A worrying case reported on last week by Financial Planning Today and widely read will reverberate for some time to come - and not in a good way.

The collapsed investment provider London Capital & Finance, which provided mini-bonds and ISAs, was forced to call in the administrators as it faced up to a financial mess which has hit 14,000 investors with holdings totalling up to £236m.

£236m mini-bond firm goes into administration

I’ll recap the details shortly (and be warned this is a complex story) but it’s worth asking in the first place: why is this story important?

Firms go bust all the time, usually leaving a hefty liability for the Financial Services Compensation Scheme and Financial Planners rolling their eyes once more as they are forced to pick up a chunk of the compensation bill. The answer is the story is important because it highlights a gap in regulation that seems to be getting larger, not smaller.

It involves firms who are partly in and partly outside the financial regulatory system. I cannot quote figures on the number of firms in this ‘grey’ area but it seems to be growing.

There have been a spate of firms recently who have devised ever more complex schemes, often using the new ISA rules on loan-type investments. Many seem to skirt much of the financial regulation in place because their ‘investments’ are marketed as ‘loan-based’ schemes and not ‘investment-based’ schemes.

Retail investors often fail to understand the difference and few understand the risks in putting their money into schemes which are not properly covered by regulation. They are attracted, however, by the promise of ‘loan-backed’ investments which may, superficially, seem inherently safer than stock-market investments.  After all investing in stocks is risky but people have to pay back loans, right?

In the case of LC&F much of what they offered was referred to as ‘mini-bonds’ or loan-backed investments, sometimes inside an ISA.

I’m not going to bash the FCA here. That would be too easy to do and their parameters are clear. There are some financial products that are outside their remit and some within. That’s just how it is. They can’t regulate everything.

LC&F was, in the main, offering investors what they claimed was a solid return of 4% to 11% per annum, using the loan repayments to fund this. HNW and affluent investors looking for more predictable returns were targeted. Many fell for the marketing promise.

These bonds were issued to raise capital for corporate borrowers but crucially they were structured as loans which are generally outside the FCA’s remit.

LC&F did not need to be regulated to issue the mini-bonds but it did need to be authorised by the FCA to promote and market them and was on the FCA register. To those outside the sector this may seem like a bizarre differentiation but it’s not the first time this approach has applied. In essence its marketing was regulated but the products were not, at least not by the FCA.

Somewhere along the way something went wrong at LC&F resulting in the FCA directing LC&F earlier this year to withdraw all its existing marketing material in relation to its Fixed Rate ISAs or bonds. It also ordered the firm to freeze its assets and not touch any money held in its bank accounts, effectively halting the firm’s ability to trade.

Administrators Smith & Williamson will now be sifting through the accounts to try to work our what went wrong and how they can best return funds to customers. Let’s hope most investors get most of their money back.

There is a chance that much of the money is still tied up in business loans and can be returned to investors. If not, there’s a big problem, potentially a £236m problem, the amount invested via the firm.

The worry for LC&F clients will be that because the mini-bonds were not regulated, the Financial Services Compensation Scheme (FSCS) will be unlikely to step in and offer compensation if losses are found.

It remains to be seen what will happen next and Financial Planning Today will bring you further news updates but in the meantime the FCA might want to cast its eye over this area to assess the risks and the dangers to investors.

Kevin O’Donnell is editor of Financial Planning Today and a financial journalist with over 30 years of experience. He previously worked for the Financial Times Group and in daily and weekly newspapers. 

Follow @FPT_Kevin