In a document released this week the Financial Conduct Authority (FCA) has warned that many promotions for investments via crowdfunding websites, including mini-bonds, provide insufficient warning of the risks to investors.
The crowdfunding review took place between April and October 2014 and included 25 websites for both loan-based and investment-based platforms. It assessed the sites against the financial promotion rules and “the requirement to be fair, clear and not misleading”.
Common issues identified in the investment-based platforms were:
• A lack of balance, where many benefits are emphasised without a prominent indication of risks.
• Insufficient, omitted or the cherry-picking of information, leading to a potentially misleading or unrealistically optimistic impression of the investment.
• The downplaying of important information. For example, risk warnings being diminished by claims that no capital had been lost or the relevant risk warnings being less prominent than performance information.
The FCA explained: “This is of particular concern for us given that 62% of equity crowdfunding investors surveyed by Nesta and the University of Cambridge (Nesta 2014) described themselves as retail investors with no previous investment experience of early stage or venture capital investment. Firms need to provide investors with appropriate information, in a comprehensive form, so that they are reasonably able to understand the nature and risks of the investment and, consequently, to make investment decisions on an informed basis.”
The FCA also warned specifically about mini-bond promotions.
A mini-bond is a type of debt security, typically issued by relatively small businesses, such as Hotel Chocolat or coffee shop chain Taylor St Baristas. They typically run for around three to five years, in general, and offer an interest rate of between 6% and 8% a year.
However, mini-bonds are illiquid and can be high risk, as the failure rate of small businesses is high. Moreover, there is no protection from the Financial Services Compensation Scheme (FSCS) if the issuer fails.
The FCA expressed the following concerns:
“• Firms are failing to make clear that mini-bonds are investments that place investors’ capital at risk, and are not deposit-based or capital-protected products. While the returns on mini-bonds can appear competitive in the current low interest environment, it is misleading to compare their interest rates with those obtainable from savings accounts where investors’ capital is not at risk.
• It is important that the promotion is balanced; in particular, the risks to capital and the lack of FSCS cover should be highlighted.
• Comparisons are sometimes made to retail bonds (such as corporate bonds listed on the stock market) but there are important differences. For example, mini-bonds are generally not traded, so investors’ money is effectively locked in until maturity as the mini-bond cannot be sold on before the end of its term. This should be made clear to prospective investors.
• Where a firm is asked to approve a financial promotion on behalf of an unauthorised firm, the firm must satisfy itself that the financial promotion is fair, clear and not misleading. It must not approve the promotion if it does not comply with our rules.”