High risk not enough rewards
24 January 2022
On 19 January 2022, the FCA published its consultation paper on "Strengthening our financial promotion rules for high risk investments, including cryptoassets" (CP 22/2).
It is no secret the FCA is concerned with the popularity of high risk retail investment products. In the regulator's view, these are not well understood by consumers nor aligned with consumer needs. These concerns have only been exacerbated by the COVID-19 pandemic, which has seen a rapid rise in consumers holding these investments.
The consultation paper is hot on the heels of the Treasury's consultation on cryptoasset promotions and contains a number of proposals to mitigate the marketing of high risk investments, some of which extend and others which compliment proposals previously published:
proposal | reference in previous update |
---|---|
Proposal 1: Introducing a new three-part classification of high-risk investments, namely (1) readily realisable securities; (2) restricted mass market investments; and (3) non-mass market investments | Sep 2020 – FCA call for input on "The Consumer Investments Market" (see our briefing here) September 2021 – FCA feedback statement on "Consumer Investments Strategy" (the "Consumer Investments Statement") (see our briefing here) August 2021 – FCA discussion paper 21/1 on "Strengthening our financial promotion rules for high-risk investments and firms approving financial promotions" (the "Discussion Paper") (see our briefing here) December 2021 – HMT consultation paper on "Financial promotion exemptions for high net worth individuals and sophisticated investors" (see our briefing here) |
Proposal 2: Strengthening the consumer journey for high risk investments by requiring improvements to risk warnings and appropriateness tests, banning inducements, and adding positive frictions | |
Proposal 3: Strengthening the requirements on firms that communicate financial promotions or approve them for unauthorised firms | July 2020 – HMT consultation paper on "Regulatory Framework for approval of financial promotions" (see our briefing here) June 2021 – HMT response to the above consultation paper (see our briefing here) |
Proposal 4: HMT has confirmed it intends to extend the scope of the financial promotion rules to "qualifying" cryptoassets. The FCA is proposing to classify cryptoassets as "restricted mass market investments" (see proposal 1) | July 2020 – HMT consultation paper on "cryptoasset promotions" (see our briefing here) January 2022 – HMT response to the above consultation (see our briefing here) |
The FCA is introducing its new risk classification to make it easier for consumers to accurately match products with their level of risk and to make the rules clearer and simpler for investment firms to apply to their products and services in practice.
The consultation paper proposes to introduce a new tripartite classification of investments, based on their level of risk. Restrictions on who can receive financial promotions relating to these investments are set out for each of the three categories, with fewer marketing restrictions for low risk investments, and greater marketing restrictions for high risk investments.
We summarise the FCA's proposals below:
Risk classification | Risk level | Types of investment caught | restrictions on financial promotion (other requirements may apply) |
---|---|---|---|
Readily Realisable Securities (RRS) | Lowest |
| No restrictions on financial promotions made to retail investors. |
Restricted Mass Market Investments (RMMI) | Medium |
|
|
Non-Mass Market Investments (NMMI) | Highest |
|
|
The FCA has proposed making the following changes to the consumer journey when the client wishes to begin trading higher risk investments:
The FCA has proposed additional requirements for firms that are able to approve financial promotions under "FSMA s21 approver" rules. In particular, if the proposals in the consultation paper are accepted, then:
As the consultation paper makes clear, these requirements will be more onerous in the cryptoasset sector, which is currently outside the regulatory perimeter, meaning that most cryptoasset firms are unauthorised and will need to appoint a s21 approver to approve financial promotions of qualifying cryptoassets.
The Treasury has announced that it intends to bring "qualifying cryptoassets" in scope of the UK's financial promotion regime. Qualifying cryptoassets are defined broadly as "any cryptographically secured digital representation of value or contractual rights which is fungible and transferable", but excludes electronic money, certain payment tokens, and central bank money. This definition would include most cryptoasset traded on retail exchanges, such as Bitcoin (BTC) and Ether (ETH).
As described above, qualifying cryptoassets will be classified as RMMIs, meaning that they will be subject to the restricted financial promotions regime, including prohibitions on inducements, new frictions in the customer trading journey and limits on the types of consumer that can be targeted by financial promotions.
The FCA, following the Treasury's approach, has proposed to exempt financial promotions to certified sophisticated investors from some of these restrictions. However, the FCA does not currently propose to extend this exemption to self-certified sophisticated investors and high net worth investors.
The contents of the consultation paper is likely to come as a profound surprise to those who have been monitoring the FCA's recent publications. However, it does demonstrate the seriousness of the FCA's intention to reduce the ability of consumers to access high risk investments, especially in the cryptoasset space as the definition of "qualifying cryptoasset" is so broad.
Of the FCA's suggestions, we are most surprised to see the strict ban on inducements, which would extend the FCA's current ban on CFD inducements far more broadly than might have been expected. We are least surprised by the proposed changes to the rules on appropriateness testing, with the FCA acknowledging in the consultation paper that its current rules have a number of weaknesses, and the new rules on s21 approvers, since the Treasury got in ahead of the FCA on that announcement.
As we said in relation to the Discussion Paper in 2021, the consultation paper is an invitation from the FCA to its stakeholders to consult on its proposals, and it does not have legal effect. However, it would be unwise not to expect the contents of the consultation paper to broadly reflect the rules that the FCA ultimately introduces. We would advise firms, especially those in the cryptoasset space, to begin thinking carefully about how they will adapt their business models, client onboarding and financial promotion approval processes to incorporate these new rules.
Co-Author: Anna Burn, Emma Tran
The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
Readers should take legal advice before applying it to specific issues or transactions.
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