On 1 December 2022, the FCA is introducing a new classification of investment products, together with new restrictions on issuing financial promotions on higher-risk products to retail consumers. From this date, the FCA is also strengthening the role of firms approving and communicating financial promotions. From 1 February 2023, the FCA is revising the declarations for the High Net Worth and Certified/Self-Certified Sophisticated Investor Statements, as well as amending the requirements around Appropriateness Assessments. Both sets of rules were confirmed in the FCA’s Policy Statement PS 22/10 issued in early August 2022.
Taken together with related initiatives from HM Treasury on approving financial promotions and qualifying cryptoassets, these changes represent a significant reboot of the regulation of financial promotions. Although these are aimed primarily at the retail sector, there are also important measures that wholesale firms should take note of.
Why are the new rules being introduced?
One of the main triggers for the new restrictions was the so-called mini-bond scandal involving London and Capital Finance (LCF). In December 2018, the FCA required LCF to immediately withdraw its promotional materials after finding them highly misleading and imposed additional restrictions on its business activities. LCF subsequently collapsed, in January 2019, owing some £237 million to about 12,500 investors and leaving taxpayers with a bill of about £120 million in compensation.
In addition, as it argued in Discussion Paper (DP 21/1) on Strengthening our Financial Promotions Rules, issued in April 2021, the FCA sees emerging risks associated with a new breed of financial consumer – typically younger and accessing promotions via online platforms and social media. These risks have become particularly prevalent in the cryptoasset space and may also have been accelerated during the pandemic/lockdown.
A reminder of the current rules on financial promotions
At the time of writing, there are three intersecting elements to the regulation of financial promotions in the UK:
Section 21 (s.21) of the Financial Services and Markets Act (FSMA), which contains the key general prohibition on the promotion of financial products and services by unauthorised persons (i.e. unregulated firms).
s.21, includes an exemption from the general prohibition where communications are approved by regulated firms.
FSMA (Financial Promotion) Order 2005 (FPO), which contains certain exemptions from s.21, including allowing unauthorised persons to issue promotions to certain types of sophisticated investors (such as investment professionals) and high net worth individuals.
COBS 4 within the FCA Handbook, which sets out the key requirements to be fulfilled by firms issuing promotions, including the overarching “fair, clear and not misleading”. These include restrictions applying to certain categories of recipients, for example, Non-Mainstream Pooled Investments (NMPI), as set out in COBS 4.12.
New financial promotions regime for high-risk investments
Under the new regime for financial promotions, investment products are split into three new categories:
1. Non-Mass Market Investments (NMMI): these consist of:
a) Non-Mainstream Pooled Investments (see above) - for example, hedge funds and other unregulated collective investment schemes; and
b) Speculative Illiquid Securities (SIS) - for example, speculative mini-bonds (see COBS 4.12B.50R for full definition).
Financial promotions of NMMI must not be communicated to retail investors.
2. Restricted Mass Market Investments (RMMI): these consist of:
a) Non-Readily Realisable Securities (NRRS). For example, shares and bonds in companies not listed on an exchange;
b) Peer-to-Peer (P2P) agreements and portfolios; and
c) Qualifying cryptoassets (subject to parliamentary approval and publication of the final rules regarding qualifying cryptoassets)
Mass marketing of RMMI to retail investors is permitted, subject to certain conditions.
3. Readily Realisable Securities (RRS): listed or exchange-traded securities. or example, shares or bonds traded on the London Stock Exchange. There are no restrictions on the marketing of RRS.
What are the new restrictions applying to RMMI?
1. A ban on incentives
Financial promotions on these investments must not offer retail investors any monetary or non-monetary incentives to invest. Examples include:
Bonuses for first-time investors or for referring another person
Free gifts or free additional investments
2. Improved risk warnings
Financial promotions must include a prescribed risk warning, such as “Don’t invest unless you’re prepared to lose all the money you invest”. The exact wording and format vary somewhat depending on the nature and location of the financial promotion – see COBS 4.12A.11R for these details.
Personalised risk warnings are also required for direct offer promotions involving RMMI. For example, “[name of client], don’t invest unless you are 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.”
3. Positive frictions
Minimum 24-hour “cooling off” periods apply to direct offer financial promotions. The purpose of this is to give retail clients sufficient time to consider whether a high-risk investment is appropriate. At least 24 hours after a retail client requesting the direct offer, the firm (or person communicating the offer) must give the client the choice (with equal prominence) of leaving the “investment journey” or continuing to receive the promotion.
Approving financial promotions from unauthorised persons
This was another weakness in the current regime for financial promotions identified by His Majesty's Treasury (HMT) and the FCA. Henceforth, firms approving a financial promotion from third parties must require, from that unauthorised person, a written quarterly attestation confirming that no material change to the promotion is required, or an explanation of the circumstances in which compliance with the rules might change. Attestations must be received within three months of the initial approval, and every three months thereafter for as long as the promotion is communicated.
The current rules in COBS 4.12 permit promotions relating to NMPI to be communicated to certain exempt categories, such as Restricted, High Net Worth (HNW), and Sophisticated investors. The FCA is revising the documentation to help consumers better categorise themselves, including: simplifying the language in the declaration forms, adding a ‘none of the above’ option to the declarations, and adding an evidence declaration where consumers will be required to state why they meet the relevant criteria. For example, stating their income to demonstrate they are high net worth.
The new rules require that, where consumers are declaring income and net assets, they must do so to the nearest £10,000 and £100,000 respectively. The FCA also sets expectations on the level of checks that would be expected to be conducted by firms, requiring that they should look for supporting evidence for the relevant criteria.
The appropriateness rules must be followed for all categories of retail client for RMMIs, unless the investor is receiving advice. The new rules will expect firms to gather the information necessary to conduct the assessment and complete its assessment, prior to the Direct Offer Financial Promotion (DOFP) being shown.
In the case of NMMI, Self-Certified Sophisticated, and High Net Worth Investors requesting to see a financial promotion, must be subject to a preliminary assessment of suitability (unless the investor is receiving advice). This requires the firm to understand the client’s personal circumstances, so they can assess whether the investment is likely to meet the client’s needs and objectives.
Firms must maintain records for at least 5 years on the following:
The outcome of client categorisation - the number of consumers categorised as High Net Worth (HNW), sophisticated and restricted, and the reason why they believe they meet those criteria.
The number of consumers who do not proceed with the consumer journey at client categorisation (those that do not get categorised).
The outcome of the appropriateness assessment.
Action points for affected firms
Firms who promote the designated high-risk investments to their clients and prospects should review their processes as a matter of urgency with the new rules now imminent, including:
Identifying in-scope investment products and financial promotions (including website, newsletter, presentations, social media).
Reviewing CRM/distribution lists for NMMI and removing ineligible retail contacts.
Ensuring prescribed risk warning is in place on in-scope promotions and updating the financial promotion approval process.
Amending procedures, distribution lists/CRM, email templates, forms and websites (etc) to comply with positive frictions, client categorisation, and appropriateness tests for in-scope products by 1st February 2023.
Updating compliance manuals and relevant policies and procedures.
Providing training to relevant staff.
Related resourcesAll resources
Proposed changes to HNW and sophisticated investors’ financial promotions exemptions watered down
Consumer Duty: a wake-up call to all? Dear CEO letter to Wealth Managers and Stockbrokers
FCA warns on insider dealing risks around market soundings
Reminder to attest your AR details - 2023