The government has confirmed that significant reforms and updates will be made to the financial promotion regime in the UK.
Section 21 of the Financial Services and Markets Act 2000 (FSMA) and the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (FPO) will be amended.
The key changes comprise:
1. Extending the scope of the legislation to include “qualifying cryptoassets”
2. Increasing the financial thresholds for certain exemptions in the FPO
3. Tightening up the certification process for certain exemptions in the FPO
4. Tightening up the approval process for financial promotions issued or approved by authorised firms.
This article summarises the proposed changes and the practical implications they entail.
The Financial Promotion Restriction
Section 21 of FSMA prohibits the communication of “financial promotions” unless they have been issued or approved by an authorised person, or they fall within an exemption.
The FCA handbook defines financial promotions as “an invitation or inducement to engage in investment activity or to engage in claims management activity that is communicated in the course of business”. To be classed as a financial promotion, the communication must therefore: (i) include an invitation or inducement i.e. the presentation of purely factual information is not a financial promotion; and (ii) relate to investment activity, as defined in s.21(8) FSMA. Investment activity includes any controlled activities, such as arranging deals in investments or advising on investments (Part 1 of Schedule 1 to the FPO), or any controlled investments, such as shares or rights under contracts of insurance (Part 2 of Schedule 1 to the FPO).
The government’s consultation response on cryptoasset promotions confirms that the scope of controlled investments will be extended to include “qualifying cryptoassets”, provisionally defined as “any cryptographically secured digital representation of value or contractual rights which is fungible and transferable”. This alteration was seen as a preferrable option to extending the definition of controlled activities.
This reform has been triggered by the prevalence of misleading advertising and misinformation in the cryptoasset market, which has driven the government to seek an extension of consumer protection in the market as investment in cryptoassets becomes more widespread. Any financial promotions in relation to cryptoassets will, once the change is implemented, fall within the financial promotion regime and be subject to FCA oversight.
Whilst the consultation confirms that these legislative changes will be targeted, there will be a transitional period of 6 months from both the publication of the proposed FPO regime and FCA rules.
The FPO identifies various exemptions which, if relied upon, allow unapproved financial promotions to be communicated by unauthorised firms. These exemptions include financial promotions targeted at “high net worth individuals” (Article 48 FPO) and “sophisticated investors” (Article 50 and 50A FPO).
High net worth individuals
The FPO regime currently defines high net worth individuals as those who had an annual income of £100,000 or more or held net assets of £250,000 or more during the previous financial year. This exemption is based on the idea that these individuals require lower levels of protection from harmful financial promotions as they are able to absorb losses more effectively.
The government consultation on financial promotion exemptions suggests that these monetary thresholds should be increased as a result of inflation and increasing income and wealth levels. Were the figures based on relative income and wealth levels today, as compared to 2005, it is claimed the thresholds would equate to £175,000 for income and £900,000 for net assets.
Although these changes would enhance the level of protection for individuals who are not readily able to absorb financial losses, increasing the threshold too extensively could reduce the investor pool which firms can target exempt financial promotions towards, thereby undermining their ability to engage in successful funding rounds. Any regulatory change will need to balance the competing interests of consumers and businesses as a result of this.
The consultation also proposes amendments to the definition of “sophisticated investor”, currently defined as someone who:
i has been a member of a network of business angels for at least the preceding 6 months;
ii has made more than one investment in an unlisted company in the preceding 2 years;
iii is working, or has worked in the preceding 2 years, in a professional capacity in private equity or finance; or
iv is, or has been in the preceding 2 years, a director of a company with an annual turnover of at least £1 million.
The consultation claims that the advent of online investment tools means that criteria (ii) is too easily met and, as with the definition of high net worth individual, criteria (iv) should be adjusted to account for inflation.
To rely on the high net worth individual or sophisticated investor exemption, the current regime requires firms to ‘believe on reasonable grounds’ that the individuals targeted by the financial promotion meet the criteria. If the individual in question signs the relevant certification found at Part 1 of Schedule 5 to the FPO, this alone will amount to ‘reasonable grounds’.
The consultation proposes changing this threshold to ‘reasonable belief’, meaning that firms would have greater responsibility for verifying the status of the individual if they are to rely on the exemption. However, the government also proposes amending the certifications so that the individual must specify which criteria of the definition is met. In this way, consumers and firms will have to take more responsibility for their reliance upon these exemptions.
Updating the thresholds for high net worth individuals and sophisticated investors will enhance consumer protection for mid-level earners and asset holders, and will reflect modern trends to a greater extent. The emphasis on placing greater responsibility on firms and individuals who rely on these exemptions will complement these reforms, but any legislative change should avoid being overly stringent as this could limit the investor pool available to firms which seek to use exempt financial promotions to target these investor groups.
A new approval gateway
Under the current regime, financial promotions are not prohibited where they have been approved by an authorised person. The government’s consultation response on approvals of financial promotions confirms that authorised firms will no longer be able to simply approve financial promotions for unauthorised firms. Section 21 would be amended so that unauthorised persons were only able to communicate their own financial promotions if these had been approved by an authorised firm which had obtained consent from the FCA to be able to provide such approvals. A universal requirement (the Financial Promotion Requirement) would be imposed on all new and existing authorised persons prohibiting them from approving the financial promotions of unauthorised persons. An existing authorised person wishing to undertake approval of financial promotions would then need to apply to the FCA to have this requirement varied or cancelled. A firm applying for authorisation would be able to apply as part of its application for authorisation to have the requirement not to approve financial promotions varied or cancelled. This will give the FCA greater oversight of the approval process. It is hoped that this new regime will be implemented by March 2023.
The FCA want authorising firms to play a more active role in monitoring the financial promotions they approve. Under the existing regime, approvers must ensure that the financial promotion complies with the regime each time it is communicated. The proposal is to make the role one of active, ongoing monitoring for the lifetime of the promotion to ensure that it achieves compliance. Whilst this may be a stringent requirement for authorised firms, the FCA proposes that attestations of ‘no material change’ could be sought every 3 months. These would offer authorised firms protection as approval could be removed in the event that a client failed to respond to a request.
Market changes which have occurred since 2005 have necessitated a change in the financial promotions regime. Whilst the regime needs to adapt to these changes to create a sufficient level of consumer protection, particularly in new markets such as cryptoassets, it will be important for the government to legislate in a way which does not deprive businesses of their ability to use tools at their disposal, such as the FPO exemptions, to continue to use financial promotions to seek investment opportunities.
For further information, please contact:
Gavin Punia, Partner, Bird & Bird