All change for the retail investments landscape

The retail investments landscape is changing for firms and investors.

Regulators are gearing up for a significant review/set of actions that will have an impact on firms operating in this area, particularly firms who sell complex products (e.g. derivatives). In part, regulators appear concerned about issues posed in relation to risky and complex products, margin trading with such products, the use of gamification elements and misleading marketing communications.

Regulators are also beginning to firm up long-term strategies in this area. The European Commission is currently consulting on the details of its Strategy for Retail Investors (see our briefing) and the FCA recently published its Consumer Investments: Strategy and Feedback Statement.

Background

In September 2021, the FCA issued its Consumer Investments: Strategy and Feedback Statement, setting out its aims to: ensure consumers benefit from investing in mainstream market products and have sufficient support (advice); and move consumers away from high-risk investments (when they have low risk appetite/resources) and reduce scams. It also provided an indication of how its approach in relation to a proposed consumer duty (see our briefing) would interact with this. This followed an April 2021 discussion paper on high risk investments (see our briefing). The FCA has also recently published its perimeter report 2020/21 which confirms that it is intending to take action in this area.

In October 2021, ESMA issued a call for evidence on retail investor protection topics under MiFID II, setting out plans in relation to disclosure, as well as its initial views on the risks posed by the digital tools and direct investor participation via online trading platforms and robo advisors. The call for evidence is part of mandate under the Strategy for Retail Investors and followed a February 2021 statement by ESMA on Gamestop share trading and a statement on PFOF (see our briefing).

We set out key themes below.

Technology/gamification

In its April 2021 discussion paper, the FCA highlighted concerns in relation to the increase in high risk investing by retail clients self-assessing as having lower risk appetites. The FCA argued that the gamification of trading had developed due to advances in mobile and internet technology. The discussion paper set out measures the FCA was considering to help retail clients accurately assess the risks and benefits of investments.

In response to trading in GameStop, ESMA issued statements in February 2021 setting out similar concerns about gamification of trading and noted an increase in retail investors taking investment decisions based entirely on information from social media and other unregulated platforms. In its September 2021 call for evidence, ESMA seeks views on whether the current regulatory framework is sufficient for current and future innovative concepts such as “social trading” or concepts that contain elements of execution only advice and whether specific action needs to be taken to address gamification.

Actions:

1. firms to review how their technology platform interacts with retail clients' trading behaviour, including incentives/prompts/encouragement for frequent trading; and
2. firms to check whether the FCA's vulnerable customer rules/guidance, and conduct rules have been taken into account in platform design.

Financial Promotion

The FCA and other regulators are cracking down in this area. The FCA has become an activist regulator in relation to marketing prohibitions/restrictions. There are already restrictions in relation to the promotion/distribution of certain instruments, including CFDs to retail, crypto derivatives, non-mainstream pooled investments and mini-bonds. If you felt that was a long list already, it is likely to grow.

In its September 2021 Statement, the FCA confirmed that it is planning restrictions applying to firms approving financial promotions for high-risk investments. It is also using technology to identify high risk financial promotions (e.g. those that promise very high returns or have a suspicious business models. This sits alongside proposals by HM Treasury whereby authorised firms are required to pass through a new regulatory gateway to be able to approve the financial promotions of unauthorised firms (see our briefing).

This appears to be part of a wider strategy to push retail away from complex products into more vanilla investments.

The FCA is also looking at marketing/promotional descriptions, whether these have disclosed sufficiently risks, and commissions/fees.

Actions:

1. firms to review marketing literature/material in relation to risks/commissions/fees to ensure accurate disclosure;
2. has FCA conduct/vulnerable customer rules been taken into account in relation to disclosures; and
3. if the firm approves promotions in relation to complex products, the product approval process should be reviewed to ensure rigour.

High risk investments

The FCA is concerned that some investors are able to access higher risk investments that do not match their risk tolerance and that COVID-19 has accelerated some of these trends.

The FCA set out its initial views on expanding the current classification of high-risk investments - this relates to the squeeze on complex products in relation to marketing/distribution noted above.

It is likely the FCA will use its new Consumer Duty powers to review products and services offered by firms – to ensure, in its view, such are specifically designed to meet the needs of consumers (e.g. higher-risk investments products are not sold to consumers without sufficient capacity for loss). The Consumer Duty will sit alongside framework such as product governance – and could mean "product manufacturer's" liability increases in relation to end investors.

In its February 2021 statement, ESMA set out concerns about the use of margin trading and other types of leverage, adding that this should only be entered into when risks are fully understood. In its October 2021 call for evidence, ESMA states that the use of margin trading increased the impact on retail investors in GameStop share trading incident and it seeks views on whether the current regular framework adequately protects retail investors against the risks of margin trading. We expect the trend - which the FCA seems to be leading - to restrict marketing and distribution of complex instruments to be extended here.

Actions for firms:

1. review how consumer duty may impact business;
2. ensure products are being manufactured/distributed in accordance with product governance principles (where relevant);
3.  review target market, to ensure appropriateness; and
4. review onboarding requirements in relation to MiFID appropriateness tests or suitability if relevant.
   

Best execution

ESMA has launched a consultation on proposals for improvements to the MiFID II framework on best execution reports.

The FCA has made enquiries as to how retail brokers are securing best execution.

Actions for firms:

1. review best execution policy and ensure costs and charges are being taken into account.
   

PFOF

PFOF has been a long-standing issue for the FCA, in particular in relation to the wholesale markets. However, FCA concerns in relation to PFOF have spread to the retail market.

The point appears to be spreading to the continent. In July 2021, ESMA issued a statement setting out investor protection concerns about PFOF in relation to MIFID requirements concerning conflict of interest, best execution, inducements, and cost transparency. ESMA considers PFOF to be incompatible with MiFID II in most cases, as it encourages firms to choose the third party offering the highest payment. In relation to best execution, ESMA reminded firms that for retail clients, the best possible result would, in the absence of a specific client instruction, "be determined based on total consideration, representing the price of the financial instrument and the costs relating to execution". ESMA asked NCAs to prioritise PFOF in their supervisory activities for 2021/early 2022 and that this should involve assessing the impact of PFOF on firms’ compliance with MiFID II requirements.

ESMA's call for evidence is also asking whether the legislative changes are needed to the current regulatory framework covering PFOF, as well as the impact of PFOF on the business models of "zero commission brokers".

Co-Author: Bisola Williams, Expertise Legal Manager