New rules on financial promotion of high-risk investments

The FCA’s concern is that consumers turn to high-risk investments in a search for higher returns than mainstream investments can offer, but often do so with limited knowledge and limited means of absorbing potential losses.

To address this, the FCA has put together a package of changes for firms when making their own financial promotions that can be broadly categorised into three areas:

• Classification of high-risk investments;
• The consumer journey into high-risk investments; and
• Stronger appropriateness assessments for RMMIs.

In the same package of changes, the FCA has also introduced new rules applicable to firms that approve financial promotions. Those rules are outside the scope of this article, which focuses on the impact for firms that make their own financial promotions.

Classification of high-risk investments

To rationalise the rules relating to high-risk investments, the FCA has drawn a distinction between two types of investment that are restricted from being mass marketed to retail customers:

Restricted Mass Market Investments (RMMIs) include:

1. Non-Readily Realisable Securities (NRRS) e.g. shares or bonds in a company not listed on an exchange;
2. Peer-to-Peer (P2P) agreements; and
3. P2P portfolios.

Non-Mass Market Investments (NMMIs) include:

1. Non-Mainstream Pooled Investments (NMPI) e.g. pooled investments in an unauthorised fund; and
2. Speculative Illiquid Securities (SIS) e.g. speculative mini-bonds.

For RMMIs, mass marketing to retail investors will only be allowed when accompanied by a risk warning and a risk summary. For NMMIs, mass marketing to retail investors will be banned entirely and financial promotions may only be directed towards exempt categories of retail investor (see client categorisation below) when accompanied by a risk warning and risk summary.

The consumer journey into high-risk investments

To prevent consumers accessing high-risk investments without understanding the risks involved, the FCA is introducing five key changes to the consumer journey:

No incentives to invest:

firms must not communicate or approve a financial promotion relating to a RMMI or NMMI that offers to a retail client any monetary or non-monetary incentive to invest, excluding shareholder benefits.

Firm competence and expertise:

firms must not communicate a financial promotion unless the individual(s) responsible for its compliance with the financial promotion rules have the appropriate competence and expertise in relation to that type of investment. If a firm does not have the appropriate competence or expertise, it must obtain approval of the financial promotion from another firm that does have it before the financial promotion is communicated.

Client categorisation:

before communicating a financial promotion in relation to a NMMI or a Direct Offer Financial Promotion [1] (DOFP) in relation to a RMMI to a retail client, firms must obtain a completed certificate (in the newly prescribed form) confirming that the client fits within one of the following exempt categories:

• certified high-net-worth individual
• certified/self-certified sophisticated investor
• certified restricted investor

These certificates require the retail client to provide reasons for why they meet the relevant criteria to be certified, including details of income, assets or businesses as appropriate. For RMMIs, firms must check that these reasons are sufficient but are under no obligation to verify that the stated evidence is true. However, for NMMIs firms must take reasonable steps to ensure that the client does meet the relevant criteria, having regard to their duties under the FCA’s Principles for Business and the client’s best interests rules.

24-hour Cooling off period:

firms must not share a DOFP for RMMIs or financial promotion for NMMIs until 24 hours after the retail client has requested to view it. When the cooling off period has elapsed, firms must invite the retail client to specify whether they wish to leave the investment journey or continue to receive the financial promotion.

Personalised risk warning:

before communicating a financial promotion of a NMMI or a DOFP of a RMMI to a retail client, firms must communicate to the client a personalised risk warning, following the prescribed form. This is a separate and earlier risk warning than the risk warning and risk summary to be provided with the financial promotion. This warning must include an invitation for the client to specify whether or not they wish to continue with the investment journey.

Stronger appropriateness and suitability assessments

For RMMIs, all retail investors must pass an appropriateness test before an order can be fulfilled, unless they are receiving professional advice. The FCA has confirmed that it expects firms to conduct the appropriateness assessment prior to the DOFP being made.

There are also detailed rules on the steps that firms should take if a retail investor fails an appropriateness test. For example, investors are allowed to re-sit the test, but after two failures must wait 24 hours between attempts. Firms must not inform investors of the answers that led to the investment being determined inappropriate; and firms must ensure that each test an investor sits is different. Importantly, firms must not encourage retail investors to re-sit the test in any way but may advise them of the option to re-sit.

For the types of investment that fall within the definition of an NMMI, self-certified sophisticated investors and high-net-worth individuals are already subject to a preliminary assessment of suitability (“PAS”) under the existing rules, unless they are receiving professional advice. The FCA has emphasised that this is different to the appropriateness test, which focuses on the client’s knowledge and experience to assess whether they understand the risks of the investment. The PAS goes a step further, requiring the firm to understand the client’s personal circumstances and assess whether the investment is likely to meet their needs and objectives.

How can we help?

We can review your procedures to ensure that your financial promotions are compliant with upcoming changes; provide advice on the classification of your investment products and the customer journey into them; and assist with the design of appropriateness tests and suitability assessments.

If you have any questions, read more and get in touch with our Financial Services team here.

[1] The FCA defines a DOFP as a non-real time financial promotion that contains an offer or invitation to enter into a controlled agreement (an agreement which, when performed constitutes a controlled activity) and which specifies the manner of response or includes a form by which a response can be made.