UK Govt consults on regulation of mini-bonds

The UK government is consulting on proposals to bring the issuance of non-transferable debt securities (mini-bonds) within the scope of financial services regulation.

London Capital & Finance (LCF) which issued non-transferable debt securities (NTDS), entered administration in January 2019, impacting 11,000 investors who had invested more than £230 million. Issuing NTDS is currently an unregulated activity and investors therefore benefitted from few regulatory protections when investing in the products.

Following the failure of LCF, the Treasury announced it would review the regulatory arrangements in place for the issuance of NTDS to retail investors. An independent investigation into the Financial Conduct Authority’s supervision of LCF carried out by Dame Elizabeth Gloster which was published in December 2020 also made a specific recommendation that the government should consider bringing the issuance of NTDS into regulation.

Under the first option, the issuance of NTDS where the proceeds are used to invest in or lend to third-party businesses or projects would become a regulated activity. It is the government’s intention that this measure wouldn’t cover issues where an entity acts as an intermediary between the issuer and the retail investor (such as a crowdfunding platform), and is carrying out a regulated activity in doing so.

The measure would therefore apply primarily to the issuance of ‘direct-to-market’ NTDS. The government believes this is a proportionate approach, as an intermediary carrying out a regulated activity is subject to FCA supervision, meaning the FCA already have oversight of the distribution of these NTDS.

Under this approach, firms wishing to carry on the activity of issuing NTDS would need to be authorised by the FCA for which they would have to meet the minimum standards to become authorised, known as the Threshold Conditions. Once authorised, the FCA would then be in a position to apply relevant FCA conduct of business, product governance, prudential and systems and controls requirements to issuers, together with the Senior Managers and Certification Regime.

The FCA’s financial promotions rules would continue (unless an exemption applies) to apply to promotions for relevant NTDS, but as an authorised firm, the issuer would be able to communicate its own financial promotions, without requiring another authorised firm to approve them. The FCA’s Principles for Businesses would also apply to the firm.

To achieve this policy option, the Dame Elizabeth Gloster report recommends that the scope of the MiFID investment service, ‘execution of orders on behalf of clients’, be extended to capture non-transferable securities (given MiFID currently only applies to transferable securities). This would involve extending the scope of onshored MiFID requirements so that the issuance of NTDS would be treated as a MIFID investment service or activity (and thus issuers would be considered MiFID investment firms).

Under the second option, the scope of the Prospectus Regulation would be extended to cover public offers of NTDS. This change would mean any issuer wishing to offer NTDS to the public in the UK would be required to produce a prospectus, which would have to be approved by the FCA before the offer could take place. Potential investors would be able to review the prospectus before deciding whether to invest in the securities being offered.

This consultation closes at midday on 21 July 2021.