Both the Treasury (‘HMT’) and the FCA have carried out consultation exercises on the financial promotions regime, including proposals to bring cryptoassets within its scope. Some proposals will definitely be implemented, while others seem very likely. In this article, financial services partner Tony Watts summarises how the new financial promotions landscape may look.
Starting point – the Financial Promotion Restriction
Section 21 Financial Services and Markets Act 2000 (‘FSMA’) states that no person shall in the course of a business communicate an invitation or inducement to engage in investment activity (a ‘financial promotion’) unless that person is authorised under the FSMA or the communication comes within an exception to this rule – the Financial Promotion Restriction.
Financial promotions can take any form, written or oral. They can originate outside the UK, but will still be subject to the Financial Promotion Restriction if they have an impact in the UK.
The definition of ‘investment activity’ is wide and does not just apply to activities for which FCA authorisation is required. For example, a company does not generally need to be FCA-authorised to issue its own shares or bonds, but any promotion of these is potentially subject to the Financial Promotion Restriction.
The main exceptions to the Financial Promotion Restriction are set out in the FSMA 2001 (Financial Promotion) Order 2005 (‘the FPO’). Very commonly used exceptions include those that allow unlisted companies to promote issues of shares or bonds to investors who can certify themselves as high net worth or sophisticated.
HMT proposes significant legislative changes to the FSMA and the FPO. The FCA proposes to change its rules relating to risk investments and authorised firms that approve financial promotions of third parties (‘Approver Firms’).
The FSMA will be amended so that Approver Firms must be specifically permitted for this activity – restrictions will be placed on their permissions which a firm can apply to the FCA to lift. HMT has confirmed that this change will be made.
HMT also proposes narrowing the exceptions for self-certified high net worth and sophisticated investors in relation to investment in unlisted securities. The FPO exceptions currently apply to those who declare themselves to be high net worth (based on net income of £100,000 or net assets of £250,000) or sophisticated (based on various criteria including more than one investment in an unlisted company in the previous two years). Both exceptions require specific risk warnings and explanations.
HMT proposals include:
- Increasing the figures for high-net-worth investors either to £150,000 income/£385,000 assets (adjusting simply for inflation) or to £175,000 income/£900,000 assets to capture the same top 1% of investors and asset owners as was originally eligible;
- Changing criteria for sophisticated investors, removing the gateway of investing in two unlisted companies in the past two years;
- Requiring the issuer of the financial promotion to have a ‘reasonable belief’ that the investor meets the relevant criteria – necessitating more detailed questions as to net worth or sophistication; and
- Simplifying the very technical language of the declarations and requiring investors to specify the exact criteria that they meet.
This HMT Consultation closed on 9 March 2021.
Finally, the Financial Promotion Restriction will be extended to ‘qualifying cryptoassets’, i.e. ‘any cryptographically secured digital representation of value which is fungible and transferable’ (though this definition may be refined). Financial promotions relating to activities relating to cryptoassets will be regulated even where (at the moment) the relevant activities may not be – see above for the similar situation as regards companies issuing their own shares or bonds.
The self-certified high net worth and sophisticated investors exceptions will not, however, apply to cryptoassets. A more limited sophisticated investor exemption (requiring a FSMA-authorised firm to confirm the sophistication of the investor) will apply – but this is very rarely used in practice.
HMT confirmed in January 2022 that it will introduce these changes.
FCA Consultation Paper CP 22/2 (Strengthening our financial promotion rules for high risk investments, including cryptoassets) proposes significant changes which will apply to FSMA-authorised firms.
Under FCA Rules, there are three main categories of high-risk investments which involve restrictions on their being promoted to retail investors. The categories (and how the FCA proposes to re-group them) are:
|Non-mainstream pooled investments (‘NMPIs)||Includes collective investments not authorised as retail funds.||These may only be promoted to retail clients who have already certified themselves as high net worth or sophisticated (using similar tests to those in the FPO) and whom the firm has assessed as suitable. Specific risk warnings are required. Under the new rules these will be grouped together as ‘Non Mass Market Investments’.|
|Speculative illiquid securities (‘SIS’)||Includes many (but not all) minibonds|
|Unlisted shares and bonds, peer-to-peer loans||Includes many investments which are offered via crowdfunding platforms||Direct Offer financial promotions (i.e. those which contain an actual offer such as an application form) may be communicated to self-certified high-net-worth and sophisticated investors but also to Restricted Investors (i.e. those who declare that they have not in the past 12 months and will not in the next 12 months invest more than 10% of net income or assets). Investors must be assessed as appropriate by the firm before they invest. The FCA will group these under the heading ‘Restricted Mass Market Investments’. Cryptoassets will be included in this category.|
The rules on promoting Restricted Mass Market Investments are in practice more flexible than those relating to Non-Mass Market Investments (and this is a potentially good result for cryptoassets promotions). For example:
- Since the rules on Restricted Mass Market Investments apply mainly to Direct Offer Financial Promotions (not all other financial promotions), they permit some flexibility with other promotional material.
- The appropriateness test required for Restricted Market Investments is less stringent than the suitability test required for Non-Mass Market Investments.
- Restricted Market Investments allow promotion to a wider market of ordinary retail investors.
FCA detailed proposals for change in relation to all high-risk investments include:
Strengthening the customer journey in relation to high-risk investments, including:
- improving risk warnings, with a single warning for all high-risk investments, clearly stating that investors may lose all their money;
- banning inducements to invest (such as refer-a-friend bonuses or early-joiner bonuses);
- adding ‘positive frictions’ to the consumer journey, making the investor pause and consider further risk warnings (together with a 24-hour cooling-off period for first-time investors with the firm);
- changing investor declarations (i.e. that investors are high net worth, sophisticated or Restricted investors) requiring evidence that investors meet the relevant criteria;
- strengthening appropriateness tests so consumers only invest following a robust assessment of their knowledge and experience – if an investor fails the test, they will not be allowed to retake it for 24 hours and different questions must be asked;
- requiring firms which allow investors to invest by credit card or other debt to have systems to assess vulnerability of clients.
Tightening the rules on Approver firms, including:
- Promotions to carry the name of the Approver Firm with a date stamp, showing when the promotion was approved;
- Approver Firms to be able to demonstrate that they have the competence and expertise in relation to the investments promoted (as mentioned above, under the HMT changes Approver Firms will also need to be specifically permitted to approve third-party promotions);
- Approver Firms must continue to monitor financial promotions after they have approved them to ensure that they continue to comply with the rules, including obtaining three-monthly confirmations from the issuer of the financial promotion. Approver Firms must be satisfied that advertised returns remain realistic.
- Approver Firms will be subject to conflict-of-interest obligations so that they do not misuse their position as to gain a competitive advantage over their rivals.
CP 22/2 close 23 March 2022. The FCA intends to confirm its final rules in the summer of 2022 and will give a three-month transitional period for firms to make changes.
Consequences of the changes to the financial promotions regime
The result of these changes (most of which will or are likely to be made) will be:
- There will be less reliance on exceptions so more financial promotions will in practice be approved by Approver Firms.
- The regime for Approver Firms will be much tougher (including the need to be specifically permitted by the FCA to approve financial promotions).
- Authorised firms will be obliged to apply much tougher tests before allowing retail clients to invest in high-risk investments.
- There will be new controls on promotion of cryptoassets – but under FCA Rules (where financial promotions are approved by a FSMA-authorised firm) investment by ordinary retail investors will at least be possible.
If you have any questions on the proposed changes to the financial promotions regime, please contact Tony Watts.
This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.