated venues where bonds that meet the required standards can be listed to help investors who are searching for yield.

The failing has been that in seeking to ‘protect’ the reputation of the ORB it has become increasingly difficult to list issues there.

This isn’t just a failing of the exchange or the regulator, but of other parties required for an issue to succeed. Their concern, not unreasonably, was that they didn’t want issues it was perceived might fail and lead to investor losses; so brilliantly have they done their job that none have failed, although there have been near misses.

Put another way, there has been so few issues in the last 4-years that it was almost a given that there would not be a failure.

The great failing of regulation has been the misunderstanding of what investors want, and in trying to push them into areas that are perceived as ‘safe’, i.e. in seeking to protect retail investors they have only succeeded in making them ‘a toxic’ area for many providers.

‘The great failing of regulation has been the misunderstanding of what investors want’

The investment providers are now so intimidated by regulation for retail investors and scared of how the regulator will treat them if something goes wrong, that, when this is coupled with the increasing cost of regulation, it’s easier for providers to simply avoid retail investors.

Ultimately, their good intentions have provided a pool of investors that mini-bond issuers have successfully tapped into. For the un-initiated, the brevity and slick nature of their marketing is ideal, unfortunately the devil is in the detail which is usually missing. But this is unadvised and unregulated investing, a slick brochure, and a headline rate wins every time.

Is there a solution? Yes, there always is. The regulator needs to understand investors and allow them to be able to access what they require, and to stop pushing them into areas and investments that aren’t regulated.

There is a templated prospectus used by exchanges around Europe, this is effectively driven by EU legislation referred to as the Prospectus Directive.

‘Is there a solution? Yes, there always is’

Within the PD template is the requirement for a high-level of disclosure by the Issuer, about their business and the market they operate in, and also full financial information. This coupled with the ORB principle of issuing an information booklet provides investors all the access they require to make a decision.

It might be argued that this maybe beyond their comprehension, but, in my experience, the fact that issuers must provide it deters many undesirables.

LC&F was, and is, a terrible mess, but one that might have been avoided had the regulator pushed all issues into the required regulated format. I say might because you cannot legislate for fraud, as Enron et al confirms. However, the stricture and structure, along with the disclosure required by the PD might have been enough to deter LC&F from trying.

Mr Bond concludes that all issuers must embrace regulation but, in turn, the regulator must understand what retail investors want and ensure that regulations meet these requirements