Ban on retail sale of "high risk investments" broadened and made permanent by FCA

The Financial Conduct Authority has been extremely busy of late proposing and implementing new policy; the latest targets on their hit-list are high risk investments such as mini-bonds and preference shares. In a consultation paper published yesterday, the FCA are asking for feedback on:

• making permanent their current temporary rules, which ban the promotion of mini-bonds and preference shares to unsophisticated investors and require a prominent warning to be included with such products; and   
• widening the scope of the rules to also apply to any listed bonds with similar features to speculative illiquid securities which are not regularly traded e.g. crowd-funding platforms.

 This is supported by an FCA research paper which showed new risk warnings improved investors’ comprehension of product risk.

What is the issue with high risk investments?

The FCA is concerned by the widespread marketing, especially online, of speculative illiquid securities (and similar products) which they consider to be opaque and difficult to understand for consumers. Products such as mini-bonds and preference shares are being mass-marketed with advertising focusing on the high rates of return and failing to emphasis sufficiently their inherent risks. 

The FCA is particularly worried about how less sophisticated investors treat high risk investments, with financial promotions for these products commonly appearing in response to online searches for 'high investment returns' or similar phrases.

What are the temporary rules?

The temporary rules were introduced by the FCA on 1 January 2020 for 12 months. Under the new rules:

• Promotions of mini-bonds and preference shares can only be made to sophisticated or high-net worth investors;
• Firms need to carry out a preliminary assessment of the suitability of a security for a high-net worth or sophisticated investor; and
• All marketing material on mini-bonds and preference shares must include prominent disclosure, including a standardised risk warning stating investors may lose all their money, the costs and charges associated with the security and the date on which the promotion was approved.

The FCA feels that these rules seem to be working. In its research paper, the FCA explained that they have run online laboratory experiments which tested the effectiveness of the new risk warning. The results showed that the new risk warning improved investors' comprehension of the risk associated with the product.

What is the FCA proposing in its consultation?

The FCA is now proposing the following new permanent rules to apply from 1 January 2021:

• Make the temporary rules permanent for debentures and preference shares;
• Expand the scope of the temporary rules so they also apply to any listed bonds with similar features to speculative illiquid securities which are not regularly traded; and
• Exclude certain securities from the rules where they relate to single-company investments.

The real change here is second point; the new proposed rules would capture crowdfunding platforms and products which are similar to mini-bonds but not currently banned. The FCA have identified over 40 UK-based issuers of debt securities that appear akin to speculative illiquid assets that were either recently or are currently listed or traded on (mainly non-UK) EEA exchanges or venues, which they think have been predominantly promoted and issued to UK retail investors.

The FCA do state in their research paper that this proposal is intended to capture a specific type of bond posing particular risks to retail investors and, if evidence arises from the consultation that types of bond are inadvertently caught, the proposals may be adjusted accordingly. But then again, the FCA may opt not to adjust their rules if they feel that consumers may be harmed if they were to do so. The direction of travel and focus is clear.

Next Steps

If you want to respond to the FCA's consultation, you have until 1 October 2020 and can do so here.

After considering feedback and adjusting the proposals as necessary, the FCA will publish a final policy statement before the end of 2020 and intend to make the new rules permanent from 1 January 2021.