Regulatory changes for non-advised EIS investors investing for the first time with Mercia EIS

Earlier this month, new rules were introduced by the Financial Conduct Authority (FCA), our regulator, which affect investments in private companies, including EIS.  VCTs are excluded from these regulations as they are more liquid.

The FCA wants to introduce friction in the process of buying these types of investment in order to ensure investors have properly considered the risks.  For new direct investors (not advised), they will be issued with personalised risk warnings, have to complete a multiple-choice questionnaire (MCQ) and we will introduce a 24 hour delay before they can complete an application.  Unlike new direct investors, existing investors, advised and execution only investors can go directly to our application forms.

The new rules are defined in “COBS 10 Annex 1 Assessing appropriateness: non-readily realisable securities”, but some of the important elements are summarise below:

1. As you will be aware, Mercia Fund Management is authorised by the FCA to undertake fund management to make the investment decisions as to what the fund should invest in, and oversee those investments as they succeed or, where applicable, fail. (COBS 10 Annex 1, section 4).
2. As mentioned above, the FCA defines VCTs are being more liquid and therefore out of scope for these regulations. The FCA states that EIS investments (and other illiquid investments) are generally suited to individuals who have their core income and savings needs met and a diversified portfolio.  In addition, clients should have invested in venture capital before, and hence understand the risks, and do not invest more than 10% of their portfolio in such investments. (COBS 10 Annex 1, section 10)
3. As an investor in our EIS fund, you may be eligible to claim on the Financial Services Compensation Scheme (FSCS) and complain to Financial Ombudsman Service (FOS) in relation to our management of the fund. (COBS 10 Annex 1, section 3 and 5).
4. While our approach mitigates many risks, it is important to note that all early stage and growth businesses can fail. If all the businesses the fund invests in fail you would lose all the capital you invested in any businesses that fail (COBS 10 Annex 1, section 2). Please note, there is no leverage in our EIS fund, so investors cannot lose more than invested. If the various tax reliefs are considered, investors  cannot lose more than 61.5% of the underlying investment, as income tax relief and loss relief (for a 45% tax payer) provide 61.5%.  Please note, this excludes the impact of our fees.
5. There are many benefits of investing in EIS, but the shares will not deliver regular dividend payments for those looking for income as well as capital growth, and if this feature is required then an EIS may not be appropriate (COBS 10 Annex 1, section 11). The Northern VCTs do however provide a regular, tax-free dividend, with a target of 5% and a 5-year track record of 8.6% on average – please see here for more detail on our VCT.
6. According to the FCA definitions, the client of Mercia is actually the EIS fund itself. As an investor in the EIS fund, you are not technically our client (although we treat you as one), but we are specifically required to act in the best interests of all of the investors as a collective. (COBS 10 Annex 1, section 1).

Please see the detail of the FCA rules here- COBS 10 Annex 1 Assessing appropriateness: non-readily realisable securities.  If you have any questions on this topic, please get in contact.