This article contains important information on proposed new rules and guidelines that are proposed to be made by the Financial Conduct Authority (“FCA”) and HM Treasury (“HMT”).
These new rules and guidelines are still open to consultation but, if adopted in their current form, may mean significant changes to:
- the types of investors that are eligible to participate in certain opportunities;
- the operational journey that an investor needs to take prior to committing their capital; and
- the scope of those assets classes currently subject to UK financial services regulation.
These FCA rules primarily impact businesses that are:
- marketing opportunities to High-Net Worth Investors, Sophisticated Investors and other investors that are not categorised as Professional Investors; or
- currently marketing cryptoasset investments and services.
This article covers the following publications:
- FCA Consultation Paper 21/13: A new Consumer Duty.
- FCA Consultation Paper 22/2: Strengthening our financial promotion rules for high-risk investments, including Cryptoassets.
- HMT Financial Promotion Exemptions for High-Net-Worth Individuals and Sophisticated Investors.
The timing of the implementation of the new rules are set out in each section.
1. Consumer Duty¹
The issue
The FCA is of the view that risky investments are still too often finding their way into the hands of investors for which they are not appropriate. In addition, the FCA is concerned that there is a general market failure where investors are not making rational decisions based on the information presented to them as part of the investment journey.
The New Consumer Duty
The FCA hopes the new Consumer Duty will fix these issues by:
- explicitly setting a higher standard of care across all retail markets, informed by the FCA's work on behavioural biases and vulnerability;
- extending rules focused on product governance and fair value, which already exist in certain sectors, across all sectors;
- focusing on matters of market practice (e.g., sludge practice) that interfere in consumer decision making and, by doing so, cause harm;
- ensuring firms consider the needs of their customers – including those with characteristics of vulnerability – and how they behave, at every stage of the product or service lifecycle; and
- requiring all firms to focus on good customer outcomes and whether those outcomes are met
The concept of the Consumer Duty will be codified in the FCA rules in two places:
- principles for business: The Consumer Duty will be a brand-new 12th Principal for Business – “A firm must act to deliver good outcomes for retail customers”. The FCA expects its Principles for Business to guide all the activities that it undertakes.
- conduct rule: the FCA will add an additional, 6th, Individual Conduct Rule – “You must act to deliver good outcomes for retail customers”.
NB: retail customers includes any person that is not a Professional Client, which includes High Net Worth Investors, Certified and Self-Certified Sophisticated Investors, etc.
What does this mean practically mean?
The new FCA rules will require firms to focus on supporting and empowering their customers to make good financial decisions and avoiding foreseeable harm at every stage of the customer relationship. Firms will have to provide consumers with information they can understand, offer products and service that are fit for purpose and provide helpful customer service.
The Consumer Duty extends to all firms involved in manufacturing and supplying products and services to retail clients: even without a direct relationship with the end consumer. The FCA is also proposing to extend the duty to include small and medium sized enterprises (SMEs), irrespective of whether they have been classified as Professional Client.
We think this new Consumer Duty means that businesses should consider the following items:
- communications – firms' communications should consistently support consumers by enabling them to make informed decisions about financial products and services. Consumers should be given the information they need, at the right time, and presented in a way they can understand.
- products and services – all products and services that are sold to consumers should be fit for purpose. They should be designed to meet consumers' needs and targeted at the consumers whose needs they are designed to meet. This is an essential requirement for products and services to be able to represent fair value for consumers.
- customer service – firms should provide a level of customer service that meets consumers' needs throughout their relationship with the firm. Customer service should enable consumers to realise the benefits of the products and services they buy and ensure that they are not hindered from acting in their own interests.
- price and value – firms should ensure that products and services are fit for purpose and represent fair value, not just because they meet consumers' needs and objectives as set out in our Products and Services outcome, but also because their price represents fair value.
What is the timeline
There implementation period starting after the FCA publish final rules (31 July 2022) and ending on 30 April 2023.
2. Strengthening of financial promotion rules for high-risk investments²
What is the FCA seeking to achieve?
The FCA is acting to address concerns about the ease and speed with which people can make high-risk investments by proposing a significant strengthening of its rules on how high-risk financial products are marketed. It is worth noting that the majority of investments, other than those made into listed instruments or funds that are directly authorised by the FCA are likely to fall under the ‘high-risk' category.
What is the FCA proposing?
Under the proposed rules, the FCA would ensure firms that approve and communicate financial marketing have relevant expertise and understanding of the investments being offered, improve risk warnings on adverts and ban incentives to invest, for example new joiner or refer-a-friend bonuses. Those looking to make certain high-risk investments would also be asked more robust questions about their knowledge and investment experience, after research found many consumers were investing without being aware of the risks.
The key changes proposed by the FCA are the following:
- classification of high‑risk investments: industry feedback has been that the FCA's existing marketing restrictions are difficult to navigate and to understand. FCA intends to rationalise the rules in COBS 4 under the terms ‘Restricted Mass Market Investments' and ‘Non‑Mass Market Investments.'
- the consumer journey into high‑risk
investments: in order to prevent investors /
consumers from ‘clicking through' or accessing
high‑risk investments without understanding the risks
involved, the FCA is proposing a package of measures to strengthen
it by:
- ensuring that there are personalised risk warnings on each product, where the investor is prompted to “take 2 minutes to understand the product”;
- adding positive frictions, such as cooling off periods (a 24 hours period for first time investors which will need to re-confirm after 24 hours their request to proceed on receiving a financial promotion in relation to a high-risk investment);
- banning financial inducements to invest i.e. refer a friend or new joiner financial bonuses;
- improving the client categorisation process through new template statements; and
- introducing appropriateness tests or preliminary assessment of suitability on certain investments.
- strengthen the role of firms approving and communicating financial promotions: FCA wants to strengthen the role of a “section 21” approver as they play an important role in enabling unauthorised issuers of high‑risk investments to reach consumers. FCA wants to develop a robust regime which will hold s21 approvers to high standards.
- applying the rules to qualifying cryptoassets: The Treasury has confirmed it intends to extend the scope of the financial promotion perimeter to include qualifying cryptoassets and the CP includes proposals on how FCA will categorise these cryptoassets once they are brought into the financial promotion regime. The intention is to apply the same rules to cryptoassets as currently apply to Non‑Readily Realisable Securities and Peer‑to‑Peer agreements (collectively this will become the ‘Restricted Mass Market Investments' category).
What is the timeline
With the exception of the extension of the scope of regulation to certain cryptoassets, the other proposals are expected to be effective from Autumn 2022.
3. Changes to the financial promotion exemptions³
On 15 December 2021, HM Treasury published their consultation on the future of the high-net-worth individuals and sophisticated investors exemptions from the financial promotion regime. Broadly speaking, the UK financial promotion regime restricts the marketing of investment opportunities to consumers unless the content of the communication has first been approved by an FCA approved firm or person, or it is communicated to an exempt person. The Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (“FPO”) introduced the three main exemptions which are subject to the consultation (although many other exemptions exist in addition). However, these three specific exemptions are commonly relied upon for the raising of early-stage financing from “angel” investors and for the promotion of certain types of non-mainstream investments.
Since these exemptions were first introduced the markets have evolved and looking at the wider FCA's objectives of protecting consumers, the HMT is proposing the following (material) changes:
- Increasing the financial thresholds for high-net-worth individuals. The net income threshold to be considered high net worth would be uprated to £150,000 (from £100,000) and the net asset threshold to £385,000 (from £250,000)
- Amending the criteria for self-certified sophisticated
investors.
- One of the criteria to be classified as a self-certified sophisticated investor is to have made more than one investment in an unlisted company in the previous two years. The government is of the view that this is no longer an indicator of investor sophistication and this element should be removed from the self-certified sophisticated investor definition.
- Another of the existing tests to be a self-certified sophisticated investor is that an individual has been in the last two years a director of a company with an annual turnover of at least £1 million. The government therefore proposes updating the threshold in line with inflation that has taken place between 2005 and 2021 to a value of £1.4 million.
- Placing a greater degree of responsibility on firms to ensure individuals meet the criteria to be deemed high net worth or sophisticated.
- Updating the high net worth individual and self-certified sophisticated investor statements. The government is proposing three substantive amendments: updating the format, simplifying the language and requiring greater investor engagement. In the current investor statements, investors only have to sign the bottom of the statement declaring they are high net worth or sophisticated, without specifying which of the relevant criteria they meet. The government is proposing that in the updated statement the investor would be required to select which specific criteria they meet in order to be classified as high net worth or sophisticated, and to set out how they meet these criteria.
- Updating the name of the high net worth individual exemption. The government proposes to amend the name of the exemption to the ‘high net worth individual' exemption, removing certified from the title.
Conclusion: What does this mean for you
As discussed in this article, ‘FCA and HMT Consultation Papers on the AR Regime', issued earlier this month, over the last two years we have strengthened our oversight arrangements which has resulted in robust due diligence and ongoing monitoring systems and controls in place.
We can provide advice and guidance when implementing these new rules, and this support could include:
- Policy and procedure updates: We can help you design new policies and procedures to comply with these new rules. This could mean providing you with one of our template policies and tailoring it with you.
- Training: we can provide bespoke training courses to various levels within your business.
Footnotes
1 https://www.fca.org.uk/publication/consultation/cp21-36.pdf
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.
