The FCA reforms the financial promotion rules for high-risk investments and for firms approving financial promotions
Financial promotions - in the form of invitations or inducements to engage in certain controlled investment activities - can only be communicated within or into the UK by, or with the approval of, a UK-regulated firm unless an exemption applies. This rule is known as the "financial promotion restriction" and is set out in section 21 of the Financial Services and Markets Act 2000 (FSMA).
Financial promotions have been high on the regulator's priority list in recent years, with 4,226 promotions amended or withdrawn in the year to July 2022 following FCA intervention.
The Rules introduce changes to the categories of investments depending on their risk profile; measures to strengthen the consumer journey such as strengthening risk warnings, banning inducements to invest, introducing positive frictions, improving client categorisation and stronger appropriateness tests; and new rules on approving of financial promotions. Many of the reforms introduced by the Rules relate to "direct offer financial promotions". Direct offer financial promotions contain or specify a manner of response by which a recipient of the promotion may make or accept an offer to enter into a "controlled agreement".
This note highlights some of the key changes.
Which firms is this relevant to?
All firms marketing regulated investment products to people in the UK will need to consider how these changes will affect them. However, the Rules carve out from their restrictions promotions that are exempt under the financial promotion regime or where a communication is otherwise excluded. As a result, the Rules have limited application for wholesale activity.
The Rules will instead be most relevant to firms dealing with or making/approving communications about investment products and activities to, or which might be seen by, retail clients (including sophisticated and high-net-worth retail clients). In particular, the Rules impose new restrictions on promotions of and by peer-to-peer (P2P) lending platforms, equity crowdfunding platforms and other private-market retail investment activities.
What should affected firms do?
- Firms involved in promoting RMMI and NMMI (see more below) should review the risk warnings on all live and planned promotions, and ensure that those promotions can link to the required risk summaries where feasible.
- Unauthorised firms relying on approval or communication of their promotions should monitor the progress of the Financials Services and Markets Bill (FS Bill) and ensure that approvers are appropriately authorised when the change to the financial promotion restriction comes into effect.
- Approving firms should assess whether, and document how, they fulfil the competence and expertise requirement for the product/service categories in respect of which they approve promotions, and consider how they wish to approach ongoing monitoring of approved promotions.
- Firms making direct offer promotions of RMMI and NMMI should understand the new requirements for the consumer journey for these promotions and ensure that their systems are able to handle the cool-off periods, suitability/appropriateness testing and other requirements being introduced by the Rules.
Financial promotions of cryptoassets
Cryptoassets that do not amount to regulated financial products (such as securities, fund units, derivatives, etc.) are not subject to the financial promotion restriction and therefore are not subject to the FCA rules on financial promotions.
The Treasury (following a consultation process) confirmed earlier this year that it intends to bring cryptoassets into the scope of the financial promotions regime when parliamentary time allows. This was not included in the recent FS Bill, so cryptoassets are still outside the financial promotions regime. As a result, the Rules do not cover cryptoassets (termed "qualifying cryptoassets") .
The FCA will issue updated rules covering promotions of cryptoassets once the relevant legislation has passed. Other than leaving out coverage of qualifying cryptoassets, the Rules differ only in select ways from the consultation proposals. We therefore expect the qualifying cryptoasset promotion rules largely to follow the rules for restricted mass market investments, which we cover below. For more on the current regulation of most cryptoassets in the UK, see our recent note on the regulation of NFTs (which will not be "qualifying cryptoassets").
Do the Rules apply to exempt promotions?
No. Where a promotion is or would be exempt from the financial promotion restriction (eg because it is covered by an exemption under the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005) or is otherwise an "excluded communication", the Rules discussed here do not apply.
New risk categories
Among the Rules' key reforms is streamlining the FCA's classification and naming of high-risk investments. Two new categories - "restricted mass market investments" (RMMI) and "non-mass market investments" (NMMI) - will be created to subsume and apply more consistent rules to investments currently in today's three high-risk investment categories (one of which is a grouping of product-specific rules).
Most of the changes in the Rules apply only to promotions for RMMI and NMMI (in each case subject to certain exemptions), and not to exempt promotions or promotions of RRS.
|Current investment/risk category and treatment||New investment/risk category and treatment|
|Readily realisable securities
Most securities listed or traded on investment exchanges/trading venues are treated as RRS, being relatively liquid, having set governance and disclosure standards, and having more accessible valuation methodologies. However, some listed securities without a sufficiently liquid trade in them might be considered speculative illiquid securities (see below).
The rules in respect of RRS remain largely unchanged, following the mainstream financial promotions regime. They are not seen as high-risk products.
|Non-readily realisable securities
(NRRS) and P2P agreements
These investments are typically relatively illiquid, where the secondary markets in them are not continuous or rarely trade.
Mass retail marketing permitted subject to restrictions on direct offer financial promotions.
"Qualifying cryptoassets" are set to join this group following further legislative changes. Their inclusion is driven more by fundamentals than by liquidity.
|Non-mainstream pooled investments
(NMPI) and speculative illiquid securities
NMPIs include units in unregulated collective investment schemes, qualified investor schemes and long-term asset funds, as well as certain other investments.
SIS are debentures or preference shares whose proceeds are reinvested in further loans, buying real estate or other investments, or funding construction.
NMPI and SIS will now be grouped together as NMMI, both being seen to have limited governance and illiquid and/or hard-to-value bases of value. Mass marketing of NMMI to retail clients will be banned.
|Complex investment products (various, including cryptoasset derivatives and restricted speculative investments like leveraged contracts for differences) - subject to product-specific requirements|
Changes to risk warnings and summaries
The Rules bring with them a new risk warning for high-risk investments. Most RMMI and NMMI promotions will now need to carry the following warning:
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.
This is slightly updated in form, but not in substance, from the warning in the Consultation Paper.
Alternative warnings exist for P2P promotions (where the risk of total loss is lower), where an FSCS claim might be possible and where space is limited, while firms may amend the warning if appropriate.
The "take 2 mins" section must link to a risk summary, for which the Rules provide a standard form. As for the risk warnings, amended forms of risk summary may be used in certain circumstances. Prominence requirements apply to the warnings and summaries based on the medium used.
Personalised risk warnings, using the name of the client, will also be required as part of the customer journey for direct offer financial promotions (ie where the promotion includes a form of response/sign-up form, etc.) of RMMI and NMMI when made digitally.
Appropriateness and suitability
Firms must assess the appropriateness of investments for retail clients before being able to invest in RMMI and assess the suitability of an investment for a retail client before being shown a promotion for NMMI. In this context, "appropriateness" assesses whether the instrument is of a type that the investor understands and should be allowed to invest in, while "suitability" goes to whether the investment is likely to meet the customer's needs and objectives. Exemptions apply where the investor is receiving investment advice.
Ban on investment incentives
Under the Rules, incentives (such as refer-a-friend or new joiner bonuses) in relation to RMMI and NMMI for retail clients will be banned. These incentives can still be used where the promotions relate to RRS and other low-risk products like roboadvisors, deposits, etc. Although the ban is worded to cover "offers to a retail client [of] any monetary or non-monetary incentive to invest", the associated guidance indicates that incentives favouring only the maker of a referral and not the recipient will also be banned. It does not matter for the purposes of the ban whether the incentive is monetary or non-monetary.
There is, however, an exemption to the ban for incentives in the form of products or services offered by the recipient of the eventual investment, or one of its affiliates. This means that shareholder benefits offered to firms raising money via crowdfunding, for example, will remain legal. As an illustration, a brewing company raising funds on a crowdfunding platform can provide discounts to investors on the beer it produces. These goods or services must however be "real economy" goods or services. A firm which sells bonds cannot include free or discounted bonds as part of the promotion.
Before communication of a direct offer financial promotion for RMMI or NMMI to a retail client, firms will need to take reasonable steps to establish whether that investor is a high-net-worth investor, sophisticated investor or restricted investor (restricted investors are only eligible for RMMI, not NMMI). The definitions, and forms of certification, for these categories are updated under the Rules.
Customer journey and "positive frictions"
Firms, and potential investors, will need to go through certain steps, termed "positive frictions", where direct offer financial promotions are used. These include a 24-hour cooling off period before showing the investor a direct offer financial promotion. The 24-hour period starts when the client requests to view the promotion, and after the 24 hours have passed the client must make a specific choice to proceed with viewing the promotion or terminate the process.
Firms can also use this time to carry out their appropriateness or suitability testing. If the client fails such a test, firms can allow one immediate retake may not permit the client to retake the test for 24 hours after the second and each subsequent failure. While they are allowed to highlight the possibility of retakes and provide further information to educate the client on the relevant issues, firms may not encourage retakes or coach customers through them.
Rules on approval of financial promotions by authorised firms
The Rules require that, when approving promotions for unauthorised firms (among other things):
- the approving firm must self-assess whether it has the necessary competence and expertise in the relevant type of instrument, product or service being marketed;
- the approving firm's name, firm reference number (FRN) and time/date of approval on the promotion (shortened to "Approver FRN [X]" with a link to the full information where space is limited) must be displayed on the promotion;
- the approving firm has to undertake ongoing monitoring to ensure that the promotion remains compliant over its lifetime, supported by attestations of no material change from the promoter;
- approvers must manage their conflicts of interest relating to approved promotions; and
- the approver must keep records of approvals and how it satisfied itself of its relevant competence and expertise on each occasion.
A couple of relevant observations in the context:
- Once qualifying cryptoassets are added to the financial promotion regime (as discussed above), as activities in relation to qualifying cryptoassets are otherwise unregulated it may be that few authorised firms will be able to fulfil the competence and expertise requirement for related products and services.
- The Rules dovetail with the updates to the financial promotion restriction set out in the FS Bill, which will limit approval of financial promotions to firms authorised by the FCA for that purpose (referred to as "s21 gateway" in the Treasury consultation). At present, any authorised firm may approve promotions.
- The FS Bill's changes to the financial promotion restriction in section 21 may not be in place by time the Rules come into effect. This could mean a period where all authorised firms remain able to authorise promotions, but where they must follow the Rules' new provisions on competence, expertise and form of promotion. Once the changes to section 21 FSMA are in place, there may be a period where it is more difficult to get promotions approved while the FCA processes applications from approvers to vary their licences.
When will the Rules start to apply?
The updated risk warnings will be the first change to come into effect, from 1 December 2022. Firms will need to have implemented all other changes by 1 February 2023.
What else should firms keep in mind?
Because changes are generally directed at promotion to retail investors, firms should also bear the new Consumer Duty in mind when implementing the Rules and promoting products under them.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.