FCA regulation around high-risk investments to be stiffened

Out-Law News | 27 Jan 2022 | 1:49 pm | 4 min. read

Financial services firms that promote high-risk investments, including those they communicate or approve on behalf of unregulated businesses, face stricter regulation in the UK under plans outlined by the Financial Conduct Authority (FCA).

The regulator has opened a consultation on strengthening financial promotion rules for high-risk investments after identifying “a rapid growth in the proportion of consumers holding high‑risk investments” and “growing evidence that consumers do not fully understand the risks involved”.

“High‑risk investments have a place in a well‑functioning consumer investment market for those who understand the risks involved and can absorb potential losses,” the FCA said. “We do not want to unnecessarily restrict consumers from investing if they want to. However, we do want them to be able to access and identify investments that suit their circumstances and attitude to risk.”

Day Josie

Josie Day

Senior Practice Development Lawyer

The FCA is seeking to tighten up the marketing requirements for high-risk investments so consumers’ decision making in this area is better informed and consumer harm reduced

The FCA’s proposals for reform are multi-faceted. Specific measures to “strengthen the consumer journey” for high-risk investments are proposed, as well as requirements for firms that communicate or approve investment promotions to self-assess whether they have sufficient competence and expertise in the investment or service in the promotion before approving or communicating it. The FCA also plans to apply its new financial promotion rules in relation to high-risk investments to cryptoassets under proposals which complement Treasury plans to extend the FCA’s regulatory remit so more cryptoasset investment promotions will be subject to the financial promotion regime.

Josie Day of Pinsent Masons said: “The FCA’s consultation paper reflects many of the key themes and risks in consumer investment markets the FCA is currently addressing in other areas of its work. A particular example is addressing harms to consumers from holding high-risk investments they may not understand, that may not meet their needs or correspond to their appetite for risk or ability to sustain financial loss. It is against this backdrop that the FCA is taking a harder look at the financial promotion regime. It is now seeking to tighten up the marketing requirements for high-risk investments so consumers’ decision making in this area is better informed and consumer harm reduced.”

On the ‘consumer journey’ plans, the FCA wants to bolster risk warning requirements and ban inducements to invest in high-risk investments. It is also seeking to require firms impose “positive frictions” – including personalised risk warnings and ‘cooling off’ periods – to help retail investors make “more considered investment decisions” and counter the “social and emotional pressures” they may face to invest in the promoted products.

Other measures proposed include changing rules around the declarations investors need to make to better categorise them, and for firms to do more to check that the restricted mass market investments consumers wish to make are appropriate relative to their knowledge and expertise.

The FCA also plans to toughen the rules that apply to authorised firms communicating and approving financial promotions – firms that effectively provide a gateway to the regulated market for unregulated businesses.

Day Josie

Josie Day

Senior Practice Development Lawyer

The new proposals for more stringent assessment by firms of their competence and expertise in relation to investments or services to which financial promotions they approve or communicate relate, would be a practical change

Just two of the 681 financial promotions reviewed by the FCA between December 2020 and August 2021 were ‘section 21’ approved promotions for investment business, but it said it expects an uptick in approvals of financial promotions for unauthorised persons in future when the plans to bring more cryptoassets within the financial promotion regime and to make changes to the financial promotion order exemptions take effect. The FCA said it wants to avoid a repeat of problems it has seen before.

“Historically, we have seen too many poor quality and non‑compliant promotions being approved and communicated to retail investors,” the FCA said. “We have seen approved promotions with inadequate due diligence by s21 approvers including, for example, promising unrealistic rates of return. Consumer harm has arisen when these promotions are made to consumers for whom the underlying investment product is unsuitable, e.g. when not aligned to the consumer’s risk appetite. In the worst cases, the investments underperformed or failed and led to significant and unexpected losses for retail investors.”

Under the specific new measures that the FCA proposes, section 21 approvers will be obliged to “ensure that the financial promotion clearly states on its face the date on which it was approved”, to help consumers consider whether the information is outdated. They will also be required to “self‑assess whether they have the necessary competence and expertise (C&E) in an investment product or service before approving or communicating a relevant financial promotion”.

Day said: “The new proposals for more stringent assessment by firms of their competence and expertise in relation to investments or services to which financial promotions they approve or communicate relate, would be a practical change.  Firms would need actively to assess the extent of their expertise in respect to the particular investment or service in the promotion. The FCA is proposing areas for firms to consider in this self-assessment, such as the qualifications and experience of the approving staff. The FCA’s proposals would mean firms would also need to record how they satisfied themselves they met this new C&E requirement with respect to the particular promotion.”

Further proposed obligations would extend existing obligations around the ongoing monitoring of financial promotions by section 21 approvers over the promotion’s lifetime, and also require them to check, on an ongoing basis, the promotion remains compliant with the FCA’s rules as well as remaining clear, fair and not misleading. The proposal for three-monthly attestations of ‘no-material change’ to the approved promotion from their client should assist approvers with this obligation.

The FCA said: “Our proposals aim to ensure the quality, competence and expertise of firms approving financial promotions, which in turn will drive improvements in the quality of approved promotions. Higher quality promotions will enable consumers to make more informed and effective investment decisions and more easily identify suitable products that meet their investment needs and risk tolerance.”

Cavill Jonathan

Jonathan Cavill

Partner

The latest proposals around financial promotion reflect the FCA’s broader desire to require regulated firms to provide a higher level of focus on good consumer outcomes and on more informed decision making by consumers in financial markets

Separate plans to amend and update the financial promotion exemptions for high-net worth individuals and sophisticated investors were set out by the Treasury in December. That consultation closes on 22 March.

Jonathan Cavill of Pinsent Masons said: “The FCA’s consultation paper follows publication of its consumer investments strategy in September last year in which it set out the objective of helping deliver a consumer investment market that helps people who want to invest do so with confidence and a three-year plan to address the harms in the market. The latest proposals around financial promotion also reflect the FCA’s broader desire to require regulated firms to provide a higher level of focus on good consumer outcomes and on more informed decision making by consumers in financial markets.”

“To this end the regulator is introducing a new ‘consumer duty’ which will require firms involved in the provision or manufacture of products or services for the retail market to consider the needs and likely outcomes for consumers throughout the lifecycle of a product or service. This supports the FCA’s existing work on vulnerable customers as well as its recent focus on the impact of D&I on regulatory risk,” he said.