Liz Coyle: Social working?
The regulator has confirmed it wants to see the market for social investment develop in a way that provides appropriate consumer protection. Liz Coyle takes a close look at what this could mean for advisers.
This time last year, the Financial Conduct Authority (FCA) issued a Call for Input, with a view to exploring whether there were regulatory barriers holding up the development of the market for ‘social investments'. It recently published its Feedback Statement FS16/11.
Social investing is a ‘niche market' at present, and the views of all stakeholders were sought - in particular those of social enterprises themselves, financial advisers and other intermediaries (including crowdfunding platforms), together with those of consumers and consumer groups.
For those who are currently not involved, but would like to understand this market better, ‘social investment' is a broad concept that combines the idea an investment can have a social ‘impact' or ‘return' as well as some form of financial return.
This social impact or return is usually focused on a specific issue, geographic area or part of the population. This is usually achieved by investing in enterprises that have a specific social objective as their primary goal.
Social investments can be made in a range of ways, including:
- directly in companies that are set up to achieve specific social objectives;
- by using collective investment schemes that pool investors' money and then invest in a range of companies aiming to achieve social impact; or
- via social impact bonds that aim to provide a specific service in return for a financial return if set levels of social impact are met.
The FCA is very clear all of these routes to social investment involve risk to investors' capital, and the expected social impact may not be achieved, so there may be no social or financial return on capital.
There is the very real risk the social enterprises invested in may prove to be unviable and fail, particularly as enterprises targeting social outcomes often share a number of characteristics with early stage ‘start-up' companies. As a consequence, there is a high risk some or all of an investors' initial capital may not be returned.
Taking these factors into account, it is helpful to look on social impact investing as a form of venture capital, in a non-standard investment.
The role of the FCA in this sector is the same as for any other area where such investments are offered to consumers. It aims to ensure consumers are protected, and to maintain the integrity of the market.
As this form of investment is ‘non-standard' and may represent a higher risk than more conventional investments - such as direct or collective holdings in shares - it is important all communications to potential investors are clear, fair and not misleading when it comes to explaining financial risks.
These are determined as complex, non-standard investments, and so it is important an appropriate level of advice or disclosure is given on the financial risks inherent in making the investment. Many of these investments will be subject to the requirements of the Markets in Financial Instruments Directive.
The jurisdiction of the Financial Ombudsman Service (FOS) to deal with complaints relating to the delivery of a social impact has been raised as a concern among advisers, and the risk the adviser might become subject to a complaint to the FOS over social outcomes could be difficult to predict or measure.
Regulated firms operating in this market are expected to consider the target market for social investments and consider appropriate distribution strategies to avoid consumer harm. The FCA has carried out this work in the context of the existing UK and EU regulatory framework. It remains under review as a result of the UK's vote to leave the EU and any consequential amendments that may follow.
The FCA wants to see the market for social investment develop in a way that provides appropriate consumer protection and is sympathetic to the philanthropic motives shared by those who choose to invest in an investment because of its social purpose. It is in this way that the FCA approached the Call for Input - it sees understanding the client as critical.
Key questions to consider include:
- Is the client's interest in the social impact only?
- Can they afford to lose all of their investment?
- Are they hoping for returns, but is the primary objective social?
- Are they looking for returns with the social impact being a secondary objective?
Time is needed to understand the market and to advise clients appropriately and the FCA sees nothing in the regulatory framework that prevents advisers from doing so. The FCA will work with the FOS to clarify for advisers - and their PI insurers - the type of complaints they may consider and how they will be approached.
Liz Coyle is compliance policy manager at SimplyBiz Group