UPDATE 2-UK watchdog, when led by BoE chief, failed on fund collapse - report

* BoE Governor Bailey apologises for LCF collapse

* Government to open compensation scheme for bondholders

* FCA says sorry for errors in handling LCF

* FCA executives to forgo bonuses after critical report (Adds Bank of England reaction, more detail)

LONDON, Dec 17 (Reuters) - Bank of England Governor Andrew Bailey came under fire on Thursday after an independent report said Britain’s markets watchdog, which he led at the time, had failed to supervise a fund properly before its collapse last year.

The demise of London Capital & Finance (LCF) left 11,600 investors in mini-bonds facing losses of up to 237 million pounds ($322 million).

Former high court judge Elizabeth Gloster said the Financial Conduct Authority’s (FCA) failure was due to “significant gaps and weaknesses” in its practices and policies.

“The investigation has concluded that the FCA did not discharge its functions in respect of LCF in a manner which enabled it effectively to fulfil its statutory objectives,” the report said.

LCF was regulated by the FCA, but the mini-bonds it sold to raise funds for small companies, were not, leaving the bulk of investors with no recourse to compensation so far.

The report said the FCA’s “flawed approach” to where the regulatory perimeter lay meant LCF was able to use its FCA-regulated status to present an “unjustified imprimatur of respectability to the market, even in relation to its non-regulated bond business”.

“Responsibility for the failure in respect of the FCA’s approach to its perimeter rests with the executive committee and Mr Bailey,” the report said.

Bailey apologised to LCF bondholders, saying that when he was CEO of the FCA between 2016 and 2020, the regulator began a substantial reform of how it supervises firms, which required changes in culture, mind-set and systems.

“I am sorry those changes did not come in time for LC&F bondholders,” Bailey said in a statement.

Britain’s finance ministry said it would set up a compensation scheme for LCF bondholders, and assess if there can be one-off compensation payments for some bondholders.

The bondholders have taken the Financial Services Compensation Scheme (FSCS) to court after it rejected most claims. The FSCS said on Thursday it would issue an update once it had discussed the finance ministry’s statement with the ministry and the FCA.

“We are very sorry for the errors we made in our handling of this case,” the FCA said. The watchdog’s new chief executive Nikhil Rathi said the report made “sobering reading” and he was committed to implementing its nine recommendations.

“We know that the FCA must make faster and more effective decisions, prioritise the right outcomes for consumers, markets and firms, and reform our approach to intelligence and information sharing,” Rathi said.

The FCA said bonuses for its executive committee members for the 2019/20 financial year, which had been deferred, would not be paid.

Ahead of the report, the FCA made a temporary ban on selling mini-bonds to retail investors permanent from January.

Britain’s Serious Fraud Office has opened an investigation into LCF. (Editing by William Schomberg and Mark Potter)