The regulatory push to improve financial promotions
We recently delivered a webinar on the topic of financial promotions. You can view the webinar here. This briefing note gives a summary of the talking points covered in the webinar. Please follow our blog or sign up to our regular financial services update to follow more up and coming developments in this important area of financial services regulation.
We are seeing a degree of uptick in regulatory activism on this topic, including:
- Industry-wide communications from the FCA setting out the regulator’s expectations of applicable standards;
- New regulatory rules and rigour as to the approval of financial promotions; and
- An enlarged scope of the financial promotions regime, including movement into new product categories such as cryptoassets.
This regulatory activism should be seen in the broader context of:
- Market, product trends and innovation in financial promotions and the way that firms engage with customers and target customers;
- Consumer protection, which is one of the FCA’s core strategic objectives;
- Regulated firms doing the right thing to deliver positive customer outcomes in line with their Consumer Duty obligations and other conduct of business obligations; and
- The regulatory perimeter as this is an area where non-regulated firms need to really think about how they engage with the consumers of financial products and business clients in the financial services sector.
Back to basics: what is a financial promotion?
The term “financial promotion” is used to describe the communication of an invitation or inducement to engage in any investment activity (or claims management activity) in the course of business.
FCA guidance refers to the regulation of communications that have a promotional element. In practice there is a need for caution as invitation and inducement have a wide meaning. If a communication looks potentially promotional, it is worth taking care.
- Engaging in investment activity is defined by reference to controlled investments and controlled activities. A simple example could be encouraging someone to buy a particular share or receive a financial service. The impact of this can reach a range of sectors including traditional investments such as insurance, credit agreements, mortgages, and emergent investments such as crypto.
- Communicating can cover communications across traditional and newer channels and includes causing a communication to be made. There are important distinctions between real time or non-real time promotions for the purposes of certain rules and solicited or unsolicited promotions, but in the first instance, all these are caught by the rules.
- The term in the course of business requires a commercial interest on the part of the communicator. The FCA intends to exclude genuine non-business communications. This term has become particularly significant recently in a social media context.
Why these rules are not just something for regulated businesses to think about
The financial promotion restriction under FSMA means that a person must not communicate a financial promotion unless they are:
- an authorised person;
- the content of the communication has been approved by an authorised person; or
- the communication can benefit from an exemption under the Financial Promotion Order.
It is a criminal offence for an unauthorised person to communicate a financial promotion in breach of this restriction. Given the wide scope of the definition of “financial promotion”, there can be very serious consequences to getting this wrong. In practice, the risk may also sometimes not be the easiest to spot particularly where financial promotions are combined as an ancillary part of a wider packaged offering for a range of other products and services. In this context, unauthorised persons may also risk falling foul of the regulatory perimeter more widely.
It is important to note from a practical perspective that this regulatory regime is not just a concern for UK-based businesses and individuals. Aside from exemptions, the other route for an unauthorised person is approval of the communication by an authorised firm.
Why authorised firms still need to think about financial promotions
Each of the FCA's conduct of business sourcebooks set out detailed financial promotion requirements which relevant communications (including financial promotions) must meet. These depend on the nature of the product or service being promoted. In addition, Principle 7 requires a firm to "pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading".
We have seen this develop into a particular area of focus for the FCA over recent years. In its 2023/24 Business Plan the FCA wrote about “enabling consumers to help themselves” and listed one of its outcomes as reducing the potential for consumer financial losses arising from mis-selling of products due to non-compliant financial promotions issued by authorised entities. There is a real potential for consumer harm here (for example in relation to high-risk investments), so there is not just a concern with the perhaps more obvious risks stemming from illegal financial promotions issued by unauthorised entities.
Over the last year at least, authorised firms will also have been considering financial promotions in the context of the new Consumer Duty. Firms must specifically consider how their communications deliver good outcomes for retail customers and promote consumer understanding. The FCA has explained in this context that compliance with the clear, fair and not misleading requirement by itself will not be sufficient to ensure compliance with the Duty. In practical terms, this may require the tailoring of communications to consider the characteristics of recipients, including any characteristics of vulnerability. It may also involve the testing, monitoring and adapting of communications on an ongoing basis to support understanding and good outcomes for customers.
Recent regulatory developments
Earlier this month, on 7 February 2024, a new gateway for firms approving financial promotions came fully into force. This means that an authorised firm might approve the financial promotions of an unauthorised person so they do not breach the financial promotion restriction.
As a result of the new rules, an authorised firm wishing to approve in this way will first need to obtain permission to do so from the FCA (known as “passing through the gateway”) or else do so within the scope of an exemption to the gateway. The general background to this new requirement includes instances of authorised firms failing to satisfy the FCA’s requirements when approving financial promotions. This can include failing to undertake adequate due diligence to ensure promotions that a firm has approved meet FCA requirements. In a worst-case scenario, this could involve inadvertently approving a scam. The FCA has also seen cases of firms approving financial promotions that relate to products that are beyond their sphere of expertise.
In summary, the new regime is intended to enable the FCA to assess the suitability of a firm before it is permitted to approve financial promotions. It will also mean that the FCA has a record of which authorised firms are approving financial promotions, making it easier for the FCA to be on the front-foot in terms of supervision.
The FCA’s approach in the consumer investments sector relating to the promotion of high-risk investments
The FCA’s consumer investments strategy published in 2021 set out a target of a 50% reduction by 2025 in the number of consumers investing in high-risk investments who indicate a low risk tolerance or demonstrate the characteristics of vulnerability. New rules came into full effect from 1 February 2023 aimed at rationalising the classification of high-risk investments and strengthening the consumer journey into such investments.
In September 2023, the FCA published its findings from its review of how firms within the Peer-to-Peer and Investment Based Crowdfunding portfolios offering Restricted Mass Market Investments (RMMIs) have complied with new rules on the customer journey. This included examples of good and poor practice, such as in the latter case risk warnings not meeting prominence requirements including due to certain design features.
Firms need to ensure changes to the customer journey have been properly implemented as this is likely to remain an area of focus given risk of harm indicated by the FCA’s consumer research.
Changes to the exemptions for unauthorised firms
Some targeted technical changes came into force on 31 January 2024 to address the fact that certain Financial Promotion Order exemptions had become outdated. These are mainly relevant for unlisted companies seeking finance from high net worth or sophisticated investors. The changes include increasing the financial thresholds for the high net worth individual exemption and amending the eligibility criteria for the self-certified sophisticated investor exemption. There is also a requirement for businesses to provide specific details of themselves in communications using these exemptions.
This a relatively focused change, but another example of legislative intent in this space.
How the FCA is responding to wider trends in the way financial promotions are communicated
The FCA has increased its focus on financial promotions in social media. This is linked to the use of social media as a go-to source of information for consumers, reflected in turn in advertising trends.
The FCA says that the landscape has evolved since its original social media and customer communications guidance in 2015 and issued new draft guidance last year. A particular focus in the new draft guidance is on “finfluencers” i.e. social media influencers who promote financial products on social media. The draft guidance includes discussion of the assumption that there must be direct compensation for the business test to be met and the promotion to be caught. On the contrary, the FCA points to circumstances where the influencer could be communicating in anticipation of future revenue from a relationship with a firm or where the promotion is aimed at acquiring more views for which the influencer will be directly compensated by the platform (rather than necessarily the firm).
Firms approving influencer’s financial promotions will need to pay particular attention to the influencer’s audience demographics and whether they are likely to have an audience demonstrating characteristics of vulnerability. Approving firms must also play an active role in ensuring the continuing compliance of the relevant communication for its lifetime. The guidance also provides pointers for authorised firms when communicating financial promotions via social media in general.
Some of the recent relevant changes to cryptoassets
Since 8 October 2023, cryptoassets have been brought within the financial promotions regime. This means that certain qualifying cryptoassets and activities fall within the list of controlled investments and controlled activities under the FPO.
A “qualifying cryptoasset” includes “any cryptographically secured digital representation of value or contractual rights that is transferable and fungible, but does not include cryptoassets which meet the definition of electronic money or an existing controlled investment”. This is a broad definition that captures many different types of cryptoassets.
Some of the key requirements include fungibility and transferability, and not already a controlled investment. The fungibility requirement means that non-fungible tokens (NFTs) are out of scope.
From a territorial perspective, the restriction is not just relevant to UK firms but applies to all firms marketing cryptoassets to UK consumers regardless of where the firm is based or what technology they use to make the promotion. Overseas firms therefore need to be careful not to communicate financial promotions to UK consumers inadvertently.
Specific exemptions in the cryptoasset context to be aware of
There is a bespoke exemption for cryptoasset businesses registered with the FCA under the UK’s anti-money laundering regulations which broadly includes cryptoasset exchange providers and custodian wallet providers. A registered cryptoasset business can communicate its own cryptoasset financial promotions to UK consumers but, importantly, cannot approve the financial promotions of others.
The FCA have stated they expect to see more firms applying for registration under the anti-money laundering regulations given this exemption. However, there is a high threshold to pass through the application process, and some cryptoasset firms fall outside of the scope of the regulations (not requiring registration). It therefore remains to be seen whether more firms will apply for registration to benefit from the exemption.
Existing exemptions in the FPO apply in the same way to cryptoasset firms but the high net worth individual exemption and the self-certified sophisticated investor exemption, both typically used for higher risk investments, do not apply to the promotion of cryptoassets. This limits the available exemptions that cryptoasset firms can rely on.
Some of the risks that the FCA see around cryptoassets and which explain FCA focus on this sub-sector
The risks that the FCA has highlighted are relatively jurisdiction agnostic and all regulators around the globe are trying to address them. They include the risks of:
- Large, unexpected and sudden loss;
- High profile firm failure resulting in significant losses for consumers;
- Comingling of client and own funds;
- Fraud, money laundering and financial crime; and
- Cyber attacks.
It is not uncommon to see misleading cryptoasset promotions offering high returns or using misleading terms and promoting risky, complex products as ‘stable’. The FCA has issued repeated warnings that cryptoassets are largely unregulated and that consumers must be prepared to lose all of their money, and will have no access to the FSCS or the FOS if things go wrong.
Another risk key risk in this sector is the lack of consumer understanding, in particular in relation to what consumers are actually investing in and what protections they do or do not have. The regulator is seeking to plug this information gap insisting on appropriate warnings.
This is likely to remain an area of regulatory focus in the light of the risks that have materialised in some recent high-profile cases. We are seeing the FCA using the existing regulatory framework to protect consumers against some of these risks.
Specific rules that firms will need to follow when promoting cryptoassets
For the purposes of the FCA’s conduct of business rules, cryptoassets fall within the category of RMMIs and carry the same restrictions as apply to the other types of investments in that category.
Firms promoting cryptoassets need to think about:
- Providing clear risk warnings, including personalised risk summaries that must account for the specifics of the cryptoasset;
- The ban on incentives to invest requiring consideration of what an incentive means in the context of cryptoassets. Benefits that are not intrinsic to the cryptoasset, or part of its function, that are used to motivate consumers to invest are likely to be captured;
- The 24-hour cooling off period which firms need to build into the process of issuing a Direct Offer Financial Promotion;
- Client categorisation requirements which mean that consumers must be categorised as a Restricted, High Net Worth, Self-certified Sophisticated or Certified Sophisticated investor and must sign an annual declaration to that effect;
- Appropriateness assessments required to ensure that the cryptoasset being promoted is appropriate for the consumer;
- Record keeping obligations;
- Consumer Duty requirements particularly those around customer understanding and the cross cutting rules; and
- The need for due diligence on the cryptoasset or service being promoted to ensure that the information being communicated is fair, clear, and not misleading.
The risks of non-compliance
The FCA is clear that it will take action where breaches occur which can include taking down websites, placing firms on its warning list, placing restrictions on firms and taking enforcement action. Within the first two weeks of the rules coming into force, the FCA had issued over 200 alerts against non-compliant promotions. It can be expected that the FCA will remain very active in monitoring compliance.
Market trends
Two key trends include “approvers” and technology. Unregulated firms have faced challenges getting their financial promotions approved by an authorised firm. This situation is likely to be exacerbated by the implementation of the approvers gateway.
A key requirement for approving firms is that they must have the relevant competence and expertise in the type of investment being promoted when approving a financial promotion. This is an obvious challenge for authorised firms that do not have expertise in cryptoassets. Approvers must also play an active role in ensuring compliance of the promotion throughout the lifecycle of the promotion. These requirements create clear risks for authorised firms approving cryptoasset financial promotions.
Another issue firms face is in the practical implementation of the rules, particularly where significant IT investment has been required to support a compliant customer journey.
The enforcement perspective and enforcement pressure points
Criminal liability
It is a criminal offence for an unauthorised person to communicate a financial promotion in breach of FSMA. This can be punished by a fine and/or up to 2 years in prison in serious cases. The FCA tends to only pursue criminal penalties in the more severe cases, but the risk is there in any case and this is an area of real focus for the FCA, so extreme caution needs to be exercised by anyone agreeing to undertake promotional activity.
Firms also need to be aware that under FSMA, the directors and officers of a company that commits a regulatory offence can be held criminally liable personally if the offence was committed with their consent, connivance or by their neglect. So corporate officers need to make sure they take this very seriously.
If a financial promotion is made by an authorised firm but without the right permissions, this is not a criminal offence. However, the firm could still be subject to FCA enforcement proceedings, which could result in a fine, suspension of permissions and various other sanctions. These are severe sanctions and so great care needs to be taken.
FCA restitutionary powers
Aside from the criminal sanctions, the FCA has wide powers under FSMA to force those involved to halt unauthorised promotional activity and remedy any harm they have caused. This includes obtaining injunctions to freeze assets, compel the payment of restitution and take other steps to remedy the impact of the unauthorised promotion. Failing to comply with an injunction is itself a criminal offence so this is a powerful tool.
The FCA can also seek the same types of injunctions against anyone “knowingly concerned” in the making of the unauthorised promotion. The term “knowingly concerned” potentially captures anyone who knows the unauthorised promotion is being made. Exactly what the phrase means has been considered by the courts. In the recent case of Skinner the court held that for a director of a company to be “knowingly concerned” in the actions of the company, the director had to know what the company did and know that it was in breach of FSMA. Just knowing that the activity had taken place was not enough on its own.
Civil liability of the promoters
In addition to action the FCA might take, consumers can also seek compensation from the maker of a financial promotion through their civil rights. The form that this action might take would depend on what the promotion actually said and what harm it has caused.
However, consumers could have the right to sue for damages under s.138D of FSMA, make complaints via the FOS or make civil claims for misrepresentation, tort or (in extreme cases) fraud. The legal rights are there if the fact pattern fits. We have seen high value civil claims pursued against high profile celebrities for allegedly false endorsements in the USA. While it is important to bear in mind that the USA has a different legal system it is not impossible that YouTubers and other internet celebrities might become the targets of litigation in the UK.
Civil liability for Firms using third party promoters
For regulated Firms using third parties to make promotions, it is vital to understand that they risk exposure to civil liabilities for unauthorised promotions, particularly under s.30 of FSMA.
If a regulated firm enters into an agreement with a customer as a consequence of an unauthorised promotion, the customer may be entitled to: (i) treat the agreement as unenforceable against them (i.e. the agreement becomes entirely one-sided in the consumer’s favour); (ii) ask for it to be set aside; and (iii) seek return of all money and property paid under the agreement together with compensation for loss.
So, firms need to make sure they have proper systems and controls in place to ensure their third party promoters are not issuing unauthorised promotions or the consequences could be ruinous.
This article was written by Martin Cook, Matthew Kaltsas-Walker, Brandon Wong and John Roberts.