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The FCA’s proposed rules around promoting what it considers ‘high risk’ investments will have considerable implications on marketing activity in financial services. Given the new rules are likely to come into effect later this year it’s important to consider now whether your products are in scope and what changes you might need to plan for.
Since the mini-bond scandal in 2019, the FCA has taken steps aimed at reducing harm in the retail investments market. Given the increasing numbers of retail customers investing in more high-risk products, with sometimes devasting effects, there is no doubt that action was needed. But some of the ideas proposed in the regulator’s Discussion Paper last year raised concerns that the promotion of most venture capital funds would be more difficult and that ultimately the proposed rule changes could hinder early-stage investment in an already challenging economic climate.
The FCA have now followed up on the Discussion Paper by opening the formal consultation: CP22/2 Strengthening our financial promotion rules for high risk investments, including cryptoassets. While some of the arguably more onerous requirements first suggested have failed to make it into the proposed rules, what has made it in will still capture firms’ attention and have considerable implications on their marketing processes.
Two new acronyms – the introduction of RMMI & NMMI
The FCA have recognised the difficulty of navigating the current financial promotions rules and are seeking to simply this by proposing two new categories of products:
Restricted Mass Market Investments (RMMI)
This category will include:
- Non-Readily Realisable Securities (NRRS), such as shares or bonds that are not listed on an exchange
- A P2P agreement/portfolio
- A qualifying cryptoasset.
It’s interesting to note that including cryptoassets within the scope of these rules forms part of a significant shift in the approach of UK regulators to cryptoassets and will be the first ‘conduct of business’ regulation of these types of investments, which have historically been unregulated.
Non-Mass Market Investments (NMMI)
This category will include:
- Non-Mainstream Pooled Investments (NMPI), for example investment funds structured as Limited Partnerships
- Speculative Illiquid Securities (SIS), for example mini-bonds.
A key proposal in the initial Discussion Paper which caused concern was the idea that promotions of funds such as (S)EIS, where the underlying assets are shares in companies with no track record, could be subject to the SIS rules. This would be a significant change as the SIS rules are more onerous than the current NRRS rules and would require, for example, a ‘preliminary assessment of suitability’ on retail clients before the product could be promoted. Importantly, as a result of the feedback to the Discussion Paper, the FCA confirms that it has decided not to pursue its proposals to expand the rules on SIS to include equity shares with similar characteristics. However, any sigh of relief may be short-lived as the FCA have stated it will revisit this issue later in the year and stress that it believes, no matter the legal form, complex and hard to understand investments should not be marketed to retail consumers.
Banning inducements to invest
The rules proposed in the Consultation Paper prohibit financial promotions of RMMIs and NMMIs from containing any monetary or non-monetary benefits. For example, ‘refer a friend’ bonuses will be banned. The key harm the FCA is seeking to prevent through this proposal is the false assumption by some investors that an investment is safe and credible because it is recommended by someone they know. Other types of inducements to invest will also be caught by the ban, including the offering of free gifts and ‘early bird discounts’ schemes where investors are offered reduced fees for investing during a particular offer window.
Improving risk warnings
There is a concern that investors are not appropriately engaging with risk warnings and often view them as ‘white noise’. The FCA picks out the commonly used warning that ‘your capital is at risk’ as an example of the type of language investors typically ignore. Aiming to remedy this, the FCA has considered the findings of extensive research and behavioural testing and propose the following risk warning be present and prominent in all financial promotions for RMMIs and NMMIs:
“Don’t invest unless you’re prepared to lose all your money invested. This is a high‑risk investment. You could lose all the money you invest and are unlikely to be protected if something goes wrong. Take 2min to learn more.”
When clicking on the link in the risk warning, the investor should be presented with a pop-up box containing further product-specific risk information. Where these promotions are not made digitally, this further risk information must be provided in a ‘durable medium’.
Positive friction in consumer journeys
The FCA are introducing ‘positive friction’ in the consumer journey, the principal aim being to prevent harm caused by consumers simply ‘clicking through’ and accessing high‑risk investments they do not understand and do not match their risk appetite.
Several possible frictions in the consumer journey were discussed, however the FCA have landed on two:
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Personalised risk warning pop-ups
Firms will need to present consumers investing in a RMMI or NMMI with them for the first time with a personalised risk warning pop-up. The warning should read:
“[Client name], this is a high‑risk investment. How would you feel if you lost the money you’re about to invest? Take 2min to learn more.”
The ‘take 2min to learn more’ wording would again need to link to product-specific risk summaries.
For RMMIs, this warning will need to appear before the Direct Offer Financial Promotion (the promotion further along the customer journey which specifies the manner of response or includes an application form to invest).
For NMMIs, this warning would need to appear before any financial promotion could be communicated.
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24-hour cooling off period for first time investors
Firms will be required to impose a minimum 24-hour cooling off period between a consumer receiving the personalised risk warning pop up and investing in a RMMI or NMMI.
Importantly, this cooling off period will only apply to first time investors with the firm and the FCA have said these rules should, therefore, not negatively affect those repeat investors for whom the investment is appropriate. However, firms will likely be more sceptical. Likely concerns could be on the impact of this rule on more experienced investors who may just want to get on and invest, and who could view these delays as more negative than ‘positive’.
Some alternate frictions that were suggested but which did not make it into the proposed rules included requiring SMS confirmations before investments are made and requiring consumers to watch ‘just in time’ educational videos. Given the work that would have been involved in implementing these requirements, we suspect their absence in the Consultation Paper will be met positively by firms.
HNWI, self-certified and restricted investor certificates
The FCA is concerned that too many consumers are incorrectly self-certifying themselves as high net worth or sophisticated and do not understand the impact of their categorisation. As a result, it is proposing to implement an evidence declaration requirement where consumers will be required to state why they meet the relevant criteria of a specific investor category. For example, consumers will be required to state their income to demonstrate they are high net worth.
Like much of the Consultation Paper, this proposal is backed by the findings of behavioural testing. For instance, the FCA found that the introduction of evidence declaration requirements resulted in a 36% reduction in self-certification. Reducing the rates of self-certification is clearly a key aim and the FCA have stated that even with the changes proposed in this Consultation Paper it “still believe[s] that self-certification is fundamentally not the right approach” and further changes may be necessary. Such changes are likely related to the Treasury’s current review: Financial promotion exemptions for high net worth individuals and sophisticated investors. Amongst other things, the Treasury’s consultation (which runs until 9 March 2022) proposes a requirement for firms to have a ‘reasonable belief’ than an individual meets the criteria of an exemption, not simply that they have signed a relevant statement, as is the case now.
More robust appropriateness tests
Non-advised consumers wishing to invest in NRRS / P2P (or RMMIs under the proposed rules) are required to demonstrate adequate knowledge and experience in the relevant investment field before they can invest. This appropriateness test is therefore a key consumer protection tool which, when used correctly, operates as a gateway to prevent consumers for whom a product or service is not appropriate from investing.
However, significant weaknesses in the FCA’s current rules have been identified and even exploited by bad actors in the market. For example, the FCA have seen cases of consumers being coached through the assessment in order to ‘pass’.
The changes proposed to the appropriateness test rules include:
- To strengthen the appropriateness test questions, the FCA will issue guidance on the types of questions to be covered, similar to the current P2P guidance. As part of this, binary yes/no questions will be discouraged, as will questions with any kind of binary choice between answers.
- The FCA will look to restrict the ease of re-taking the test by introducing a minimum time period between a consumer ‘failing’ the appropriateness test and the firm re-assessing appropriateness. The FCA are proposing a minimum of 24 hours but state that firms should consider increasing this where the products offered are higher risk or more complex.
- Where a consumer ‘fails’ the assessment and opts to re-take, firms will be required to ask different questions. This is intended to encourage consumers to do further research rather than passing through trial and error.
Record keeping obligations
An easily overlooked, but arguably more onerous, element of the rules proposed in the Consultation Paper are those relating to record-keeping. The FCA expect firms to record and be able to reproduce on request various data items that will demonstrate the effectiveness of the proposals.
For example, the specific metrics firms will be required to record include:
- The number of users who are presented with the risk warnings (standard and personalised), and the number of users that click on the link to ‘take 2min to learn’
- The number of consumers who do not proceed with the consumer journey after the personalised risk warning
- The number of consumers that are subject to the 24hour cooling off period, and the number of consumers who do not proceed with the consumer journey after the 24hour cooling off period
- The outcome of client categorisation (the number of consumers categorised as HNW, sophisticated and restricted and the reasons why the firm believe they meet the category).
The granularity of this data may pose significant operational challenges and IT changes will likely be required to adequately capture the data needed to comply.
Role and responsibilities of approvers of financial promotions
The FCA wants to see more responsibility placed on firms that approve financial promotions for unauthorised persons. This is due to concerns around the quality of financial promotions that the FCA has seen in the past that have been approved by authorised firms for unauthorised persons. They key requirements proposed include the following;
- A requirement to include a date stamp for approved promotions
- New competence and expertise requirements for firms issuing/approving promotions where firms will be required to self-assess the competence and expertise of staff involved in approving the financial promotion
- The FCA will introduce a new Financial Promotion Requirement (FPR) which will appear on the FCA Register and will, by default, prohibit firms from approving financial promotions for unauthorised persons other than group entities and Appointed Representatives. Firms who want to have this requirement lifted will need to apply for a variation/cancellation of the FPR
- The FCA propose imposing stringent ongoing monitoring requirements intended to move away from a ‘once and done’ approach to approvals. Under the new rules, approvers will be required to collect attestations of ‘no material change’ from clients they have approved financial promotions for every 3 months. Where these attestations are not provided, firms will be required to consider withdrawing their approval.
What next?
The deadline for responding to the consultation paper is 23 March 2022 and the FCA expect to publish final rules in the summer, after which firms will have 3 months to comply.
In the meantime, and given the likelihood of these rules being implemented with few material changes, we would suggest firms take the following steps now:
- Assess the products you offer and determine how they will be categorised under the new classification system
- Start planning for the required changes to your marketing, for example by identifying material in need of updates and drafting clear product-specific risk summaries
- Engage with IT to assess the impact of the changes and plan for implementation.
We can help
Our team of regulatory experts can help you understand how these rules may apply to you and assess what changes you need to make to meet the new requirements. We can also help with ongoing compliance support including advice and training on financial promotions.
