Introduction

The FCA’s is considering what changes it should make to its financial promotion rules to help retail investors make more effective decisions (see DP21/1).

The FCA’s proposals are unsurprising given the harm seen recently in the retail investment market, for example, the losses suffered by investors following the collapse of London Capital and Finance, mass-marketing of high risk products which are unsuitable, and abuse of the financial promotions exemptions by unauthorised firms.

Although the FCA recognises that higher‑risk investments can have a place in a well‑functioning consumer investment market for those consumers who understand the risks and who can absorb potential losses, they have put forward proposals which could have a significant impact on the business models for certain firms. The FCA proposals have the potential to make the customer investment journey (particularly where it is online) burdensome and potentially unattractive to investors.

Firms that approve financial promotions for unauthorised persons should also expect enhanced regulatory obligations.

Next steps

The consultation closed on 1 July 2021. The FCA intends to test its proposals using behavioural research to obtain better insight on the effectiveness of the measures. The FCA plans to consult on rule changes later this year.

The FCA will also publish a full response to the call for input, together with the next steps in its wider consumer investment strategy and a second summary of its work to tackle harm in the consumer investment market.

The proposals relating to the FCA ‘gateway’ for authorised firms that approve financial promotions for communication by unauthorised persons (section 21 approvers) will require a change in legislation. We understand that the Government intends to bring forward the relevant legislation when parliamentary time allows. The FCA has also said that it intends to consult on its proposals for implementing the gateway in due course.

What is a financial promotion?

A financial promotion is an invitation or inducement to engage in investment activity that is communicated by way of business.

There are three ways to communicate a financial promotion:

  1. Authorised firms can communicate their own financial promotions but must comply with the FCA rules, for example the overarching fair clear and not misleading requirement, and the restrictions set out in COBS 4, in particular COBS 4.7 (direct offer promotions of non-readily realisable securities (NRRS) and P2P agreements), COBS 4.12 (promotions of non-mainstream pooled investments (NMPIs), and COBS 4.14 (promotions of speculative illiquid securities (SISs). Broadly speaking, more restrictions apply to high-risk products.
  2. Authorised firms can approve financial promotions for communication by unauthorised persons. The FCA rules noted above apply to the authorised firm. The FCA reminded firms that there is (currently) an expectation that the approver is heavily involved beyond the financial promotion for an NMPI or SIS as it has responsibility for ensuring compliance with COBS 4, including ensuring, where applicable, that the product is appropriate for each investor.
  3. Unauthorised persons can communicate financial promotions without any approval if they comply with the conditions of an exemption in the Financial Promotions Order, e.g. to a High Net worth Investor (HNWI) or sophisticated investor. The FCA proposals do not cover financial promotions by unauthorised persons under the financial promotion exemptions – this is outside the remit of the FCA and so government intervention is required. The Government in its consultation on the “Regulatory Framework for Approval of Financial Promotions”; noted that it will continue to keep the legislative framework underpinning the regulation of financial promotions under review.

The FCA proposals

Changes to the way investments are currently classified

The FCA is exploring the following:

  • Including equity shares as a type of security that can be a SIS alongside debentures and preference shares (so that they cannot be mass-marketed).

    The FCA has in the past seen some structures which involve ordinary shares issued to raise capital for speculative purposes, with a focus on attractive returns and the implication that they are secure or asset-backed. The FCA is also concerned that ordinary shares could offer an easy arbitrage for issuers seeking to raise funds for highly risky and opaque activities that are more akin to unregulated collective investment schemes but which are structured to remain outside the definition of an NMPI. The FCA plans to target equity shares issued for on‑lending, buying or acquiring investments or buying or funding the development of property, but has asked for views on whether there are any other features of investments which may make them inappropriate for retail investors.

  • Whether existing requirements for P2P platforms adequately protect retail investors from the risks of P2P agreements which share features with SISs (or should mass marketing of these products also be banned).

The FCA is also proposing to make changes to the definition of readily realisable securities (RRS) – currently these include government-issued securities and UK/EEA listed securities. The FCA said that it no longer considers it appropriate to treat EEA exchanges differently to exchanges in other third countries (e.g. the US) and so is proposing to remove “or EEA State” from the definition of RRS for the purposes of its financial promotion rules. The FCA also wants to remove any fixed income securities traded on an exchange regulated MTF from the definition.

Strengthening the process for categorising retail investors

The FCA noted that there are several changes it could make to strengthen the process for categorising retail investors (as HNWIs etc.), for example, it could require firms to:

  • take reasonable steps to independently verify that a retail investor meets the relevant requirements to be characterised as a HNWI or sophisticated investor– previous arguments that checking payslips or bank statements being too onerous or intrusive are likely to be rejected by the FCA, who countered that the development of Open Banking and Open Finance technologies reduce the burden of verification;
  • have grounds to reasonably believe that an investor meets the relevant requirements (and to document those grounds);
  • have regard to any information that they hold about the relevant individual from other interactions, or collected as part of the appropriateness or preliminary suitability assessment, when considering whether to question a declaration; and/or
  • to question or verify declarations where there are certain ‘red flags’, for example where an investor attempts to invest an amount over a certain threshold.

Possible ways suggested by the FCA to help consumers better categorise themselves include the following:

  • Clearer and more prominent risk warnings at the point when the investor makes the declaration.
  • Designing the clearer risk warning to directly address social and emotional drivers of investment choice that may induce people to make an incorrect declaration (to address harms caused where investors are coached into saying the right things to satisfy the relevant criteria).
  • Making other changes to make customers make an active choice, e.g. banning the use of pre-ticked boxes; changing the format of the declaration; introducing positive frictions into the declaration process to encourage reflection and more mindful interaction.

The FCA is also considering how other positive frictions could be added to the consumer journey in response to a financial promotion and how it could help further segment high risk investments from the mass market – to stop a consumer from simply ‘clicking through’ and accessing high risk investments.

The ideas considered by the FCA include deposit collection and introducing cooling-off periods, for example by requiring SMS confirmations before investments are made. More burdensome ideas include requiring consumers to watch education videos or pass an online test before investing.

Improving risk warnings

The FCA considers that although risk warnings alone cannot address the challenges identified, there is a role for a clear, prominent and concise risk warning and that more can be done to help consumers engage with them. Behavioural experiments run by the FCA alongside Warwick Business School on the relative effect of the standard “Your capital is at risk warning” against the standardised risk warning for SIS products showed that the SIS risk warning improved investors’ comprehension of the risks of investing in speculative mini‑bonds.

The FCA has asked for views on whether the SIS risk warnings should be applied more broadly. The FCA is also keen to explore whether visual‑based risk warnings could help influence consumer behaviour.

Enhancing requirements on “section 21 approvers”

In addition to the FCA ‘gateway’ for approval of financial promotions (see related developments below), the FCA is considering whether it should include more prescriptive requirements for ‘section 21 approvers’ to actively monitor a financial promotion after approval, so that they are in a better position to assess whether it needs to withdraw its approval at any time.

Specific ongoing monitoring requirements suggested include requiring firms to check the following:

  • Whether any amendments made to a promotion would require it to be re-approved.
  • Whether there has been any changes that may affect whether the promotion continues to be fair, clear and not misleading, e.g. changes in matters covered by the due diligence on the issuer/investment, reconsideration of the ongoing viability of the proposition described in the promotion, or whether the advertised rates of return continue to be reasonably achievable.
  • Whether the funds raised are being used for the purposes described in the financial promotion.
  • Whether relevant requirements, including the new requirements that the FCA introduce, are being followed.

As noted above, the FCA expects a ‘section 21 approver’ to be heavily involved in the investment process for an NMPI or SIS. However, the FCA considers that more could be done in relation to approval of direct offer financial promotions of NRRS and P2P agreements as there is currently no explicit expectation that a section 21 approver is actively involved on an investor‑by‑investor basis in the same way as for NMPIs or SISs. The FCA is considering how involved a section 21 approve should be in an automated online appropriateness online process operated by the unauthorised person on an ongoing basis, e.g. a requirement on the section 21 approver to check that the process complies with FCA rules on an ongoing basis.

FCA “gateway” for approval of financial promotions

The Government is making changes to the regulatory framework for the approval of financial promotions. The changes would mean that authorised firms would only be able to approve the financial promotions of unauthorised firms if the authorised firm has passed through a new regulatory ‘gateway’ operated by the FCA.

All new and existing authorised firms will have a Financial Promotions Requirement on their permissions which will prohibit them from approving the financial promotions of an unauthorised person. If they want to approve financial promotions, they will need to apply to the FCA to have the prohibition removed either entirely (allowing them to approve all types of financial promotions), or partially (allowing them to approve certain types of financial promotions). The FCA will be able to refuse an application if this is deemed necessary in order to advance its operational objectives. Transitional provisions will be introduced to allow firms to transition smoothly.

Cryptoassets

Last July, HM Treasury consulted on has proposals to bring unregulated cryptoassets into the scope of the financial promotion regime, to enhance consumer protection. The consultation closed in October 2020. We understand that further detail will be set out in due course.

FCA digital disruption campaign to prevent investment harm

The FCA has launched a campaign to help consumers make better informed investment. The campaign uses online advertising to disrupt investors’ journeys and drive them to the high return investments webpage and covers key questions consumers should ask before investing.

SPACs and listing rules

Following Lord Hill’s UK Listing Review report published on 3 March 2021, the FCA intends to consult on potential amendments to the Listing Rules and related guidance to strengthen protections for investors in special purpose acquisition companies (SPACs).

Further regulation of non-transferable debt securities (NTDS)

On 19 April 2021, the Treasury published a consultation discussing the case for further regulation relating to the direct‑to‑market issuance of NTDS, either by making the making the issuance of certain types of NTDS a regulated activity and/or extending the scope of the Prospectus Regulation to cover public offers of NTDS.