HIGHER RISK INVESTMENT (“HRI“) STRATEGY STATEMENT
In September 2021, the FCA published a Strategy Statement in relation to HRIs. The FCA describe HRIs as opportunities whereby high returns are being promised, and although product names and descriptions change frequently, examples of HRIs might include:
- high return bonds or mini-bonds often advertised as eligible to be included in Individual Savings Accounts (ISAs);
- innovative finance ISAs (IFISAs);
- unregulated collective investment schemes (UCIS);
- contracts for difference;
- land banking;
- cryptoassets (eg Bitcoin);
- foreign exchange products;
- peer-to-peer lending; and
- investment based crowdfunding.
HRIs have a valued place in a well-functioning market, enabling individuals to save for either planned or unexpected life events, and giving essential funding to businesses. However, the FCA has become increasingly concerned by how readily accessible HRIs are by investors with a risk tolerance that is unsuitable. A rapid growth in the proportion of consumers holding HRIs has occurred since the start of the COVID-19 pandemic, driven by social and emotional factors which makes such individuals particularly vulnerable to unexpected losses. Unexpected and significant losses of this kind can in turn, undermine wider confidence in the investment landscape and threaten a firm’s ability to raise capital when the post-COVID landscape is already so economically precarious.
PURPOSE OF CP22/2
At the time of the Strategy Statement’s publication, the FCA had commenced taking certain steps to mitigate HRI risks. For example, a permanent ban on the mass marketing of speculative illiquid securities. January 2022 has seen the release of the FCA’s Consultation Paper “Strengthening our financial promotion rules for high risk investments, including cryptoassets” (“CP22/2”). The FCA does confirm that there is no appetite to unduly restrict consumers and there is recognition that consumer knowledge in relation to investing comes from the information that they get in financial promotions. Financial promotions are defined in the FCA Handbook as “an invitation or inducement to engage in investment activity … that is communicated in the course of business” and such communications are required to satisfy the criteria contained in the FCA’s Conduct of Business Sourcebook (“COBS 4”) including, amongst other things, that they are be clear, fair and not misleading. The FCA notes however, that even when such requirements are met, consumers may still not grasp that the underlying product is unsuitable for them.
THE EXISTING FINANCIAL PROMOTIONS FRAMEWORK
Three core elements work together to govern the marketing of financial services in what is known collectively as the financial promotions regime (“FPR”). It comprises:
- Section 21 of the Financial Services and Markets Act 2000 (FSMA): which prohibits the communication of a financial promotion unless it is communicated or approved by an authorised person. Breaching this s21 ‘financial promotion restriction’ is a criminal offence.
- The FSMA (Financial Promotion) Order 2005 (“FPO”): includes a number of exemptions from the financial promotion restriction. In certain circumstances and subject to certain conditions, unauthorised persons are allowed to communicate a financial promotion
- The FCA Handbook: which prescribe the financial promotion rules that apply to authorised firms that are communicating or approving financial promotion communications.
Covering four key areas, CP22/2 contains proposals that will enable the FCA to take the financial promotion rules further.
CP22/2 PROPOSALS
Changes contemplated by the FCA cover:
1. The Classification of HRIs.
Respondents to the FCA’s discussion paper of April 2021 (DP21/1), expressed that the rules prescribed in COBS 4 were difficult and hard to navigate. In CP22/2 the FCA proposes rationalising them through introduction of new categories as follows:
| New category | Investments included | Mass marketing rules |
| Restricted Mass Market Investments” (“RMMIs”) | · Non-readily realisable securities (e.g., shares or bonds not listed on an exchange);
· Qualifying cryptoassets; and · P2P agreements |
Mass marketing will be allowed to retail investors subject to certain restrictions |
| Non-Mass Market Investments” (“NMMIs”) | · Non-mainstream pooled investments (e.g., pooled investments in an unauthorised fund – such as an unregulated collective investment scheme); and
· Speculative illiquid securities (e.g., speculative mini-bonds) |
Mass marketing will be banned to retail investors |
2. The consumer journey into HRIs.
Existing marketing restrictions are intended to ensure consumers only access HRIs knowingly but the FCA believe that this approach is not working as well as it could. Too many consumers are just “clicking through” and accessing HRIs without full realisation of the shift in risk and accordingly, the FCA suggests:
- a ban on financial promotions for HRIs that contain any benefit (monetary or non-monetary) that can incentivise investment activity;
- a risk warning for RMMIs (see definition above) complete with a link that leads the customer to further prescribed information regarding the risks of investing. The proposed risk warning is: “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.”;
- a personalised risk warning pop-up for first time investors with a firm before they receive a direct offer or financial promotion;
- a 24-hour cooling off period for first time investors with a firm before they can actually receive the direct offer financial promotion;
- consumers needing to state why they meet the relevant criteria for an exemption (e.g., restricted investor, High Net Worth investor, self-certified sophisticated investor), which may in turn, require the consumer to e.g state their income; and
- specific requirements on the appropriateness assessment for RMMI products (e.g. restricting the number of retakes that a potential consumer can have).
All of the above would also apply to promotions of qualifying cryptoassets.
3. Strengthening the role of firms approving and communicating financial promotions
This would be achieved by amending the FPR so that financial promotions made by unauthorised persons can only be approved by certain regulated firms that have been given specific FCA permission. Such “section 21 approvers” are able to approve unauthorised firms making financial promotions, and the FCA wants to build a robust regime into this to hold section 21 approvers to high standards. They suggest:
- a rule requiring firms to self-assess whether they have the necessary competence and expertise in an investment product or service before granting any section 21 approvals;
- a rule requiring section 21 approvers to have a continuing relationship with those for whom they approve promotions for the life of the promotion and to actively monitor it after approval for any changes that might mean the promotion no longer complies;
- extending the conflict-of-interest rules to cover the financial promotions approvals;
- a rule requiring section 21 approvers to collect every three months from clients’ attestations of ‘no material change’ throughout the lifetime of the approved promotion; and
- requiring section 21 approvers to perform an appropriateness test and periodically check the compliance of such appropriateness tests, throughout the lifetime of a promotion.
4. Applying financial promotion rules to qualifying cryptoassets.
Pursuant to Her Majesty’s Treasury confirmation that the scope of the FPR will be extended to include “qualifying cryptoassets”, the FCA is looking at how they will be categorised once in scope. Their intention is to generally apply the same rules to cryptoassets as those currently applied to non-readily realisable securities and P2P agreements. Importantly, however, the proposals state that it should not be possible for ‘direct offer’ financial promotions of qualifying cryptoassets to be made to self-certified sophisticated investors.
NEXT STEPS
The consultation closes for comments on 23 March 2022 and the FCA intends to confirm its final rules this summer 2022. When the final rules are published, firms will then have three months to comply with the asks in relation to the consumer journey and for section 21 approvers. The cryptoasset promotion changes will, however, apply immediately from the date that qualifying cryptoassets are become caught by FPR.
To read the FCA’s consultation paper CP22/2 , please see here.
To read the FCA’s press release warning of young investors taking big financial risks, please see here.
To read the FCA’s description of high return investments, please see here.
To read the full consultation produced by HM Treasury, please see here.
For more information, and any guidance or advice on the financial promotion rules applicable to you and your firm, Cleveland & Co External in-house counsel™, your specialist outsourced legal team, are here to help.
