The FCA’s new financial promotions regime for high-risk investments

Background on the FCA’s Financial Promotions Regime for HRIs

This article summarises the significant features of the FCA’s forthcoming financial promotions regime for high-risk investments (HRIs).  The article looks primarily at the impact these new rules will have on firms that are authorised by the FCA and who market financial instruments; that is, it does not consider the specific requirements of firms that promote P2P agreements or portfolios, nor does it discuss the particular requirements that apply to so called “S21 Approvers”, though many of the changes discussed in this article apply equally to such firms.  While a part of the new rules relating to non-readily realisable investments come into effect on 1 December 2022, with the full rules coming into effect on 1 February 2023, this article looks at the rules as they will be once all are in force.

The FCA issued Policy Statement PS 22/10 “Strengthening our financial promotion rules for high‑risk investments and firms approving financial promotions” on 1 August 2022.  In this Policy Statement, the FCA accepts that HRIs have a place in a well-functioning consumer investment market for those investors who both understand the risks involved and can absorb potential loses.  The FCA, however, feels that the current market allows too many investors to make investments that are not aligned with their risk tolerance and, against the current economic background with increased inflation and costs of living, are not likely to meet their needs.  The FCA’s market investigation has revealed that there is an increasing risk of more people seeking to invest in HRIs that are not suitable and this regime is intended to prevent this, so far as possible.

The FCA’s Consumer Investment Strategy and the Consumer Duty

The FCA makes the point that self-directed investors, as it calls non-advised investors, are increasingly likely to buy investment products where they do not understand the risks involved.  The FCA also draws a distinction between a financial promotion that simply seeks to comply with the “fair, clear and not-misleading” requirement in COBS and that, as well as doing this, also seeks to ensure that recipients receive the information they need in order to understand the risks involved and whether the investment will meet their needs.  This approach reflects the FCA’s Consumer Investment Strategy and, in particular, its approach contained within the forthcoming Consumer Duty regime; most obviously the consumer understanding outcome.  The FCA believes these changes will ensure its financial promotions regime is robust and remains fit for purpose in a changing investment environment with promotions distributed to a mass audience at increasing speed via on-line platforms and through social media.

The FCA’s new rules on promoting HRIs mark a policy shift by the regulator and an acceptance that a regulatory regime, or at least its financial promotions element, can no longer remain media neutral.  The FCA acknowledges that it expects the implementation of its new financial promotion rules for HRIs to lead to some products disappearing from the market for retail investors but feels that this outcome is to be welcomed as it is these investments that are not appropriate for retail investors.  Significantly, the FCA has set itself the target to halve the number of consumers with a low risk tolerance or characteristics of vulnerability investing in HRIs by 2025.

Classification of investments

The FCA’s new FPR introduced a revised classification regime for retail financial promotion as follows:

Readily Realisable Securities (RRSs)

These are listed or exchange traded securities where the usual standards of fair, clear and not misleading, risk warnings and, in time, the requirements of the Consumer Duty will apply, but on which there will be no marketing restrictions.

Restricted Mass Market Investments (RMMIs)

This class includes Non-Readily Realisable Securities (NRRS) such as shares or bonds in a company not listed on an exchange.  Mass marketing is permitted, however, as the name makes clear, this is subject to certain restrictions.

Non-Mass-Market Investments (NMMIs)

This class includes investments such as non-mainstream pooled investments such as unregulated collective investment schemes, unregulated qualified investor schemes, unregulated long-term asset funds and speculative illiquid securities such as speculative mini-bonds.  Again, as the name makes clear, the mass-marketing of these investments to retail investors is prohibited.

The level of marketing restriction reflects the regulator’s view of the risk of harm to retail investors that investments in each category represent.

Standardised risk warnings and risk summaries

In recognition of its research demonstrating that the standardised “Capital at Risk” warning has proved to be ineffective and is seen as “wallpaper” the FCA has set out what it sees as suitably clear and concise risk warnings for HRIs.

The Standardised Risk Warning for a Restricted Mass Market Investment is:

Don’t invest unless you’re prepared to lose all the money you invest. This is a high-risk investment and you are unlikely to be protected if something goes wrong. Take 2 mins to learn more.

Where there are character limits imposed by a third-party marketing provider the truncated risk warning may be used:

Don’t invest unless you’re prepared to lose all the money you invest.

The “Take 2 mins to learn more” must, where the financial promotion is communicated by way of a website, mobile application or other digital medium, be a link which, when activated, delivers the appropriate risk summary in a pop-up box (or equivalent).  Where the financial promotion is not delivered by way of a website etc., then the risk summary needs to accompany the financial promotion.  The risk summary is to be chosen from the different prescribed versions depending upon the nature of the investment, for example, there are ones for non-readily realisable securities which are shares and those which are debentures.

Firms may diverge from the standardised risk summary if they have a valid reason for doing so, for example, on grounds of irrelevance, where inclusion of a specific part would itself be misleading, or where there are other risks that should be included.  Where firms do diverge from the prescribed risk summary, they must record their rationale for doing so.  A firm’s amended risk summary must always summarise the key risks of the investment and should be able to be read in “around two minutes”.  It is unclear what level of reading ability firms are expected to assume readers possess and it is worth noting the FCA’s FG22/5 Final non-Handbook Guidance for firms on the Consumer Duty which reveals that its research shows that one in seven UK adults have literacy skills at or below those expected of a 9-11 year old.  Here, the consumer understanding outcome comes into play as well as the products and services outcome – and firms will have to think carefully how to ensure that their risk summaries, and all communications directed at consumers, are understandable by the target audience.

The FCA recognises it is possible that, in time, any such prescribed risk warnings may, in their turn, become “wallpaper” and so evolution is to be expected in the form of risk warnings.

Personalised risk warnings

Where the financial promotion is a direct offer financial promotion for a RMMI, or a financial promotion for a NMMI, the risk warning must be “personalised”; that is before communicating the direct offer financial promotion, or financial promotion, the firm must obtain the retail client’s full name and, having done so, communicate to that retail client the following personalised risk warning:

[Client name], this is a high-risk investment. How would you feel if you lost the money you’re about to invest? Take 2 mins to learn more.

Personalised risk warnings are designed to complement the main risk warnings and so give retail customers the greatest opportunity to view the risk summary and to understand the risks of the investment they are contemplating.

A personalised risk warning is not mandatory if the retail client has previously received a direct offer financial promotion relating to a RMMI, or a financial promotion relating to a NMMI, from the firm.

Prominence requirements

The risk warnings and the risk summaries must be prominent, taking into account the content, size and orientation of the financial promotion as a whole and, except where the risk warning cannot be provided in writing (such as a television advertisement) be clearly legible, contained within its own border and with bold and underlined.  Where the financial promotion is to be communicated by a website or mobile application the risk warning and risk summary must be statically fixed and visible at the top of the screen, below anything else that also stays static, even when the retail client scrolls up or down the webpage and be included on each linked webpage on the website or page on the application relating to the relevant investment.  In the case of a television broadcast, be prominently fixed on the screen for the duration of the broadcast.  The new rules also mandate the financial promotion must not contain any design feature which has the intent or effect of reducing the visibility or prominence of the risk warning or risk summary.  The “Take 2 mins to learn more” appropriate risk summary in a pop-up box (or equivalent) must, as well as complying with the other requirements, be statically fixed and visible in the middle of the screen and be the main focus of the screen.

The FCA directs firms to look once again at the (then) FSA’s financial promotions guidance on prominence from September 2011.  When considering website design, the FCA directs firms to the Web Accessibility Initiative’s Web Content Accessibility Guidelines, in yet another recognition that the days of regulating in a media neutral manner have passed.

Incentives to Invest

The FCA believes that incentives to invest can unduly influence consumers’ investment decisions and so its new rules for marketing HRIs include significant restrictions on firms’ ability to use these as an inducement to get consumers to invest.  Here, the FCA accepts that this measure may well negatively affect some firms’ profitability but accepts this as an inevitable consequence of what the regulator is trying to achieve – which includes the removal of social or emotional influences from consumers’ investment decisions.  The prohibition of incentives only applies to financial promotions targeted at retail investors, including those sent to high net worth investors and sophisticated investors.  It will not affect the terms offered by firms to professional and institutional investors.  Nor will it affect “shareholder benefits”.  Gratifyingly, the FCA specifically confirms that, as an example, a brewing company raising funds on a crowdfunding platform can provide discounts to investors on the beer it produces!

24-Hour Cooling off periods

The FCA has proceeded with its proposals, though in a modified form, to introduce a minimum 24-hour cooling off period for financial promotions marketing both RMMIs and NMMIs.  This is intended to, in the FCA’s words, introduce an appropriate degree of positive friction into the process through which retail investors make HRIs; giving the investor the opportunity to spend more time researching the investment before making a decision.  For RMMIs the 24-hour cooling off period commences when the retail investor requests to receive the director offer financial promotion and for NMMIs, when the retail investor requests to view the financial promotion; at which point the firm must invite the retail client to specify whether they wish to leave the investment journey or continue to view the direct offer financial promotion or financial promotion, as appropriate.

During this time firms may still proceed with other parts of the onboarding process, such as KYC/AML checks, showing personalised risk warnings, client categorisation, and appropriateness assessments (for RMMIs) and preliminary assessments of suitability for NMMIs.

The FCA makes the point that, by allowing other parts of the customer journey to proceed during this 24-hour colling off period, it is likely that it will, in itself, have only a minimal impact on reputable firms who already deploy a robust consumer journey.  The FCA also recognises, however, the impact the 24-hour cooling off period is likely to have on time sensitive investment but regards this as the inevitable outcome of what its policies are intended to achieve; namely to ensure consumers have time to consider whether the investment is likely to be appropriate for them or not and not to be rushed into making investment decisions.

As with personalised risk warnings, the 24-hour cooling off periods do not apply to retail clients who have previously received a direct offer financial promotion relating to a RMMI, or a financial promotion relating to a NMMI (as the case may be), from the firm.

Retail investor categorisation

Under the HRI regime, prospective investors will need to state why they met the relevant criteria when they sign the relevant declaration.  For RMMIs, the firm will have to take reasonable steps to establish that the retail client is one of a certified high net worth investor, certified sophisticated investor, self-certified sophisticated investor or certified restricted investor. For NMMIs the firm will have to take reasonable steps to establish that the retail client is one of a certified high net worth investor, certified sophisticated investor or self-certified sophisticated investor.  As previously, the “certificates” will have to be current, for example, issued within the preceding 12 months.  The form of the certificates has been enhanced and now requires high net worth investors to state their income/net assets to the nearest £10,000/£100,000, sophisticated investors will need to provide the names of the relevant organisations, companies, unlisted companies or business angel networks, as appropriate and restricted investors will need to provide the percentage of net assets they have invested in, and will invest in, HRIs.  Firms will be required to take reasonable steps to ascertain that the retail client does, in fact, meet the income and net assets criteria, or have the requisite experience, knowledge or expertise to understand the risks.

The FCA remains concerned that the self-certification regime is not working well and makes reference to the HMT consultation on reform of the Financial Promotions Order, which should be taken as a sign that it is likely there will be further restrictions on the ability of firms to use the self-certification exemptions in the future.

Appropriateness test for RMMIs

The new rules require firms promoting RMMIs to undertake an appropriateness assessment (unless the investor is receiving advice) to assess the retail client’s knowledge and experience of making investments in RMMIs.  This assessment must be performed before the firm processes an application or order from the client to invest in a RMMI.  The FCA does not prescribe how this assessment is to be performed but it directs the manner of testing must be designed to ensure that retail clients are only able to invest in RMMIs which they have the knowledge and experience to understand, particularly in relation to the risks.  The rules also require that the firm must not provide the retail client with assistance, information, guidance or feedback which might affect the substance of the information that they provide.  While it is left up to individual firms to decide how to perform the appropriateness test, the rules contemplate testing in the form the use of question banks that the firm will require the retail client to answer.  Here, in another example of crafting rules which anticipate an online distribution model, the questions must change each time the retail client attempts the test and the following requirements must be observed:

• questions inviting yes/no answers must not be used
• multiple-choice questions must offer at least three plausible answers (excluding a “don’t know” response)
• the questions must address matters that are relevant to the specific type of investment in which the retail client has expressed interest
• the retail client should only be informed of the outcome of an appropriateness assessment once they have provided all of the information required for the assessment to be undertaken
• the retail client must not be informed of the particular answers which led to RMMI being assessed as not appropriate for them
• any questions used to undertake a further assessment of appropriateness should be sufficiently different such that the retail client could not simply infer the answers that would lead to an assessment of appropriateness from the outcome of their responses to a previous set of questions
• consumers must wait at least 24 hours before undertaking the appropriateness test again from their second assessment onwards.

The FCA makes the point that simply informing a retail investor who fails an appropriateness test which answers they got wrong does little to encourage consumer reflection or education and only encourages them to simply to change their answer in any subsequent assessment without improving their own understanding.  For this reason, the new rules include guidance to the effect that firms are not prevented from informing the retail client of the broad reasons for which a RMMI was assessed not to be appropriate for them or of the nature of the deficiencies identified in their knowledge or experience.  The obligations placed upon firms under the forthcoming Consumer Duty, particularly the consumer understanding outcome, would almost certainly mean that firms have an obligation to provide such an explanation so that the retail client understands what the conclusion of the appropriateness test meant, so they can make an informed decision on whether to undergo the assessment again.  The FCA’s Policy Statement, but not the new rules, tells firms that they should also consider pointing consumers towards educational material so they can improve their knowledge on the risks if they’re still interested in continuing.  Once again, this probably reflects the expectations placed upon such firms under the Consumer Duty.

While, under the new rules, an appropriateness assessment is only required on the first occasion that a particular retail client responds to a direct offer financial promotion relating to a specific type of RMMI, the FCA expects firms to consider whether it would be in the best interests of the retail client for a further assessment to be undertaken, for example due to lapse of time, even where this is not required.  Once again, this echoes elements of the Consumer Duty.

Record-Keeping Obligations

The are some specific record-keeping obligations that apply to firms communicating a direct offer financial promotion in respect of a RMMI.  These are that the firm must record (and keep for a minimum of 5 years) the following information:

• the total number of assessments undertaken
• the number of assessments resulting in a determination that the investment was appropriate
• the number of assessments resulting in a determination that the investment was not appropriate
• in respect of each retail client, the outcome of the appropriateness process
• in respect of each retail client, the number of times that retail client was subject to an appropriateness assessment in respect of the same investment.

The 24-hour lock-out

Where a retail investor has taken a firm’s appropriateness test and failed to pass it, the firm is allowed to let them retake the test once without waiting for 24 hours before doing so. If the retail investor fails the test a second time, the firm must ensure that they wait at least 24 hours between each subsequent attempt to complete the assessment.  The FCA stresses that it is open to firms to impose the 24-hour lock out period after the first attempt if they deem it appropriate.  Firms may inform retail investors of their options for retaking their assessments again after the end of the 24-hour lock out, these communications should not in any way be either persistent or persuasive in nature.

Suitability and NMMIs

When marketing NMMIs to certified high net worth investors and self-certified sophisticated investors, the firm making the promotion must undertake a preliminary assessment of suitability before the financial promotion is made to the retail client. This preliminary assessment of suitability does not apply where the firm making the promotion is providing the client with advice; when of course a full assessment of suitability is required.  The preliminary assessments of suitability are not the same as the suitability requirements for an advised sale, instead, this requires that the firm takes reasonable steps to acquaint itself with the client’s profile and objectives in order to ascertain whether the NMMI under contemplation is likely to be suitable for that client. The firm must not promote the NMMI to the client if it does not consider it likely to be suitable for that client following such preliminary assessment.  Unlike the appropriateness assessment for RMMIs, the firm must perform the preliminary assessment of suitability in advance of each communication regarding a financial promotion relating to a NMMI to a particular retail client.

Competency & expertise

Firms must not communicate a financial promotion unless the individual or individuals responsible for the compliance of the financial promotion with the financial promotion rules has or have appropriate competence and expertise.  Appropriate competence and expertise in this context mean competence and expertise in the investment or financial service to which the financial promotion relates.  In addition, if a firm communicates a financial promotion which relates to a NMMI addressed to or disseminated in such a way that it is likely to be received by a retail client, the person allocated the compliance oversight function in the firm must make a record at or near the time of the communication or approval certifying that the promotion complies with the restrictions set out in section 238 of the Act and in COBS 4.12B, as applicable.  The making of this record may be delegated to one or more employees of the firm who report to and are supervised by the person allocated the compliance oversight function, provided the process for certification of compliance has been reviewed and approved by the person allocated the compliance oversight function no more than 12 months before the date of the communication of the promotion.

Conclusion

These new restrictions on the marketing of HRIs should be viewed alongside the forthcoming Consumer Duty, as both reflect the FCA’s intention to deliver on its Consumer Investment Strategy.  Firms engaging in selling HRIs to the retail market would do well to consider the impact of these two new regimes on their business model on a holistic basis.  To do otherwise, risks charting a course through the financial promotions regime that fails to deliver on the regulatory expectations under the Consumer Duty.

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