On 15 December 2021, HM Treasury published their consultation on the future of the high net worth individuals and sophisticated investors exemptions from the financial promotion regime. Broadly speaking, the UK financial promotion regime restricts the marketing of investment opportunities to consumers unless the content of the communication has first been approved by an FCA approved firm or person, or it is communicated to an exempt person. The Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 ("FPO") introduced the three main exemptions which are subject to the consultation (although many other exemptions exist in addition). However, these three specific exemptions are commonly relied upon for the raising of early stage financing from "angel" investors and for the promotion of certain types of non-mainstream investments. As things stand the three relevant exemptions are:
1. Certified High Net Worth ("HNW") Individuals - the individual has self-certified that they had an income of £100,000 or more in the previous year or they hold net assets of £250,000 or more;
2. Sophisticated Investors – an authorised person (third party) has signed a certificate declaring that the investor is sufficiently knowledgeable to understand the risks associated with the relevant type of investment; and
3. Self-Certified Sophisticated Investors – an individual can self-certify that they are a sophisticated investor if they meet one of four criteria:
- they are a member of a network or syndicate of business angels;
- they have made more than one investment in an unlisted company in the previous two years;
- they have worked in a professional capacity in the private equity sector or in the provision of finance for SMEs in the previous two years; or
- 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.
Why the Treasury is consulting
The exemptions were introduced in 2001, and the Treasury noted that there has been significant economic, social and technological change since then. For example, in relation to the HNW individual exemption, in 2001, only 1% of the population were earning in £100,000 or more, whereas in 2019, that figure is now 3%. The Treasury also noted that with the introduction of pension freedoms in 2015, pension savers are more likely to fall within the HNW individual exemption as they are able to withdraw larger amounts from their pension pots, which would not have previously been included in the exemption calculation.
In respect of technological advancement, the Treasury said that the requirement of a self-certified investor having made more than one investment in an unlisted company in the previous two years is no longer an accurate measure of an individual's experience in investing. This is because many more ordinary retail investors were investing in unlisted companies due to the rise of crowdfunding and the ease of online retail investing.
In addition, although it is the FCA who enforce the rules relating to financial promotion, as there are proposed legislative amendments to the FPO, it is the Treasury consulting on this as they are the Governmental body responsible for setting the UK's financial services policy. The FCA is just the regulator whose powers are derived from such legislation.
Why the Treasury is consulting now
Looking at the FCA's wider objective of protecting retail consumers along with the their recent forward looking statement of adapting to technological and economic change, it seems that the Treasury and FCA is taking a more adaptive, but heavy-handed, approach to adapt regulation in line with technological developments. For example, the ease and accessibility of minibonds (which the FCA term "speculative illiquid securities") combined with minimal regulation, were very attractive to both issuers and consumers alike. However, in 2020, the promotion of such were heavily regulated by the FCA insomuch as they can no longer be promoted to retail consumers. Likewise, the FCA announced earlier this year that they would begin regulating 'buy-now-pay-later' schemes after an astronomical rise in their value and popularity.
Looking at this current consultation, it seems that is reflective of the above approach, as the Treasury talks about amending these exemptions to reflect the change which has occurred since they were first introduced in the early 2000s, both technological (e.g. the ease and accessibility of online investments) and economical (e.g. the rise in people earning over £100,000). Looking forward, we have no doubt the Treasury and FCA will adopt this approach at some point when they deal with the rise of cryptocurrency and NFTs.
In light of the above, HM Treasury has proposed five reforms to the regime which are:
1. Increasing the financial thresholds for high net worth individuals - as discussed above, to reflect the rise in inflation from 2001 (54% according to the report), the Treasury proposes to increase the thresholds for high net worth individuals to at least £150,000 in respect of income and at least £385,000 (and possibly £900,000!) in respect of net assets;
2. Amending the criteria for self-certified sophistication - as we mention above, the current criterion of a self-certified sophisticated investor having made more than one investment is seen as outdated due to the ease of online investment. The Treasury has therefore proposed removing this from the criteria of self-certified investors. The Treasury have not yet proposed a replacement test but have asked stakeholders for their views on what test might be more suitable to demonstrate the required levels of sophistication;
3. Placing a greater degree of responsibility on firms to ensure individuals meet the criteria to be deemed high net worth or sophisticated – the Treasury has proposed shifting the emphasis on a firm to having a 'reasonable belief' that the investor actually the meets the relevant exemption requirements, rather than just a reasonable belief that the investor has signed the HNW or sophisticated investor statement. This onus would on be for the firm to determine how they would come to this conclusion (and to document accordingly);
4. Updating the high net worth individual and self-certified investor statements – the Treasury has proposed to update the format to make the information clearer to the investor, simplifying the language to make the implications of losing protections clearer and requiring greater investor engagement by the investor setting out how they qualify for the exemption; and
5. Names of the exemptions – as the certified high new worth individual exemption does not actually require third party certification, the Treasury has proposed amending the name to simply "high net worth individual".
The Howard Kennedy view
Whilst the exemption regime may have in some instances been a mere 'tick-box' exercise without real engagement from the firm or the investor, these proposed changes continue the regulatory direction of travel in recent months and imposing greater scrutiny on investment gateways. Some of these proposed changes will have a material impact for those involved, especially for early-stage companies looking to raise finance. For example, if the changes are implemented, there will be an instant reduction in the size of the pool of potential exempt investors, especially ones who might have previously be deemed to be a high net worth investor due to the thresholds being raised by more than 50%. Combining these proposed changes with the FCA's focus on restricting the marketing of mini-bonds, potentially complex funds (which the FCA term "non-mainstream pooled investments") and potentially illiquid investments (which the FCA term "non-readily realisable securities") we see ever increasing barriers to entry and restrictions to the options available for raising finance by early-stage companies. However, will these changes open the door for SMEs to find more innovative ways of raising alternative finance? We will have to wait and see.
That this regulatory pincer movement is likely drive SMEs to raise money by even more alternative means and in to the expanding crypto and token markets seems an unintended irony. That this all serves to hinder capital raising in the UK post-Brexit and in the age of Covid feels to some as having a lemming-like political agenda driving it to destroy the UK's reputation as a global financial leader. But whilst politicians might consider it their role to preach in arenas where they have little actual knowledge, it is beyond the remit of this article to have a view on such matters. We do not wish to be King Canute; we just ride the waves.)
The consultation closes on 9 March 2022 and we intend to submit comments during that window. We would be delighted to speak to you if you wish to comment too.