Her Majesty’s Revenue and Customs will incur new expenditure in connection with the Government’s response to the covid-19 pandemic in 2021-22.
Parliamentary approval for additional resources of £6,065,000,000 for this new expenditure will be sought in a main estimate for Her Majesty’s Revenue and Customs. Pending that approval, urgent expenditure estimated at £6,065,000,000 will be met by repayable cash advances from the Contingencies Fund.
Further requests to the Contingencies Fund may be made as necessary to fund covid-19 activity delivered by Her Majesty’s Revenue and Customs.
On 17 December 2020, I announced that the Treasury would set up a compensation scheme for bondholders who suffered losses after investing in London Capital & Finance (LCF) (HCWS678)[1]. This statement provides an update on the Government’s approach, including the details of the scheme and the next steps for bondholders.
LCF was a Financial Conduct Authority (FCA) authorised firm which issued unregulated non-transferable debt securities, commonly known as “mini-bonds”, to investors and then speculatively invested the funds received in a number of underlying businesses. LCF went into administration in January 2019 and at the point of failure 11,625 bondholders had invested around £237 million.
This has been a very difficult time for LCF bondholders, many of whom are elderly and have lost their hard-earned savings. As I noted in my last statement, for some, this will have formed part of an investment portfolio, but for others, it will have represented a significant portion of their savings.
One of the key purposes of regulation is to ensure that investors have the right information to understand their risk. Within this system even a regulator doing everything right will not be able to, and should not be expected to, ensure a zero-failure regime. That is why statute has established the Financial Services Compensation Scheme (FSCS), which is the compensation scheme for customers of failed financial services firms in the UK. Its scope is strictly limited and it is only able to pay out when a relevant regulated activity has been undertaken. The FSCS has considered LCF claims in detail and has been able to protect around 2,800 bondholders, paying out over £57 million in compensation.
In November last year, I asked Lord Hill of Oareford CBE to carry out an independent review of the UK’s listing arrangements. Strong public markets are a vital component of the UK economy and the Government are committed to ensuring that the UK’s markets are as competitive as possible, and to supporting the many different companies that use markets to raise capital, including technology firms as mentioned in Lord Hill’s report.
At Budget last month, Lord Hill published his UK listing review1. It made 14 recommendations. Today, I am pleased to set out how the Government intend to take forward each of the recommendations made.
Seven of the recommendations are directed towards the Financial Conduct Authority (FCA), our independent regulator. As the FCA set out in its public response on 3 March, it welcomes the report and intends to consider all the relevant recommendations carefully, including on free float, dual class share structures, and special purpose acquisition companies (SPACs). It has committed to acting quickly where appropriate, including by publishing a consultation by the summer, and a specific consultation on SPACs before that.
Six key recommendations are directed towards HM Treasury (HMT), and I outline how we will be taking forward each recommendation, in turn, below.
First, I agree to present an annual “State of the City” report to Parliament (recommendation 1). I am grateful for the suggestions provided as to what this report could cover, and I believe this would benefit the UK’s capital markets. I will present the first of these reports in 2022.
Lord Hill recommended that HMT considers an additional “growth” or “competitiveness” objective for the FCA, as part of the future regulatory framework (FRF) review (recommendation 2). The first consultation on the FRF review closed on 19 February. This review seeks to ensure the UK’s regulatory framework is fit for our future outside the EU and the first consultation welcomed stakeholder views on the current set of statutory objectives. It also sought views on the future overall accountability framework for the FCA (and PRA). The Government are currently considering the 120 stakeholder responses received in relation to this consultation and will use these to inform a second consultation later this year. I will carefully consider this recommendation as part of that process.
It is an important point of principle that Government do not step in to pay compensation in respect of failed financial services firms that fall outside the FSCS. Doing so would create the wrong set of incentives for individuals and an unnecessary burden on the taxpayer. However, the situation regarding LCF is unique and exceptional. After considering the issues in detail, the Government have decided to establish a compensation scheme for LCF bondholders. The scheme I am announcing today appropriately balances the interests of both bondholders and the taxpayer and will ensure that all LCF bondholders receive a fair level of compensation in respect of the financial loss they have suffered.
LCF’s business model was highly unusual, both in its scale and structure. In particular, it was authorised by the FCA despite generating no income from regulated activities. This allowed LCF’s unregulated activity of selling mini-bonds to benefit from the “halo effect” of being issued by an authorised firm, helping LCF gain respectability and grow to an unprecedented scale before it failed, resulting in losses for thousands of bondholders.
A complex range of interconnected factors contributed to the scale of losses for LCF bondholders. Clearly individuals have responsibility for choosing investments that are suitable for their risk profile. The high interest rates on offer from LCF, particularly when compared with deposit accounts, should have prompted questions from potential bondholders about the risks. While some may have understood those risks and invested anyway, LCF’s disclosure materials and marketing strategy may have led others to believe they were investing in a product that was far safer than it was.
Bondholders have reported LCF using a range of dishonest tactics to persuade them to invest. For example, some novice investors have said they were encouraged to declare themselves to be sophisticated and experienced, thereby enabling them to access products that should have been out of reach. Furthermore, LCF appears to have adopted flawed investment and marketing strategies and paid high commissions of up to 25% to the sales agent.
Bondholders have been badly let down by LCF, but they have also been let down by the regulatory system that is designed to protect them. The independent investigation led by Dame Elizabeth Gloster[2], which the Government published at the end of last year, concluded that the FCA did not discharge its functions in respect of LCF in a manner which enabled it to effectively fulfil its statutory objectives during the relevant period.
While I have not seen evidence that would indicate that the regulatory failings at the FCA were the primary cause of the losses incurred by LCF bondholders, they are a significant factor that the Government have taken into account when deciding to establish this scheme. Indeed, the Government do not ordinarily step in to pay compensation to consumers in relation to allegations of fraud, investment losses, mis-selling or mis-buying of investments. I would, however, like to make it clear that neither the Government nor the FCA accept any legal liability for the failure of LCF or the losses incurred by its bondholders.
In these extraordinary circumstances, the Government have decided to establish a compensation scheme. However, it is imperative to avoid creating the misconception that Government will stand behind bad investments in future, even where FSCS protection does not apply. That would create a moral hazard for investors and potentially lead individuals to choose unsuitable investments, thinking the Government will provide compensation if things go wrong. The ultimate responsibility for choosing suitable investments must remain with individuals.
To avoid creating this misconception, and to take into account the wide range of factors that contributed to the losses that Government would not ordinarily compensate for, the Government will establish a scheme that provides 80% of LCF bondholders’ initial investment up to a maximum of £68,000. Where bondholders have received interest payments from LCF or distributions from the administrators, Smith & Williamson, these will be deducted from the amount of compensation payable. The scheme will be available to all LCF bondholders who have not already received compensation from the FSCS and represents 80% of the compensation they would have received had they been eligible for FSCS protection.
Around 97% of all LCF bondholders invested less than £85,000 and therefore will not reach the compensation cap under either the Government scheme or the FSCS. The Government expect to pay out around £120 million in compensation in total and the scheme to have paid all bondholders within six months of securing the necessary primary legislation, which the Government will bring forward as soon as parliamentary time allows.
Bondholders do not need to do anything at this stage and Government will provide further details on how the scheme will operate in due course. The scheme will be simple and straightforward to navigate. Bondholders will not need to use a claims management company, solicitor or any other organisation to help them claim.
I am mindful that some individuals may be anxious to receive their compensation and I urge bondholders to be vigilant to the risk of scammers posing as services to help them claim. To reiterate, the scheme has not opened yet and bondholders should await further announcements from the Government on next steps.
One of the challenges highlighted by Dame Elizabeth Gloster’s report is that, despite exhibiting many of the characteristics of other regulated financial services activities, the issuance of mini-bonds is not currently a regulated activity. The Government are committed to ensuring the financial services sector is well regulated and consumers are adequately protected, and the Treasury is therefore today launching a consultation on proposals to bring the issuance of mini-bonds into FCA regulation. This consultation is the culmination of a review into the regulation of mini-bonds that I announced in May 2019 and delivers on one of the recommendations made in Dame Elizabeth Gloster’s report.
In addition, the FCA is continuing its work to address the recommendations in Dame Elizabeth Gloster’s report, including through its ongoing transformation programme. A number of important steps have already been taken and I welcome the FCA’s commitment to report publicly on the progress of these vital reforms.
Finally, I wish to reiterate my sympathy for LCF bondholders. I hope the compensation offered by the Government scheme will offer some relief to the distress and hardship suffered and provide closure on this difficult matter.
Three of the recommendations, on reviewing the UK’s prospectus regime (recommendation 7), considering whether prospectuses drawn up under other jurisdictions’ rules can be used to facilitate secondary listings in the UK (recommendation 8) and facilitating the provision of forward-looking information by issuers in prospectuses (recommendation 9), all deal with the UK’s prospectus regime. Again, I strongly welcome this, and agree we need to consider reforms to ensure these documents are fit for purpose. I can confirm that the Government will bring forward a public consultation on the UK’s prospectus regime later this year.
Lord Hill also raised the issue of improving the efficiency of further capital raising by listed companies (recommendation 13). This is a highly technical area, and I agree that bringing together expertise specifically on this issue will be helpful to consider what more can be done to improve capital raising processes and I am happy to help convene such a group. My officials will be considering what form this will take over the coming weeks.
One of the recommendations, concerning how technology can be used to improve retail investor involvement in corporate actions and their undertaking of an appropriate stewardship role, is directed towards the Department for Business, Energy and Industrial Strategy (BEIS). As such, this recommendation will be taken forward by BEIS as part of its wider consideration of the findings from the Law Commission’s recent scoping study on intermediated securities. BEIS expects to announce a response to the study later this year.
Finally, Lord Hill concluded by drawing the Government’s attention to other issues raised with the review illustrating how the wider financial ecosystem may impact UK listings. I would like to thank Lord Hill for bringing these issues to my attention.
I would like to conclude by again thanking Lord Hill for his work, and I look forward to taking forward his recommendations.