Creating Or Advising On High-risk Products? You'd Better Read On
Background
In August 2022, following its consultation (CP 22/2), the FCA published its Policy Statement 22/10 containing stronger rules to help tackle misleading financial promotions that may encourage consumer investing in high-risk products. The FCA presented this as a ‘key branch in its Consumer Investment Strategy’.
Certainly, these products normally sit on the periphery of investment advice and bring with them acute risks, but they do have their uses in the right circumstances.
These new financial promotions compliance rules are now in place, so this article is essential reading for any firm developing, dealing, arranging, or advising on so-called ‘high-risk products’.
Why has the FCA introduced these new financial promotion standards?
Worryingly consumers are increasingly responsible for making complex decisions about how they invest their long-term savings. This, combined with a plethora of choices, has led the FCA to believe that it’s increasingly easy to target inexperienced consumers with adverts for high-risk investments online, which would not be in their best interests.
The regulator believes that COVID has accelerated this trend and points to its Financial Lives Survey from 2020, in which it expresses its calculation that 6% of adults holding investments have increased their holdings of high-risk holdings. This view is supported by data received from IPSOS MORI. The FCA has said that better outcomes for investors in higher-risk investment are “a critical element” in its Consumer Duty and without tougher financial promotions compliance rules around the promotions of these products, retail customers will continue to suffer harm.
To redress the balance, in its Policy Statement, the FCA effectively delivered a “minimum baseline” for firms offering high-risk investments and has set a clear expectation of financial promotions compliance. However, the FCA is expecting firms to go above and beyond these minimum standards and believes that many products will be removed from the shelf for retail investors or will face reduced takeup as a result of the changes.
Introduction over, let’s get into the detail ….
• Know your RMMIs from your NMMIs and where current products fit…The FCA has categorised high-risk investments so to ensure that products with similar characteristics are regulated in the same way. All high-risk investments are either now referred to as ‘Restricted Mass Market Investments’ or as ‘Non-Mass Market Investments’. Existing high-risk investments l fall under these new categories.
Non Readily Realisable Securities (NRRS), such as peer-to-peer agreements are still permitted to be marketed to retail consumers, subject to certain restrictions, and will come under the banner of ‘Restricted Mass Market Investments’.
‘Non-Mass Market Investments’ now include Non-Mainstream Pooled Investments (NMPI) and Speculative Illiquid Securities (SIS), which remain banned from being mass marketed to retail investors. The FCA has decided to exempt closed-ended investment funds from the rules.
The aforementioned categorisation is based on the FCA’s opinion that the ‘riskiness’ of an investment is based on a variety of factors. These include :
• credit risk;
• market risk;
• concentration risk;
• liquidity risk;
• the complexity of the investment;
• the degree of information imbalance between market participants;
• the ability for consumers to reasonably understand the investment; and
• whether the investment is subject to other protections which may mitigate harm to consumers.
• New risk warnings have landed
A new standard risk warning is now required in all financial promotions for RMMIs and NMMIs, plus a set of prescribed format requirements for how this should be displayed.
The standard warning is:
‘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.’
The FCA has also introduced a standard summary of risk information for the particular investment type (a ‘risk summary’), which needs to be linked to the wording ‘Take 2min to learn more’ text or alternatively be provided to the consumer in a durable medium (possible outside of a digital setting).
Firms will be allowed to use an alternative risk warning if the prescribed risk warning could be shown to be misleading or confusing for investors, although this will be very restricted and would need to be evidenced.
The FCA is expected to create more differentiation in the risk warning in its second phase of work in 2023, alongside reviewing the planned classification of investments within the financial promotions compliance rules.
• Higher standards for approvers of financial promotions for high-risk investments
The FCA is placing more focus on the role of ‘section 21 approvers’ (taken from Section 21 of FSMA), as it believes these firms/individuals play a pivotal role in enabling unauthorised issuers of high-risk investments to reach their consumers by approving their financial promotions compliance.
Consequently, the FCA has developed a robust regime that will ensure s21 approvers will need to meet much higher standards. The FCA’s overall expectation is that these approving firms must have the relevant expertise in the promotion of higher-risk investments, monitor their use, and direct their removal when financial promotions are no longer compliant.
Here are some of the key requirements for s21 firms to consider:
1. The approver will need to assess whether it has relevant experience and/or qualifications in the investment product/ sector that is the subject of the financial promotion. As part of this, approver firms will need to assess the previous employment history and qualifications of the individuals responsible for approving promotions and whether they have relevant experience.
2. The approver will need to confirm that it has adequate resources, systems, and controls in place to approve and monitor the financial promotion, particularly when the firm is approving large volumes of promotions.
3. Approvers will need to obtain an attestation of ‘no material change’ from product manufacturers with approved promotions every three months, for the lifetime of the promotion.
4. A firm issuing a promotion will include ‘Approver FRN xxxxxx’ (and the relevant FRN number must be inserted). This text must be ‘clickable’ and must open a page where the firm’s full name, and the date of the approval, must be displayed.
• A 24-hour cooling-off period
A minimum 24-hour cooling-off period will be applied for the first time for RMMIs and NMMIs. This would mean that the consumer could not receive the financial promotion unless they reconfirmed their request to proceed after waiting at least 24 hours.
Interestingly, the FCA accepted that this requirement may create some uncertainty in terms of how it may conflict with the FCA’s Consumer Duty, coming into effect later this year. In the meantime, the FCA has pressed ahead with the new requirements.
It’s also worth noting that the FCA’s ‘DOFP rules’ are not intended to limit the information firms can otherwise provide to consumers about their investments. For example, a financial promotion can contain information about the investment opportunity such as potential rates of return and how clients’ funds will be invested. This information alone, without a ‘manner of response’ or ‘form by which any response may be made’ would not trigger the additional protections.
• Customers will need to confirm their categorisation
Consumers will be required to state why they meet the relevant criteria. For example, by stating their income to show they are in fact high net worth; firms will need to check that this complies with the appropriate classification (although they will not be required to verify this).
• Tougher requirements for appropriateness tests
Appropriateness tests must be applied to all RMMIs, for all categories of retail clients (namely restricted, certified high net worth, certified and self-certified sophisticated investors). Naturally, this will not apply to advised clients. The FCA will be issuing guidance on the types of questions to be covered by an appropriateness assessment for RMMIs. Ultimately, the FCA wants to ensure that a high-risk product is determined to be appropriate for a consumer before an order or application is fulfilled.
In addition, firms will only have ‘one bite at the cherry’ during a 24-hour period, i.e., where an investment is assessed as being inappropriate for a consumer, the firm cannot re-assess the appropriateness of that investment for the same client for at least 24 hours.
The FCA is also planning to introduce a financial promotions compliance rule that the questions firms ask must be different each time a consumer is subject to the assessment. Also, consumers should only be told the broad areas that caused the investment to be assessed as inappropriate, rather than the specific questions. Consumers must also not be encouraged to retake the test after the investment has been assessed as inappropriate.
In the case of Non-Mass Market Investments, investors (who must be self-certified sophisticated and high net worth investors) requesting to see a financial promotion must also be subject to a preliminary assessment of suitability unless the investor is receiving advice, before being able to view the financial promotion.
• All incentives to invest will be banned
With the exception of crowdfunding schemes (because of the impact on shareholder benefits), all incentives of any kind to invest in high-risk investments (e.g., ‘refer a friend’), re now banned. The FCA has also warned product providers that it will take action if it sees attempts to navigate around the “intention of the rules”.
• Record keeping
Predictably, firms will need to keep accurate records of their marketing of RMMIs & NMMIs. However, given the new data requirements following the Consumer Duty, the FCA has indicated that it expects firms to record only metrics relating to client categorisation and appropriateness assessments. We however would expect firms to record details of any preliminary assessment of suitability.
• Crypto normalisation
Crypto assets are now making inroads into retail financial services and although they currently sit outside the FCA’s remit, the Treasury has confirmed its intention to legislate to bring certain crypto assets into the scope of the current financial promotions compliance regime, with special measures.
CP22/2 lays out the proposed rules for crypto asset promotions which will become rules once the relevant legislation has been made by the Treasury.
Nick Hunt, Senior Investments Manager - Connect with Nick Hunt on LinkiedIn
How can we help you?
Thistle Initiatives has supported firms for over 10 years as a trusted financial promotions compliance and regulatory advisor. In addition to assisting you as-and-when, our team of specialists can serve as your right hand in a meeting and complying with regulations. We understand the importance of staying up-to-date and compliant and are dedicated to providing the guidance and support needed to do so.
Are you looking for help with the implications of financial promotions compliance for your firm, either as a manufacturer or as a financial adviser recommending these changes? Contact our specialist team now to schedule a free consultation. Get in touch with us by calling 0207 436 0630 or sending an email to info@thistleinitiatives.co.uk.