High-risk investments - what do the final rules say?

High-risk investments - what do the final rules say?

Following publication of the Consumer Duty final rules, the FCA has now issued final rules for firms publishing or approving financial promotions in relation to high-risk investments (HRI). These new rules are largely consistent with the February consultation: CP22/2.

To recap, the FCA is dissatisfied with the way some firms have promoted HRIs to consumers. Research has shown a significant percentage of consumers do not appreciate the level of risk associated with these products, and the FCA is concerned that many consumers are overly exposed without sufficient safeguards. To improve consumer protections, the new rules cover the adequacy of risk warnings prior to access, the introduction of positive frictions in customer journeys and requirements for firms who approve financial promotions for third parties.

In a previous article we summarised the FCA’s proposals and in this article, we present what is key in the final rules.

Which firms does this apply to?

Firms which issue, or approve for issue, financial promotions in relation to HRIs which are directed at, or likely to be received by, retail clients. HRIs comprise Peer-to-Peer (P2P) investments, non-mainstream pooled investments, non-readily realisable securities and speculative illiquid securities.

Summary of the final rules

Classification of high-risk investments

There are no major changes to the proposals with three categories of investment product [list]. Instruments like P2P investments will continue to be classed as restricted mass market investments (RMMIs) with existing restrictions applicable. The key update in the final rules is that investments issued by local authorities will fall out of scope. unless they are unregulated collective investment schemes (UCIS). In which case they will remain subject to restrictions on the promotion of UCISs.

Risk warnings and associated risk summaries

Following feedback to the FCA proposed rules, the risk warning statement required for promotions of RMMIs and non-mass market investments (NMMIs) has been shortened. New investment risk warning statements have been issued as follows:

P2P agreement or portfolio - Don’t invest unless you’re prepared to lose money. This is a high-risk investment. You may not be able to access your money easily and are unlikely to be protected if something goes wrong. Take 2mins to learn more.

HRIs where the provision/ issuance of the investment gives rise to an FSCS claim - Don’t invest unless you’re prepared to lose all the money you invest. This is a high-risk investment. Take 2mins to learn more.

Shares in closed-ended investment funds listed under Chapter 15 of the Listing Rules - Exempt from HRI risk warning requirements.

All other HRIs - 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 ‘Take 2 mins to learn more’ component of the risk warning will need to link to risk summaries. The FCA are allowing firms to tailor these prescribed risk summaries to the nature of the investment.

The rules also require personalised risk warning pop-ups. These should be provided before a Direct Order Financial Promotion (DOFP) for RMMIs or a financial promotion for NMMIs are communicated to the consumer.

Firms are also reminded that under the Consumer Duty, they should monitor the effectiveness of the risk warnings and improve them where necessary.

Incentives to invest

Despite significant disagreements from industry, the FCA have proceeded with their proposals to ban all incentives to invest in these high-risk investments. An exemption has been allowed for ‘real economy’ goods and services offered by issuers of, or borrowers under, HRIs for example, a brewing company raising funds on a crowdfunding platform and offering investors or lenders discounts on the beer produced.

Cooling off period

There are no changes to the proposals to introduce a mandatory 24-hour cooling off period for first time investors seeking to invest in RMMIs or NMMIs. This is based on behavioural research that such friction in onboarding may help protect consumers. Further clarity has been provided to help firms implement this. 

Firms making DOFP RMMIs will be required to wait 24 hours from the time the consumer requests the DOFP to issuing it to them. In the intervening period, the firm is allowed to carry out activities such as KYC/AML checks, providing personalised risk warnings, client categorisation and appropriateness assessment. For NMMIs, firms must also wait 24 hours from request, before showing financial promotions to consumers.

Client categorisation

The original FCA proposals required potential investors to indicate how they meet the high net worth, sophisticated or restricted investor criteria, and to provide details of their income or the entity of which they are director (if they self-certify as ‘sophisticated’). These proposals have been retained. To address privacy concerns however, investors will now only have to provide their income to the nearest ten thousand pounds and net assets to the nearest one hundred thousand pounds.

Appropriateness assessment

There are no major changes from the original proposals to strengthen appropriateness assessments before consumers can invest in high-risk investments. The FCA have however clarified that the minimum 24-hour cooling off period applies from the prospective investors’ second assessment onwards.

Record keeping

To avoid duplication and potential confusion with the requirements of the Consumer Duty, the FCA have streamlined record keeping requirements. Final rules now require firms to record simplified metrics i.e., the number of consumers categorised as HNW, sophisticated and restricted and why; and appropriateness assessments with outcomes for each consumer.

Implementation period

Firms must complete implementation of main risk warning rules and risk summary (excluding personalised risk warnings) by 1 December 2022. The rest of the rules will apply from 1 February 2023.

Approving financial promotions

The changes proposed to tighten the approval of promotions are unchanged except for a minor clarification. The FCA add that where space is limited, an alternative time and date stamp format will be acceptable. In relation to competence and expertise, the FCA have clarified that firms need to meet requirements in relation to the investment product itself and not the underlying investments.   

Further changes have been announced in the Financial Services and Markets Bill which will mean that firms wishing to approve promotions of unauthorised firms will require permissions from FCA. Firms will be restricted to approvals within their sphere of expertise.

What does this mean for firms?

Firms who distribute or approve financial promotions related to HRIs will need to thoroughly review customer journeys to ensure they are in line with the new rules. With risk warning requirements due to commence in December 2022, and all other requirements coming into force in February 2023, firms have a relatively short implementation period.

Firms will also need to ensure that their work plan for implementing the new rules, complements implementation plans for the new Consumer Duty requirements.

We have published a series of articles on the Consumer Duty and how firms can go about implementing the changes. Please visit our regulatory insights page to learn more.
 

How can BDO help?

We are already helping clients understand how the new rules will impact their business and how they will work alongside The Consumer Duty. If you would like to find out how we can support you in implementation please get in touch with Richard Barnwell.