Last week the Financial Conduct Authority (FCA), the financial services regulator, announced that it was finally cracking down on mini-bonds. As of January 2020, they will no longer be marketed to retail investors.
A mini-bond is a form of debt security. You lend your money to a company in return for a high regular income, while you will get your original stake back when the bond matures. The interest rate is typically around 8%.
But a high return implies high risk. Companies don't have to be authorised by the FCA to issue mini-bonds and the products are unregulated. Mini-bonds can't be traded, so once you've invested your money is locked away until maturity. If the company goes bust during that time, you may not get your money back. In January London Capital & Finance (LCF) went bust after collecting £237m from almost 12,000 investors, who may now lose their savings.
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Too little, too late?
While it is good news that the FCA is taking action to curb the mini-bond market, it isn't going to protect everyone from investing in these very high-risk products. The ban only covers "mini-bonds designed to raise funds that are lent on to third parties, invested in other companies, or used to develop property", says Robert Smith in the Financial Times. "It is not banning mini-bonds entirely." Firms using them to fund their own operations will be exempt. So, the notorious "burrito bond" marketed by Mexican restaurant chain Chilango earlier this year would still be allowed. That attracted £3.7m in investments after offering investors free burritos. Today Chilango is facing financial problems.
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The key issue with mini-bonds is that companies are increasingly marketing them at ordinary investors. "The businesses involved would typically face short shrift from professional fixed-income investors because of their dubious cash flows or weak asset bases," says Smith. But inexperienced investors see a rate of return far above what they can get from their bank. Along with the word bond, which is usually associated with a relatively safe investment, that makes them appealing. Note too that the FCA ban only applies to regulated firms, so "investors still need to be on their guard for scams and be wary of anything that looks too good to be true", says Jonathan Jones in The Daily Telegraph.
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