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Last Friday, the UK Financial Conduct Authority (“FCA”) published DP21/1, its latest discussion paper entitled ‘Strengthening our financial promotion rules for high-risk investments and firms approving financial promotions’. With the consultation period now open for market participants to respond to the paper, Ollie Blears summarises the key proposals tabled by the regulator as it seeks to calibrate upcoming changes to the existing financial promotion regime.


DP21/1 (“the paper”) is the latest instalment in a series of materials and measures promulgated by the FCA over the course of the last twelve months pursuant to its mission statement set out in last year’s business plan to make the topic of consumer investments a regulatory priority.

Other recent actions taken by the FCA include January’s separate bans on the mass-marketing of speculative illiquid securities and the sale of crypto-derivatives to retail customers, and a ‘call for input’ paper published in September 2020 seeking stakeholder feedback on the consumer investment market.

In parallel, the Government (acting by HM Treasury) have consulted the market on both the promotion of cryptoassets and a new gateway through which FCA-authorised firms would need to pass to be able to approve the financial promotions of unauthorised firms. The fine balance between protecting consumers and consumers taking responsibility for their own actions is evidently foremost in regulators’ minds at the moment.

The timing of this wave of regulatory consultation and action could not be more relevant. Since the publication of the FCA’s business plan in April 2020, the COVID-19 pandemic has accelerated the UK’s digital transition and caused all manner of economic upheaval. Caught in such crosswinds, a generation of (often younger) investors have been either searching for yield or searching for entertainment (or both) in perceived ‘high-risk’ investments. Crowdfunding, cryptocurrencies and commission-free app-based trading platforms all feature in this arena, as does peer-to-peer lending, collective investment schemes and mini-bonds (the latter made infamous by the collapse in 2019 of London Capital & Finance).

Whilst the above examples can each be isolated and their merits and risks assessed individually, they are all connected by the common thread of the scope of the UK’s financial promotion regime and thus subject to various degrees of marketing restrictions. The FCA is of the view that the existing regime is not currently providing sufficient protection for consumers, a view which they consider is supported by recent research findings. The paper therefore sets out three areas where the FCA believes that further changes could be made to protect consumers from harm:

• the classification of high-risk investments (i.e. any investment which is subject to marketing restrictions – see below);

• the segmentation of the high-risk investment market; and

• the role of FCA-authorised firms which approve financial promotions on behalf of unauthorised firms.

FCA’s classification of investments for purpose of marketing restrictions

Classification of high-risk investments

Seen by the FCA as the first step in segmenting the high-risk investment market, the regulator currently classifies investments for the purpose of marketing restrictions in the buckets as shown by the above infographic.

In very broad terms, a sliding scale of restrictions is then applied across the buckets, with readily realisable securities (“RRS”) such as shares bought on the LSE or AIM generally subject to no marketing restrictions, and mini-bonds issued to raise proceeds which are on-lent for property development (for instance) (“SIS”) and certain unregulated collective investment schemes (“NMPI”s) subject to blanket restrictions on their mass marketing to retail investors.

This classification methodology has developed over time as the FCA reacts to new investments and new technology entering the marketplace. With such an iterative approach, the FCA acknowledges that the ‘buckets’ may not capture the full universe of high-risk investments and there may be inconsistencies in how some investments are treated. For instance a particular investment could currently be structured in a way so that it is classified in a bucket which is subject to lesser marketing restrictions, despite characteristics of the investment lending themselves to a stricter classification.

Characteristics of an investment is a concept which the FCA makes it clear is a key concern when addressing correct classification to prevent possible arbitrage. Examples include the investment’s relative riskiness compared to other assets, the use of the proceeds by the issuer (i.e. will they be on-lent or pooled?), fee structure transparency and whether the investor is able to understand what’s being advertised or sold to them. The FCA’s position is that all investments that pose a high risk to consumers are captured by the classifications and that investments with similar characteristics should be treated in the same way.

A specific example highlighted in the paper is that the current SIS rules in the FCA Handbook (COBS 4.14) do not cover shares in companies other than preference shares. So ordinary shares in companies that carry on the activities which are included under the definition of a SIS are not subject to the SIS rules, and the FCA is aware of cases where structures have been devised involving ordinary shares intending to raise capital from retail clients for speculative purposes. The FCA is proposing to include equity shares as a type of security that can be a SIS, alongside debentures and preference shares.

Another example of arbitrage opportunity under the current classification rules are P2P agreements which have similar features to a SIS (e.g. where the bilateral loan is made to a property developer) but at present are specifically excluded from the SIS rules by virtue of being a P2P agreement (albeit subject to other, lesser marketing restrictions). The FCA is seeking feedback on whether the current mass-marketing ban of SIS should be extended to those P2P agreements which have the relevant features of a SIS.

Although not explicitly referenced, where the FCA ponders on its classification approach to new investments as they enter the scope of the wider financial promotion regime, it is implicit that cryptocurrencies such as bitcoin and Ethereum are in mind, given that HM Treasury has recently proposed to in-scope such unregulated exchange tokens. Whilst some marketing restrictions should be expected, attempts to ‘bucket’ tokens with the restrictions applicable to non-readily realisable securities (“NRRS”) would pose some difficult questions given the decentralised and highly liquid nature of such cryptoassets. Similarly, how might the direct offer financial promotion restrictions apply to those FCA-authorised firms involved with crypto-wallet providers and exchanges?

Notably and commendably, the FCA does acknowledge that in cases where an investment is issued to finance a single business carrying on a commercial activity that has been deliberately chosen by the investor (e.g. an NRRS issued by a company which is crowdfunding), the investor is likely to understand the riskiness of the investment and marketing is allowed, subject to the restrictions placed on direct offer financial promotions. So long as the correct systems and processes are in place for those involved in crowdfunding-related promotions, this appears a favourable standpoint from the regulator for the benefit of the crowdfunding industry.

Segmentation of the high-risk investment market

Once investments have been classified as ‘high-risk’, then the FCA has historically sought to apply the correct level of marketing restrictions to segment such investments from the mainstream market, and the paper isolates three areas in particular where the FCA believes more could perhaps be done to strengthen such segmentation for the benefit of consumers and their ability to make effective decisions:

• categorisation of retail investors (i.e. as high net worth, sophisticated or restricted) where the FCA rules restrict the communication of financial promotions (or direct offer financial promotions) to retail investors;

• improvement of risk warnings to better help consumers understand and engage with such warnings; and

• adding ‘positive friction’ to the consumer journey when making a high-risk investment (i.e. during the onboarding or application process)

The FCA states that its current concern is there too ‘clicking through’ taking place during application processes and prospective investors can easily sail through the prescribed checkpoints without sufficient understanding of what they are about to pay for (e.g. that the investment is not protected by the Financial Services Compensation Scheme or that it is illiquid in nature).

To borrow a recent example from the US market, the rise and fall of Gamestop as a high-risk, high-return opportunity facilitated by the commission-free trading app Robinhood was undoubtedly a lesson to many younger investors of the risks of ‘spontaneous investing’. Perhaps a useful lesson when punting $20, but a painful one if you’ve been encouraged to invest much more at the height of the saga.

The FCA states that it is therefore considering several changes to strengthen the obligations imposed on FCA-authorised firms with regards to the investor categorisation stage at the point of onboarding or application. These include a requirement for firms to take ‘reasonable steps’ to independently verify that a retail investor is either high net worth, sophisticated or that it is not investing more than 10% of its net assets (and thus eligible to be categorised as a ‘restricted’ investor), and a requirement to query or verify investor declarations where certain ‘red flags’ exist, such as an attempt to invest an overtly large amount (if a restricted investor) for instance.

The FCA acknowledges the inevitable drawbacks that such requirements might create for FCA-authorised firms acting as gatekeepers of such processes, not least in terms of cost and the wider impact on healthy retail investment were such categorisation to slide into de facto suitability assessments on each individual investor.

With regards to risk warnings, which market feedback received by the FCA has suggested do not always hit home as effectively as they might, the FCA is considering whether visual-based risk warnings (in addition to written risk warnings) or standardised risk warnings (such as those introduced for SISs) could help influence consumer behaviour.

The shortest section given to this area is that of introducing possible additional frictions to a prospective investor’s journey at the onboarding or application stage. Measures suggested by the FCA include cooling off periods or requiring SMS confirmations before investments are made. Here, there feels an implicit recognition by the FCA that such measures (and there are more onerous examples given) could be too far-reaching and tricky to implement across the board.

Role of authorised firms

The third salient area subject to scrutiny is that of the role of those FCA-authorised firms who are engaged by unauthorised firms (typically most issuers who are fundraising) to review and approve the latter’s financial promotions prior to their advertisement (on social media, billboards, by email etc.).

Specifically, the FCA is of the view that the current rules could go further to ensure that approved financial promotions continue to comply with FCA requirements on an ongoing basis. Suggested ongoing monitoring requirements include the checking (by the engaged FCA-authorised firm):

• as to whether any amendments have been made to previously approved financial promotions which might require them to be re-approved;

• whether any changes to the underlying business of the issuer might affect whether the previously approved financial promotion continues to be ‘fair, clear and not misleading’ (the minimum standard for any financial promotion); and

• whether the funds raised through the issue of an investment are indeed being used for the purposes as was described in the financial promotion.

Helpfully, the FCA does acknowledge the possible implications and burdens on authorised firms that such a strengthening of requirements might entail. The risk being that the role becomes so resource-intensive for SME FCA-authorised firms that financial promotion approvals becomes economically unviable for such gatekeepers and the market (and consequently competition) shrinks such that only large cap authorised firms have the capacity to satisfy such role (and charge accordingly).

Finally, the topic of appropriateness tests is covered by the FCA in the paper, where relevant to the marketing of direct offer financial promotions by issuers (most prevalent in crowdfunding). Here, the FCA recognises that there is no expectation that engaged authorised firms should be actively involved on an investor-by-investor basis when reviewing whether the investment in question is appropriate for applicants, and that most appropriateness assessments are generally automated exercises. However, the FCA proposes a similar suggestion as above with regards to approvals, in that authorised firms should be required to monitor the quality of the appropriateness checks on an ongoing basis and ensure that it is fit for purpose, as supposed to an initial blessing with no further responsibility. This seems fair, and a not too obtrusive burden on such authorised firms who should have the right systems and processes in place to do so in any event.

Next Steps

The FCA has stated that market feedback to this paper will help to shape the changes it plans to consult on later in the year so as to ensure that such change have the intended impact.

The regulator also plans to publish a full response to the September 2020 call for input paper in due course, together with outlining the next steps in its wider consumer strategy. A number of the changes referred to above will also be subject to behavioural research in sandbox environments to gauge their effectiveness before they are taken any further.

RW Blears intends to respond to the questions posed by the FCA in the paper and the submitted response will shortly be available on our website. The consultation period closes on Thursday, 1 July 2021.

Ollie Blears
6 May 2021

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