The UK’s rules on financial promotions and marketing of investments are changing – tightening the regime for peer-to-peer loan (“P2P”) and equity crowdfunding, plus extending regulation to cryptoassets. Innovate Finance's Head of P2P, Mike Carter, and our Head of Regulatory Affairs, Rachel Waggott, have put together this guide to the new rules.
The headlines
- Certain cryptoassets will be brought within the scope of the UK’s financial promotions regime by HM Treasury (“HMT”).
- These qualifying cryptoassets, alongside equity crowdfunding and P2P loans will form a newly defined category – Restricted Mass Market Investments (“RMMI”) – for the purposes of the Financial Conduct Authority (“FCA”) rules on financial promotions.
- P2P property loans will remain for now in the same category (RMMI) as other P2P loans and will not be moved to the stricter category of Non-Mass Market Investments; however, the FCA indicates that it will give more consideration to this classification later in 2022, so uncertainty lingers.
- The newly applied RMMI designation does not change the regulatory status of the underlying activities – i.e. to the extent that an activity relating to qualifying cryptoassets is unregulated today; it will remain unregulated once the new financial promotion rules apply.
- Financial promotions and marketing relating to RMMI must be approved by an authorised person.
- Authorised firms wishing to approve the financial promotions of unauthorised firms will need FCA approval. A new authorisations gateway (to be overseen by the FCA) will be introduced via legislation.
- Consumers can only receive a “direct offer” financial promotion for an RMMI if they are a “restricted” investor (who has made a declaration that they will not invest more than 10% of their assets in these asset classes), a “high net worth” or “sophisticated” investor.
- Customer journeys will be strengthened considerably, with a number of behavioural research backed interventions proposed by FCA, including: prescribed and tailored risk warnings; a 24-hour cooling off period for new investors; and where a consumer fails the appropriateness test, a minimum period of 24-hours must elapse before they can retake the test.
- Inducements to invest are to be banned (eg “new joiner” or “refer-a-friend” bonuses).
- The minimum financial criteria to qualify as a ‘high net worth’ investor are to be revised upwards by HMT.
- HMT is also consulting on a proposal that firms must have a documented, “reasonable belief” that a consumer belongs to the self-stated financial category to which they identify (i.e. “high net worth”, “restricted” or “sophisticated” investor).
- Taken together, HMT and FCA’s proposals have significant impact and are likely to materially reduce both the number of promotions and the number of retail consumers accessing RMMI offerings.
What are the consultation papers and wider backdrop?
On 18 January 2022, HM Treasury (“HMT”) published the response to its July 2020 consultation on cryptoasset promotions. This sets out new rules to bring cryptoassets within the scope of the UK’s financial promotions regime. In effect, these rules mean that anyone who is not regulated in the UK, even if based overseas, will find it increasingly challenging to market or advertise certain cryptoassets and related activities in the UK.
The FCA consultation (“CP 22/2”) – published on 19 January 2022 – complements HMT’s work and sets out proposals to strengthen the financial promotion rules that apply to high-risk investments, which will include marketing related to cryptoassets, P2P loans and equity crowdfunding. The FCA’s consultation follows on from its April 2021 discussion paper (“DP 21/1”) on the same issues, and is a key part of the regulator’s consumer investment strategy. Central to that strategy is the aim to address the potential harm from consumers investing in high-risk investments that do not match their risk tolerance.
Additionally, HMT published a consultation on 15 December 2021 looking to redefine the minimum financial criteria for qualifying as a high net worth investor and sophisticated investor. The consultation paper includes a proposal that firms are to have a “reasonable belief” that an investor meets the relevant criteria when self-certifying.
More broadly, these announcements dovetail with a number of other domestic proposals, including the draft Online Safety Bill and new Consumer Duty. With reference to the Online Safety Bill, the FCA has called for legislative change to address concerns outside its remit – including recommendations that paid-for advertising and consumer-generated content are within scope of the Bill. The FCA is also consulting in parallel on a new Consumer Duty, which aims to bolster consumer protection through driving culture change at firms. If the new duty is introduced, firms will be expected to assess and evidence how they are acting to achieve good outcomes in the interests of retail consumers.
The Government and FCA announcements also follow the Advertising Standards Authority’s ban on a number of advertisements from crypto exchanges and crypto trading platforms.
What’s changing?
Certain cryptoassets are being brought within the scope of the financial promotions regime
HMT indicated that it will extend the restriction of financial promotions – as set out in section 21 of the Financial Services and Markets Act 2000 (“FSMA”) – to a range of unregulated tokens, defined as “qualifying cryptoassets”. These qualifying cryptoassets will be added to the list of “controlled investments'' in the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (“FPO”). Further, qualifying cryptoassets will be linked with the controlled activities such as dealing, managing, advising and agreeing in the FPO. The controlled activities do not include cryptoasset lending activities or Decentralised Finance, as HMT considered this would be unnecessary and disproportionate extension of the regulatory perimeter.
HMT broadly defines qualifying cryptoassets as any cryptographically secured digital representation of value or contractual rights which is fungible and transferable. The exceptions to the definition of qualifying cryptoassets include non-fungible tokens, non-transferable cryptoassets, and electronic money and currency issued by a bank or public authority. HMT has flagged that the definitions could be subject to change.
The FCA’s proposals seek to apply financial promotion rules for “high-risk investments”, such as equity-based crowdfunding and P2P agreements, to qualifying cryptoassets, once they are brought within the financial promotions regime by HMT.
A significant proportion of disintermediated FinTech investments will fall within a newly defined investment category created by FCA
Taken together, qualifying cryptoassets, equity-based crowdfunding and P2P agreements, will form part of a newly created category of “Restricted Mass Market Investments” (“RMMI”). This is a move on the part of the FCA to rationalise its financial promotion rules (section COBS 4 of the FCA Handbook). The proposals do not change the regulatory status of the underlying activities – i.e. to the extent that an activity relating to qualifying cryptoassets, for example, is unregulated today; it will remain unregulated once the new financial promotion rules apply.
The FCA’s earlier discussion paper (DP 21/1) on high-risk investments had initially proposed that P2P property loans be placed in the most restrictive marketing category (“Non-Mass Market Investments”); however, the FCA has reversed its position on this for now, but notes it will give more consideration to this area later in 2022, so uncertainty remains for these loan assets.
Marketing and advertising to retail consumers: HMT and FCA rules tighten, including a new ‘section 21’ gateway for firms approving promotions issued by third parties
Financial promotions take many forms, including social media posts, emails, and adverts in print, on webpages, or other online media.
When are you permitted to communicate a financial promotion?
When HMT’s extension to the financial promotion regime takes effect, it means that it will be illegal to communicate a financial promotion that is capable of having an effect in the UK unless:
- The person issuing the promotion is an FCA/Prudential Regulation Authority (“PRA”) authorised person;
- It is approved by an FCA/PRA authorised person (written communications only); or
- It falls within an exemption from the FPO.
Breach of the regime carries criminal penalties.
Who can approve a financial promotion for a third party?
HMT trailed in June 2021 that Government intends to legislate to introduce a new regulatory gateway relating to section 21 FSMA – when parliament time allows – for authorised firms who approve the financial promotions of unauthorised firms / persons. Any firm wishing to approve the financial promotions of unauthorised firms would first need to obtain the consent of the FCA – this is to ensure that approving firms have the relevant expertise in the promotions they approve and the overall quality of financial promotions in the market is high. The FCA is to consult on draft guidance for firms applying to the section 21 gateway when legislation has been published, in due course.
HMT has acknowledged that the pool of FCA/PRA authorised persons who would willingly approve a financial promotion could be relatively small, which then points to the increasing difficulty of marketing and advertising qualifying cryptoassets to UK based retail consumers in future. The income and asset level which HMT settles on following the closure of the FPO exemptions consultation will therefore be pivotal.
How do the FCA rules on financial promotions and RMMI build on the legislative framework?
The FCA proposals allow the mass-marketing of RMMI to retail consumers, so long as requirements of the FCA’s financial promotion rules, including special requirements for “direct offer financial promotions”, are followed.
Generally, a direct offer means a promotion that specifies how consumers should respond or includes a form for them to respond immediately. Firms cannot make a direct offer unless certain conditions apply:
- First, the recipient of such a promotion must be categorised as either a certified high net worth 1 investor, a certified sophisticated investor, a self-certified sophisticated 2 investor, or a certified “restricted”3 investor according to FCA Handbook definitions. The rules do not apply where the investor is being advised.
- Second, firms must comply with FCA Handbook rules on appropriateness.
What are the FCA and HMT doing to ensure verification of customers’ financial categorisation?
The FCA remains concerned that too many customers are incorrectly self-certifying themselves as high net worth or sophisticated and do not understand the impact of their categorisation. As such, the FCA is consulting on proposed changes to the customer journey and to the investor declaration form for “restricted”, “high net worth” and “sophisticated” investors to introduce an “evidence declaration” and simplify the declaration.
The FCA has also welcomed the HMT consultation to reform the FPO exemptions (launched in December 2021). This includes a proposal that the financial definition of a “high net worth” investor be updated to reflect inflation. Moreover, HMT’s consultation proposes a requirement that firms have a “reasonable belief” (which is documented) that an investor is in the self-stated financial category to which they identify. This proposal was originally put forward by the FCA in DP 21/1, but it has been dropped in CP 22/2 because HMT are taking the lead on it.
Innovate Finance members’ feedback on these proposals in 2021 was that it is currently not possible to verify, on an automated basis, an individual’s financial net worth — this can only be achieved through manual assessment of a customer’s financial documents, which would have severe operational and financial implications for any FinTech business.
Strengthening the customer journey: including new risk warnings, more robust appropriateness tests, and a ban on inducements to invest
As well as marketing restrictions, described above, all RMMI are within scope of new interventions to strengthen the customer journey. These interventions are based on FCA behavioural testing and research to ensure retail investors understand the risks they are taking.
Risk warnings
The customer journey will be required to include a prescribed risk warning for all new potential customers:
“Don’t invest unless you’re prepared to lose all of your money invested. This is a high-risk investment. You could lose all the money you invest and are unlikely to be protected if something goes wrong. Take 2 min to learn more”.
The FCA proposes a “two minute pop up”, which is voluntary for the customer to follow. This pop-up box should provide further risk information specific to the firm’s business model and product being promoted.
For first time investors, the FCA proposes:
- A personalised risk warning pop-up:
“[Client name], this is a high-risk investment. How would you feel if you lost the money you’re about to invest? Take 2 min to learn more”, linked to a product-specific pop-up risk warning; and
- A 24-hour cooling off period after they have received this risk warning and before they can proceed further.
These “positive frictions” are to be introduced to counteract social and / or emotional pressures to invest and support considered decision making.
Banning inducement to invest
The FCA intends to ban monetary and non-monetary benefits to incentivise investment activity, including incentives paid in cryptocurrency. The FCA’s rationale is that these inducements encourage investments that are not aligned to the investor’s risk tolerance and are abused by bad actors.
Strengthening the appropriateness tests
Currently potential customers must pass an appropriateness test as part of their sign-on journey, typically a series of questions and answers. Usually if the customer fails to provide enough correct answers they may re-take the test. The FCA is proposing that:
- The customer cannot re-take the test for at least 24 hours; and
- The questions must be different each time the customer takes the test.
The FCA indicated it will issue non-exhaustive guidance for firms’ appropriateness tests for RMMI offerings, similar to that issued earlier in the context of P2P agreements. As part of this guidance, there will be a suggestion for firms to avoid any kind of binary choice between answers.
What is the impact?
Increased compliance burden for firms
The FCA is increasingly turning to its Behavioural Economics and Design Unit to inform policy interventions – firms offering RMMI-related products and services should carefully consider behavioural incentives and outcomes driven by the design of their customer journeys. Firms will also need to introduce a range of new interventions in the customer journey, described above, and measure their effectiveness.
The FCA has set out a detailed list of data points that they want firms to collect in the new customer journey, so that the regulator can monitor the impact of the changes. This includes for example the number of consumers that are subject to the 24-hour cooling off period, and the number of consumers who do not proceed with the consumer journey after the 24-hour cooling off period.
Further, firms that approve and communicate financial marketing must have relevant expertise and understanding of the investments being offered. It would benefit firms to have a well evidenced learning and development programme for employees.
Enforceability of the new regime
Combined, the HMT and FCA proposals have extensive territorial scope. The financial promotions regime applies to communications “capable of having an effect in the UK”, and captures communications created overseas.
It is an open question as to how enforceable the new rules will be against firms that are not themselves regulated or UK incorporated.
Monitoring firms’ compliance, and processing applications at the section 21 gateway, will require significant additional resources on the part of the FCA.
Timing of next steps
There are a number of interlinked pieces of the jigsaw here, which means an exact timetable is not possible.
Broadly speaking, the new FCA requirements, the Treasury’s reformed FPO exemptions, and bringing cryptoassets into the financial promotions regime could all come into force in autumn 2022; whilst the introduction of the section 21 gateway (which requires primary legislation) is likely to be part of a Financial Services Bill later this year that may not come into force until 2023, at the earliest.
It is possible therefore that the current authorisations rules apply initially before the introduction of the proposed gateway.
Further information
If you have any questions or comments, please do not hesitate to get in touch at policy@innovatefinance.com
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1 Individuals must sign a declaration to say they have: an annual income of at least £100,000; or net assets of £250,000 or more, excluding primary residence, pensions and rights under qualifying contracts of insurance. This statement must have been signed in the 12 months immediately prior to the promotion being made.
2 Individuals who have: a certificate signed in the preceding three years by a UK authorised person (not party to the investment activity relating to the financial promotion) stating that they are sufficiently knowledgeable to understand the risks associated with the relevant type of investment; and themselves signed a certificate in the preceding 12 months stating they qualified for this exemption and understood the implications.
3 To be a restricted investor, the individual must sign a declaration to say they have not in the last 12 months, and will not in the next 12 months, invest more than 10% of their net assets (certain assets being excluded from this calculation) in these types of RMMI.
