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Proposed Changes to Financial Promotion Exemptions to Strengthen Protections for Consumers

February 24, 2022 Reports and White Papers

HM Treasury proposes amendments to the exemptions for financial promotion

The HM Treasury has recently released two consultation papers on certain proposed changes to the existing financial promotion regime in order to address issues with that regime and strengthen protections for consumers.

What constitutes a financial promotion?

A financial promotion comprises any form of communication that contains an invitation or inducement to engage in investment activity either in the U.K. or in a manner that could have an effect in the U.K. There is no specified form as to what specifically constitutes ‘communication’ and it can therefore include advertisements placed through print, broadcast or online; marketing brochures; direct mail; or even social media.

Section 21 of the Financial Markets and Services Act 2000 (FMSA) sets out the general restriction on the making of financial promotions, which provides that a person must not, in the course of business, communicate an invitation or inducement to engage in investment activity or claim management activity, unless it has been approved or made by a U.K.-regulated financial institution.

Which exemptions are being consulted on?

The Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (Amendment) includes a number of specific exemptions from the section 21 restriction on making financial promotions. As such, financial promotions can be made to certain categories of exempt persons without needing to be approved or made by an FCA-authorised institution.

HM Treasury is currently consulting on some proposed changes to certain of these exemptions in a consultation paper it issued on 15 December 2021, being:

  • certified high-net-worth individuals (Article 48 of the FPO);
  • sophisticated investors (Article 50 of the FPO); and
  • self-certified sophisticated investors (Article 50A of the FPO)

As a part of their review, HM Treasury continues to be of the view that these exemptions should be retained due to the importance they play in relation to investment in small and midsize enterprises (SMEs), which are a major part of the U.K. economy. The proposed amendments by the HM Treasury centre around the need to update these exemptions to reflect the current social and economic climate (noting that it is over 20 years since the exemptions were introduced and 15 years since they were last reviewed). Furthermore, the U.K. Government has become aware of the fact that certain of the exemptions have been misused by some firms by marketing inappropriate products to ordinary retail investors. A case in point is the failure of London Capital and Finance to determine whether or not certain retail bondholders fell within the scope of the sophisticated or high-net-worth investor categories without checking whether they did, in fact, meet the relevant criteria. As a result of this, the U.K. Government has recommended the financial promotion exemptions outlined above be reconsidered to ensure that consumers are better protected. This involves the following proposals set out below:

  • To increase the financial thresholds for certified high-net-worth individuals (Article 48 FPO):
    • Investments to which the exemption applies: shares and other securities in unlisted companies and therefore aimed at start-up companies.
    • What it is now: an individual who self-certifies in a signed statement that they meet the requirements of the exemption and acknowledge that for the preceding financial year they have an annual income of £100,000 or hold net assets of at least £250,000 (this excludes an individual’s primary residence, pension or life insurance).
    • What is being proposed:
      Two alternative options are being proposed for industry consultation and feedback:
      There is also a proposal to amend the name of this exemption, to remove the word ‘certified’, to clarify that there is, in fact, no third-party certification required to rely on this exemption.
      • increasing the thresholds in line with inflation so that the income requirement would rise to £150,000 and the net assets requirement would rise to £385,000; or
      • increasing the threshold to guarantee only the top 1% of earners would be eligible to rely on this exemption, by increasing the income requirement to £175,000 and the net assets requirement to £900,000.
  • To amend the eligibility criteria in relation to self-certified sophisticated investors (Article 50A FPO):
  • Investments to which the exemption applies: shares and other securities in unlisted companies and therefore aimed at start-up companies being able to raise capital from “business angels” and the like.
    • What it is now: An individual is allowed to self-certify that they are a sophisticated investor on the basis they meet one of the following criteria:
      1. they are a member of a network or syndicate of business angels (and have been for at least six months prior);
      2. they have made more than one investment in an unlisted company in the previous two years;
      3. they are working or have worked in the previous two years in a professional capacity in the private equity sector or in the provision of finance for SMEs; or
      4. they are currently or have been in the previous two years a director of a company with an annual turnover of at least £1 million.
    • What is being proposed: The HM Treasury is proposing:
      • to remove criteria (ii) above due to the rise of online investments and marketing; and
      • to update and increase threshold for criteria (iv) in line with inflation, to a company with an annual turnover of at least £1.4 million.
  • To implement a greater degree of responsibility on firms to ensure that individuals meet the eligibility criteria required, to be deemed a high-net-worth individual or sophisticated investor:
    • Reason for proposed change:
      • The issue is that the HM Treasury considers that too much responsibility is left solely to the investor to determine whether or not they meet the criteria to be able to rely on the relevant exemption, with communicators of financial promotions largely relying upon investor statements. Currently, parties who communicate financial promotion materials to potential investors must only have a ‘reasonable belief’ that an individual has signed an investor statement confirming that they can rely on an applicable exemption.
    • What is being proposed:
      • While investors would still be required to sign an investor statement, it is proposed that the party making the communication makes a determination of how it comes to its ‘reasonable belief’ that the investor falls within the relevant exemption and documents that information. This, in effect, is meant to share the responsibility with the party making the communication, to better ensure investors have met the relevant criteria.
  • Updating the form of high-net-worth individual and self-certified investor statements
    • Reason for proposed change:
      • The HM Treasury hopes to ensure there is greater engagement from investors with investment information such as investor statements, as well as better understanding by investors of the applicability of the investor exemptions.
    • What is being proposed:
      • various updates to the format of the investor statements to make sure specific eligibility criteria for reliance on relevant exemptions are more easily identifiable by prospective investors – such as through formatting and reorganising the documents;
      • a simplification of the language in investors statements as much as it practicable;
      • simplifying the language in investor statements (as much as is practicable); and
      • implementing other practical changes such as asking investors to identify what exemption criteria specifically applies to them, to create greater investor engagement with investor statements.

When will the changes be introduced?

The HM Treasury’s consultation for these proposed changes closes on 9 March 2022. The FCA’s own consultation regarding financial promotion ends on 9 March 2022.

Key points on the proposed changes to FPO exemptions

Firms should be aware that the HM Treasury’s proposed increase to the thresholds for high-net-worth individuals and sophisticated investors is likely to also filter through to the FCA’s Non-Mainstream Pooled Investment rules and could overall cause a reduction in potential investors for particular high-risk investments and SMEs throughout the U.K. market.

Further, the requirement for firms to hold a ‘reasonable belief’ that a particular investor meets the specific criteria to be classed as a high-net-worth individual or sophisticated investor means firms should consider and review their client relationship procedures and processes, and formalise a way for the firm to determine:

  • how such a belief can be met; and
  • a system for recording or documenting that belief.

Further, subscription statements and placing letters are examples of some standard form documents that relevant parties and firms involved in capital raising will need to ensure they are prepared to update or have updated ahead of any amendments or rule changes as a result of these proposals.

High-Risk Investments

On 19 January 2022, the FCA also published a separate consultation paper setting out proposals to strengthen the existing financial promotion rules relating to high-risk investments and the firms approving any relevant financial promotions. The consultation closes on 23 March 2022 and, subject to the responses received, the FCA intends to confirm its final rules in the summer of 2022.

A key part of the FCA’s strategy behind the consultation is to address the harm from consumers investing in high-risk investments that do not match their risk appetite. These investments include:

  • investment-based crowdfunding (IBCF);
  • peer-to-peer lending (P2P);
  • other non-readily realisable securities (NRRS) such as unlisted shares;
  • non-mainstream pooled investments (NMPI) such as unregulated collective investment schemes ; and
  • speculative illiquid assets (SISs) such as speculative mini-bonds.

The FCA is concerned that investments made in these high-risk investments can lead to unexpected and significant losses for consumers and undermine wider confidence in investments, making it harder for all firms to raise capital. The FCA makes it clear that it does not want to restrict consumers who want to invest, but rather it wants them to be able to identify and access investments that suit their circumstances and attitude to risk.

Following the recent interventions that the FCA has already made to address the potential harm from high-risk investments, the FCA is now consulting on proposals to ban the mass-marketing of SISs, as well to ensure that financial promotions for cryptoassets will be brought within the financial promotions regime. The key proposed changes include:

  • Changing the classification of high-risk investments: the FCA is proposing to reclassify securities into three different categories.
    • Readily Realisable Securities: securities that are listed for which no additional marketing restrictions apply.
    • Restricted Mass Marketing Investments: These are NRRS, P2P agreements and qualifying cryptoassets for which marketing to retail investors will be allowed, subject to additional safeguards.
    • Non-Mass Market Investments: these will comprise NMPI and SIS for which marketing to retail investors will be prohibited. There are no proposed changes to extend the scope of the investments covered by these rules.
  • Strengthening the role of firms approving and communicating financial promotions: The FCA wants to develop a robust regime to complement the proposed section 21 approval process which, when implemented, will hold firms that approve section 21 promotions to high standards. This is designed to ensure that approving firms have the relevant expertise in the promotions they approve and that the overall quality of financial promotions in the market is high.
  • Strengthening Rules to Enhance Consumer Protection: The FCA is proposing to amend the current financial promotion rules to introduce a package of measures to strengthen them by making changes to the following areas: improving risk warnings, banning inducements to invest for all high-risk investments, introducing “positive frictions” (personalised risk popup warnings for first-time investors and a 24-hour cooling off period), improving client categorisation and stronger appropriateness tests to be conducted by FCA-authorised firms.
  • Applying financial promotion rules to qualifying cryptoassets: The FCA is considering how it will categorise cryptoassets once they are brought into the financial promotion regime. Qualifying cryptoassets are defined as being fungible (i.e., freely replaceable by another of a similar nature or kind) and transferable. It intends in general to apply the same rules to cryptoassets as are currently applied to "restricted mass market investments". However, the FCA proposes that "direct offer" financial promotions of qualifying cryptoassets should not be made to self-certified sophisticated investors.

Proposals to strengthen regulatory rules

The FCA is also proposing to introduce changes to require firms that have approved a financial promotion to take reasonable steps to monitor the continuing compliance of the financial promotion with the financial promotion rules for the lifetime of the promotion. Under the proposed guidance, this would include periodically assessing whether there have been any changes to the relevant financial promotion, which mean that it is no longer being lawfully communicated or has ceased to be fair, clear and not misleading. If, at any time, the firm becomes aware that the approved promotion no longer complies with the financial promotion rules, it must withdraw its approval and notify any person known to be relying on its approval.

In addition, firms approving financial promotions should collect confirmations from their clients that there have been no material changes to the contents of the financial promotion they have approved every three months, and for the lifetime of the promotion. Approvers should consider any changes disclosed in an attestation and, where necessary, withdraw approval as soon as reasonably practicable. If the client does not respond or the approver is otherwise unable to get an attestation from their client, they should consider withdrawing approval in any case.

How Armstrong Teasdale can help

Our Capital Markets team is experienced in advising clients on the financial promotion regime and to help prepare organisations ahead of the proposed amendments. If you would also like to discuss these proposed changes, please contact one of the members of our Capital Markets team.

This publication is provided by Armstrong Teasdale Limited for informational purposes only. The information contained in this publication should not be construed as legal advice. Any questions or further information regarding the matters discussed in this publication can be directed to Armstrong Teasdale’s U.K. Capital Markets team.

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