On the 5th day of Christmas HMT gave to me 5 revisions to the fin prom regime

On 15 December 2021, HM Treasury published a consultation paper outlining five proposed revisions to the financial promotion exemptions for high net worth (HNW) individuals, sophisticated investors, and self-certified sophisticated investors.

HM Treasury is of the view that while financial promotion exemptions are important and should be retained (especially to facilitate capital raising for SMEs), thresholds for exempt investors should be recalibrated to reflect investor's experience or their ability to absorb losses, revisions are required to help ensure exempt investors understand the regulatory protections they are losing and that investors can take responsibility for their investment decisions, and revisions are required reduce the risk of firms mis-using the exemptions (as is the case with some firms, particularly unauthorised firms today).

The five proposal aimed at achieving the above purposes are:

1. Increasing the net income threshold to £150,0000 and the net assets threshold to £385,000 for HNW individuals;
2. Dropping the word "certified" from the HNW individual exemption to simply "high net worth individuals";
3. With respect to for self-certified sophisticated investors, removing the "one investment in an unlisted company in the previous two years" as an indicator of sophistication, and increasing the threshold of being in the last two years a director in a company with annual turnover of at least £1 million to £1.4 million;
4. Introducing a requirement for firms to believe on reasonable grounds that an investor meets the HNW or sophisticated investor definitions and to document how they've came to this conclusion; and
5. Updating the HNW and self-certified sophisticated investor statements so that it is clearer, and to enable more investor engagement.

The scope of the exemptions remain unchanged. For example, the HNW individual and self-certified sophisticated investor exemptions only apply to investments in unlisted companies, whereas the sophisticated investor exemption applies to more instruments. This does not change.

In addition, the revisions apply to exemptions relating to the promotion of both investment activities and collective investment schemes.

The Government also understands that a number of overseas firms which rely on the overseas persons exclusion (OPE) also rely on the HNW individual and sophisticated investor exemptions in order to undertake regulated activities with UK clients by way of a "legitimate approach" (i.e. overseas firms may provide cross-border financial services in the UK without being authorised if the firm does not breach the FPO, for example by relying on an exemption). The consultation does not address the impact of the proposals on overseas persons, but the Government will consider responses from overseas persons as well as responses to its call for evidence for the overseas framework, when determining next steps.

The deadline for responses is 9 March 2021.

Current state of play

Under section 21 of FSMA, a person must be authorised by the FCA or PRA to communicate financial promotions, or where the person is unauthorised, have its financial promotions approved by an authorised person before they are communicated (unless an exemption applies). This is referred to as the "financial promotion restriction".

The Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (FPO) includes a number of exemptions from the financial promotion restriction and include those for:

• certified HNW individuals (Article 48 of the FPO);
• sophisticated investors (Article 50 of the FPO); and
• self-certified sophisticated investors (Article 50A of the FPO).

A similar restriction exists in section 238 of FSMA for the promotion of collective investment schemes, and there are exemptions in article 21, 23, and 23A of the Promotion of Collective Investment Schemes (Exemptions) Order 2001 (PCIS) which mirror the above FPO exemptions.

Reliance by UK firms

The purpose of these exemptions, when they were introduced in 2001, were to facilitate SME directly promoting investment opportunities to "business angels", as the cost of having a financial promotion approved by an authorised person were prohibitive in the case of SMEs seeking small levels of capital.

Currently, these exemptions are used for a wider purpose than originally intended.

The Government is aware of firms misusing the exemptions to market products (often higher risk investments) to retail investors. This ranges from firms undertaking superficial checks, to retail investors being coached to answer questions about the exemptions, so they are classified as HNW or sophisticated, when in reality they don’t meet the criteria, to statements investors are required to sign being hidden in significant amounts of information, in which investors are told to sign the statements as a formality without any real explanation as to what it means or the regulatory protections the consumer is giving up.

The proposals in more detail

Proposal 1 – Increasing the net income and net asset test for HNW individuals

HNW individuals are those who certify that they have earned a net income of £100,000 in the previous year or hold net assets of at least £250,000.

The Governments is proposing to increase the net income threshold to £150,0000 and the net assets threshold to £385,000. The Government is not proposing to change the assets in scope of the net asset calculation.

Reasons for these proposals include:

• since the financial thresholds were introduced in 2001, inflation has eroded their value in real terms. Between 2001 and 2021, inflation has meant that prices have risen by 54%;
• the pension freedoms introduced in 2015 allow consumers to withdraw funds from their pension pots, invest outside pension wrappers, and meet the HNW thresholds as a result of funds withdrawn; and
• the increase would reduce retail clients accessing higher risk investments by relying on these exemptions.

Proposal 5 – Updating the name of the certified HNW individual exemption to simply "high net worth individual"

We do not consider this proposal further.

Proposal 2 – Removing the "one investment in an unlisted company in the previous two years" as an indicator of sophistication, and increasing the threshold of being in the last two years a director in a company with annual turnover of at least £1 million to £1.4 million

There are different tests which if an investor meets, would qualify them as a sophisticated investor.

The Government is proposing to: (a) remove the test that allows an investor to be treated as sophisticated if they made more than one investment in an unlisted company in the previous two years; and (b) amend the test that allows an investor to be treated as sophisticated if, in the last two years, they have been a director in a company with an annual turnover of at least £1 million. The threshold will be increased to £1.4 million in line with inflation.

With respect to (a), in 2005, when the exemption was introduced, investors would have only been able to invest in unlisted securities through a broker. This is no longer the case given online investing and crowdfunding platforms, evidenced by the fact that at least 1.6 million consumers hold investments in unlisted companies (according to the FCA Financial Lives Survey 2020). Therefore this is no longer an indicator of investor sophistication.

The Government is not currently proposing a replacement for this test but would welcome views from stakeholders.

Proposal 3 – Requiring firms to document how they've come to a reasonable belief than an investor meets the HNW or sophisticated investor definitions

There is no obligation on firms to check that an individual meets the HNW or sophisticated investor criteria. The Government proposes to shift some of this evidential burden to firms so that they must have a reasonable belief that an individual meets the HNW or sophisticated investor definitions, and document how they've come to this conclusion accordingly.
The Government also proposes that firms be provided to provide their address, contact details, and if appropriate Companies House number or equivalent in any communications using the exemptions.

Reasons for these proposals include:

• some investors do not understand or engage with the exemptions. For example, investors often cannot remember how they had categorised themselves (i.e. HNW or sophisticated);

• according to FCA behavioural studies, internet users do not engage with technical information (e.g. T&Cs, privacy notices) they are presented with online, which they have to declare they have read or understood. A similar "click-through" phenomenon likely applies here; and
• unauthorised persons are increasingly marketing high risk investments to consumers in reliance on these exemptions (rather than requiring an authorised person to approved the financial promotions). This does not pose an issue with the exemption themselves but is an important consideration for the Government when proposing amendments.

Proposal 4 – Updating the HNW and self-certified sophisticated investor statements

As discussed above, some investors do not understand or engage with the information presented to them, including statements investors are required to sign to be classified as HNW or sophisticated. As a result, some investors may incorrectly certify themselves, or do not understand the regulatory protections they are giving up.

The Government proposes making three substantive changes to investor statements to remedy these problems:

• updating the format, such as by breaking up text, re-ordering the content etc.;
• simplifying language by using fewer references to other pieces of financial services legislation; and
• requiring greater investor engagement such as requiring investors to select which specific criteria they meet in order to be classified as high net worth or sophisticated, and to set out how they meet these criteria.

Snapshot of proposed financial promotion reforms over the last 18 months

HM Treasury's proposals follow a swathe of publications, hinting at material reforms to the marketing of (high risk) investments to retail clients:

• In September 2020, the FCA published a call for input in the consumer investments market, hinting that the £100k annual income / £250k net asset tests should be increased for the HNW and self-certified sophisticated investors exemption. See our briefing here.
• In April 2021, the FCA published a discussion paper "Strengthening our financial promotion rules for high-risk investments and firms approving financial promotions", examining the possibility of segmenting how high-risk investments are categorised, and the role of authorised persons who approve financial promotions. See our briefing here.
• Following its July 2020 consultation, in July 2021, the UK Government confirmed plans to introduce a "gateway" for the approval of unauthorised persons' financial promotions. Under this regime, all new and existing authorised firms will be prohibited from approving the financial promotions of unauthorised persons (to be implemented via a requirement on their permission), unless they apply to have the requirement varied or removed. See our briefing here, and here.