On 29 April 2021, the Financial Conduct Authority (“FCA”) published a Discussion Paper DP21/1 concerning the proposed strengthening of the financial promotion rules for high-risk investments and firms approving financial promotions (the “Discussion Paper”). The Discussion Paper relates to:

1. Classification of high-risk investments

Background

At present, the FCA rules relating to financial promotion classify investments into the following categories:

Questions by FCA

The FCA is considering changing these classifications and is seeking views on the following two questions:

Potential arbitrage relating to SISs

The rules for SISs are in place to target and regulate the financial promotion of speculative investments. The FCA states that it considers the use of the proceeds to be the key to the classification of the investment, not the legal structure that is adopted. However, at present, the rules for SISs only apply to debentures and preference shares, which the FCA believes leads to other possible routes for arbitrage.

In this respect, the FCA proposes the following two changes:

RRSs

The Discussion Paper also proposes changes to the definition of an RRS, which is currently as follows:

(a) a government or public security denominated in the currency of the country of its issuer;

(b) any other security which is:

(i) admitted to official listing on an exchange in the UK; or

(ii) regularly traded on or under the rules of such an exchange; or

(iii) regularly traded on or under the rules of a recognised investment exchange or (except in relation to unsolicited real time financial promotions) designated investment exchange;

(c) a newly issued security which can reasonably be expected to fall within (b) when it begins to be traded.”

The FCA has not set out any new definition for an RRS, but it has identified two issues with this definition:

In response to these issues, the FCA proposes to change the definition of RRSs by:

The FCA is also seeking views on how to amend the definition of an RRS in the context of the financial promotion rules and considering whether the focus on liquidity by reference to a list of investment exchanges would be the right way to distinguish securities appropriate for mass-marketing without restrictions to retail investors.

2. Further segmenting the high-risk investments market

The FCA is proposing new rules to:

Strengthening the process for categorising retail investors

At the current time, client classification is often a self-certification process, for example, with the investor confirming that they meet certain criteria. The Discussion Paper outlines the FCA’s view that further obligations should be placed on firms during the categorisation process in order to ensure the accurate categorisation of investors. The FCA proposes that such obligations could include requiring firms to:

The Discussion Paper also proposes that consumers should receive better help to categorise themselves and that this might be done by:

Improving risk warnings

The FCA presents evidence that risk warnings are most successfully heeded by consumers when they are conveyed in a particular manner. Therefore, rather than focusing on the amount of information provided to the consumer, the FCA has suggested the following improvements to the format of risk warnings:

Positive frictions in consumer journeys

The FCA is concerned with striking a balance between allowing investors who have the financial resources to accept higher risk to do so, and ensuring that such investors understand the risk they are taking. The FCA proposes the following measures to create positive friction for consumers investing in higher risk products:

3. The role of an authorised firm that approves a financial promotion

In the Discussion Paper, the FCA considers whether the role of a so-called “section 21 approver” should be changed. The FCA proposes that the scope of the role of a section 21 approver should be widened to include:

Ongoing obligations

At present, a section 21 approver must withdraw its approval if it becomes aware that the financial promotion no longer complies the FCA rules (for example, the financial promotion is no longer fair, clear and not misleading). The FCA proposes that this passive obligation should instead before an active obligation, which wouldrequire the section 21 approver to monitor the financial promotion after approval has been given. The FCA suggests monitoring:

Involvement in client categorisation and appropriateness/suitability assessments

For NMPIs and SISs, a retail investor must be certified as either high net worth or sophisticated and the firm must take reasonable steps to acquaint itself with the investor’s profile and objectives to determine the suitability of NMPIs and SISs for a particular retail investor. Therefore, the FCA states when a section 21 approver approves a financial promotion in relation to an NMPI or a SIS, they should also have the expertise to understand whether an investment is suitable for any given investor.

Furthermore, for NRRSs and P2P agreements, a retail investor must be certified as a high net worth, sophisticated or “restricted” investor and certain rules must be complied with, including determining the appropriateness of NRRSs and P2P agreement for a particular retail investor. Compliance with such rules is often carried out by an automated online system. It is the section 21 approver’s role to ensure that these systems comply with the rules and at present the approver is only required to confirm compliance at the point of approval. Therefore, the FCA proposes that section 21 approvers should be required to confirm the compliance of such automated systems on an ongoing basis.

Next Steps

The FCA welcomes all comments on its proposed changes by 1st July 2021. After this period has elapsed, it will consider the feedback and consult on proposed rule changes later this year.

Co-authored by Isabella Ramsay.