FCA Consultation Paper “Strengthening our financial promotion rules for high risk investments, including crypto-assets” (CP 22/2) Innovate Finance response
About Innovate Finance
Innovate Finance is the independent industry body that represents and advances the global FinTech community in the UK. Innovate Finance’s mission is to accelerate the UK's leading role in the financial services sector by directly supporting the next generation of technology-led innovators.
The UK FinTech sector encompasses businesses from seed-stage start-ups to global financial institutions, illustrating the change that is occurring across the financial services industry. Since its inception in the era following the Global Financial Crisis of 2008, FinTech has been synonymous with delivering transparency, innovation and inclusivity to financial services. As well as creating new businesses and new jobs, it has fundamentally changed the way in which consumers and businesses are able to access finance.
Our response to this consultation has been shaped by engagement with members including leading platforms in the peer-to-peer (“P2P”) (36H Group), equity-based crowdfunding and crypto-asset sectors. We have also taken a wider view in terms of the impact on trust, international competitiveness, start-up business environment and investment landscape in the UK Fintech ecosystem as a whole.
Innovate Finance welcomes the opportunity to respond to the FCA’s consultation, “Strengthening our financial promotion rules for high risk investments, including crypto-assets” (“CP 22/2”).
Innovate Finance supports the application of financial promotion rules to crypto-assets to ensure there is appropriate marketing, including protection for those in vulnerable circumstances, clear risk advice and warnings, and the avoidance of inappropriate inducements and selling techniques.
We are seriously concerned that:
- In relation to crypto-assets, the CP 22/2 proposals, and their interplay with the UK’s financial promotion regime, would prevent firms from obtaining s. 21 approvals for otherwise compliant crypto-asset promotions both under the existing regime and under the proposed new s. 21 regulatory gateway for approvers of financial promotions. Crypto-assets largely sit outside the regulatory perimeter, and the majority of crypto firms are not authorised entities (as per the definition under s. 31 Financial Services and Markets Act 2000 (“FSMA”)). That means these firms cannot approve their own financial promotions, and there is a dearth of suitable third-party approvers. This is a fundamental flaw in both the FCA approach and the HM Treasury proposals on crypto-asset financial promotions and this needs to be addressed, providing a route for crypto-asset firm authorisations.
- The FCA’s proposed categorisation of restricted mass market investments (“RMMI”) lumps together very different assets with very different risk profiles and characteristics. P2P (illiquid but low volatility and low risk of loss) is very different to a speculative exchange token which can be very volatile in value but is liquid. These require different types of risk warnings and tailored approaches under the financial promotions regime.
- In terms of P2P and equity crowdfunding, the existing financial promotions regime has already severely damaged the viability and competitiveness of the retail P2P operations of UK platforms. Already platforms responsible for over 50% of the sector’s loan volumes have withdrawn from the retail market following the publication of final policy in 2019 (FCA PS 19/14). Building on this and applying additional controls will adversely impact the market (and the SMEs and house builders which access funding from platforms), and it will severely restrict what has traditionally been a route to market for new entrant start-ups. Further evidence is set out in Annex A.
Overall, CP22/2 proposals need to be re-thought, with HM Treasury and the FCA working together to:
develop a proportionate approach for P2P and equity crowdfunding; and
create an authorisation route for crypto-asset firms.
- A route to authorisation for crypto firms must be developed. This will require HM Treasury and the FCA to work together and legislate as appropriate. This could include allowing firms with e-money licences to be recognised as authorised persons for the purposes of approving their own crypto financial promotions. Alternatively, this could involve developing a bespoke crypto firm authorisation regime that provides necessary assurance on the approval of financial promotions; this could include elements of the Senior Managers and Certification Regime (“SM&CR”) and the FCA’s new Consumer Duty, without applying other consumer safeguards such as the Financial Services Compensation Scheme (“FSCS”).
- A lower-risk category should be created for P2P and equity crowdfunding. We consider that P2P and equity crowdfunding is of a low-risk nature and that additional risk warnings (appropriate to the product) alongside proposed positive frictions should be sufficient for the level of risk associated with these investments — enabling the restriction on marketing only to certain categories of retail consumers to be removed. In other words, for P2P and equity crowdfunding, we are supportive of applying additional customer journey safeguards as proposed in CP 22/2, but then we suggest that P2P and equity crowdfunding firms should be permitted to communicate direct offer financial promotions without the precondition that this marketing be limited only to high net worth (“HNW”), sophisticated investors and restricted investors. Further details on the risk profile of P2P investments is set out in Annex B.
We set out a summary of our key points below, and we would be pleased to discuss this response in more detail with the FCA and/or facilitate discussions directly with our members.
Summary of key points
Absence of a strategic, holistic approach to digital assets and underlying technology is harmful to consumers and responsible businesses
The UK regulators and government have not taken a strategic and holistic approach to digital assets and the underlying technology — in contrast to the European Union and other international jurisdictions, the UK treatment of crypto for example is piecemeal and has primarily been approached through an anti-money laundering lens.
The UK has the opportunity to be the leading G7 country for blockchain-enabled financial services, including payments systems, Environmental, Social and Governance (“ESG”) assurance and capital markets infrastructure. To capitalise on this, we now need a strong vision from the UK government, a joined-up strategy and a regulatory system that can evolve in collaboration with industry and other nations.
In its approach to the wide range of digital assets and digital finance, the UK needs an overall vision and strategy for the UK’s aims in future finance: priorities, service parameters and global competitiveness. This should provide a joined-up approach to innovation in the interests of consumers, including consumer protections; firms’ conduct and financial stability; and international competitiveness and UK economic benefits. By and large a bespoke regime is required, given the fundamentally different nature of these products and services and the global nature of the market.
To date in the UK:
- the FCA has introduced an anti-money laundering (“AML”) and counter-terrorist financing (“CTF”) authorisation gateway for crypto-asset firms (including exchanges and currencies);
- HM Treasury and the FCA have published proposals on extending the financial promotions regime to capture qualifying crypto-assets;
- the Bank of England and HM Treasury have started work on exploring the concept of a Central Bank Digital Currency (“CBDC”); and
- HM Treasury has issued a consultation on the UK regulatory approach to crypto-assets and stablecoin, and the Bank of England has issued a discussion paper on digital money and the use of stablecoin.
Continuing to take this piecemeal approach to digital assets and distributed ledger technology will be damaging to UK competitiveness and damaging to consumers.
The FCA’s approach to crypto is disjointed and potentially harmful to consumers whilst stifling responsible businesses. Responsible crypto businesses in the UK face an existential threat as a result of the FCA and HM Treasury proposals — unless a route is developed to enable crypto-asset firms to be authorised to approve financial promotions. As a result, there is a real risk that UK retail consumers are targeted by financial promotions from unscrupulous overseas crypto firms — while we recognise that the UK financial promotions regime has extraterritorial reach, in practice it will be extremely challenging for the FCA and other agencies to crack down on this illegal activity by overseas firms.
Firms providing crypto assets face a Catch-22 situation under the FCA proposals
Financial promotions need to be approved by an authorised person as defined by s. 31 of the Financial Services and Markets Act 2000 (“FSMA”) (in other words this excludes authorised persons under the Electronic Money Regulations 2011). This authorised person must complete a self-assessment to state that they possess the necessary competence and expertise to approve the financial promotion in question, maintain records of how they have met the necessary competence and expertise requirements, and (where relevant) ensure appropriateness assessments and other requirements in CP 22/2 and the wider FCA Handbook have been satisfied throughout the life of the promotion.
Crypto-asset firms by and large are outside scope of the UK’s regulatory perimeter, and there is no declared intention from HM Treasury and the FCA to bring them within the regulatory perimeter, so these firms have no pathway to become an authorised person for the purposes of Part 4A permissions under FSMA. Some crypto firms are authorised under the Electronic Money Regulations, however.
This means that crypto firms cannot approve their own or other firms’ financial promotions. And there are no suitable authorised persons which are able, willing and not conflicted to provide approval of crypto financial promotions. In short, the overall effect of CP 22/2 proposals will be to stop firms communicating all financial promotions of crypto assets, unless they can rely on one of the exemptions under the Financial Services and Markets (Financial Promotions) Order 2005 (“FPO”).
Without developing a proven, viable route for approval of crypto asset financial promotions — or a route for the relevant authorisation of crypto firms, so they can approve their own financial promotions — the proposed rules regarding the consumer journey in CP 22/2 are redundant in the most part, as the overwhelming majority of crypto firms will not be able to get out of the starting blocks.
A workable route to allow crypto firms to secure approvals for financial promotions must be developed. That will require HM Treasury and the FCA to work together and legislate as appropriate. This could include allowing those with e-money licences to be recognised as authorised persons for the purposes of the new s. 21 regulatory approvals gateway. Or developing a bespoke crypto firm authorisation regime that provides necessary assurance on financial promotion aspects; this regime could apply elements of the Senior Managers and Certification Regime (“SM&CR”) and the FCA’s new Consumer Duty to firms, without applying other consumer protections such as the Financial Services Compensation Scheme (“FSCS”).
UK Financial Promotion rules are unfit for a digital world
We note the definition of financial promotion as set out in FSMA, associated legislation, and the FCA Handbook. Broadly this can be summarised as, “an invitation or inducement to engage in investment activity (or claims management activity), that is communicated in the course of business. They can take many forms, including adverts in print, broadcast or online media, marketing brochures, emails, websites or social media posts. ”
It is clear from CP 22/2 and through Innovate Finance’s participation at FCA industry roundtables that the regulator has not yet satisfactorily articulated the boundaries between direct offer financial promotions and firms’ marketing of an app, website or platform — including P2P and equity crowdfunding platform and crypto exchanges — as a tool for transactions.
We would urge the regulator to provide further guidance and clarification on this matter.
Lack of FCA and HM Treasury co-ordination on inter-related issues
We note the FCA has stated in CP22/2:
“We still believe that there needs to be significant changes to the FPO exemptions, particularly to the relevant thresholds and consumers’ ability to self-certify, issues on which the Government has recently consulted.”
Innovate Finance submitted a response to the HM Treasury consultation on financial promotions exemptions. In particular, we argued that the proposal that a firm should have a “reasonable belief” as to the accuracy of a consumer’s self-certification status is not possible to achieve on an automated basis today. Introducing this requirement in the context of retail investors and the FCA’s newly defined category of RMMI would have a material, detrimental impact on the P2P, equity crowdfunding and crypto-asset sectors.
We urge the FCA and HM Treasury to co-ordinate more closely on these interrelated issues because it creates a high degree of business uncertainty for firms.
Extending the application of Speculative Illiquid Securities (“SIS”) rules
We welcome the FCA’s decision not to extend the application of Speculative Illiquid Securities (“SIS”) rules to P2P property loans. However, we note that the FCA intends to “revisit this issue later in the year”.
Having consulted and concluded that this was not appropriate, it is unhelpful and destabilising to the market for the regulator to comment that it will revisit the matter again later this year. Future possible extension gives rise to huge damage to both fundraising and availability of investment opportunities.
We would urge the FCA to heed the majority of responses to its earlier discussion paper (DP 21/1), to take note of the sector data and make a commitment not to revisit this issue in the short or medium term.
Absence of coherent and objective criteria for the classification of high-risk investments
Our members have expressed concern about the absence of coherent and objective criteria for an investment to be included in the regulator’s newly defined category of RMMI, which we understand is based in part on the high return investments list originally introduced by the FCA in January 2020.
This categorisation and associated rules on marketing has significant commercial consequences for retail investment platforms and crypto firms.
The P2P sector, for example, argues that its returns have low volatility and could not be considered high risk over the last ten years. Innovate Finance raised this issue in our response to the FCA’s earlier discussion paper (DP 21/1), and we have provided data to support this assertion. Several P2P platforms have exited the P2P market in favour of institutional funding because the operational cost of maintaining a retail P2P platform is no longer viable.
The 10% of assets limit for restricted investors is no longer appropriate
According to HM Treasury data, only the top three percent of earners (2019 data) would qualify under the HNW investor criteria (minimum income £100,000). This means that the majority of investors are likely to qualify as restricted investors, and as such be subject to the 10% limit for all RMMI investments. The FCA’s proposals would increase the number of types of assets for which the majority of retail investors (restricted investors) are limited to 10% of net assets. In other words, for restricted investors, any crypto assets will now count towards the 10% limit on their net assets alongside P2P and non-readily realisable securities including equity crowdfunding.
Failure to consider the effects of a diversified portfolio
The FCA’s consultation contains no discussion of the portfolio/diversification elements of investing. The consultation paper treats all high-risk investment as if it was about single "bets". The risk profile when investing in twenty, or fifty, unlisted companies or P2P loans is vastly different from the risk profile of investing in one. To ignore this implies a fundamental misunderstanding of how these investments work and where the real risks lie.
There is also no mention at all of the potential benefits to consumers of being able to access (with appropriate protections) high-risk investments. We have historically had a serious ‘wealth gap’ in society: only a minority of people are able to invest in higher-risk, higher-returning assets, thereby increasing their wealth; while those from lower socioeconomic groups are stuck in supposedly ‘safer’ assets that fail to grow their capital and (especially in times of high inflation, like now), result in losses in real terms.
One of the great financial innovations of the last ten years has been helping to close this gap by opening up investment opportunities to a wider range of the UK population in terms of socioeconomic background, enabling those who want exposure to alternative investments the chance to get it. So, while we appreciate the FCA's statement that "we do not want to unnecessarily restrict consumers from investing if they want to" (paragraph 4.1), we think inadequate consideration has been given to the availability of these types of investments as part of a portfolio.
Unintended consequences for equality and diversity outcomes
The FCA observed that “recent research suggests that consumers newly investing in high-risk investments (those investing for less than 3 years) are more likely to be female, younger, more ethnically diverse and to be in a lower socioeconomic group compared with traditional investors”.
We would invite the FCA to share further modelling and data points on the net effect of CP 22/2 proposals in relation to equality and diversity outcomes. For example, in turning the above referenced groups away from RMMI, does the FCA anticipate that these retail investors will cease investing altogether, or does the regulator consider that it may inadvertently drive a shift in behaviour towards high risk offshore investments, which afford fewer consumer protections.
Timescales for implementation are inadequate
We note that the FCA intends to afford firms three months from publishing final rules to comply with the new requirements for the consumer journey and for the s. 21 approvers.
Feedback from our members indicates three months is insufficient to implement the necessary changes. We recommend that firms be given at least four to six months’ time to allow for implementation and adequate testing and refinement. This response is subject to any changes required as a result of the HM Treasury consultation on exemptions under the FPO, which may require additional operational work on the part of firms.
The cost benefit analysis is flawed
We do not consider the cost benefit analysis to be a satisfactory assessment of the full costs and potential impacts. No assessment seems to have been made in terms of the practical implications of the proposals, and there is no assessment of the impact on start-ups, scale-ups and wider UK competitiveness (domestic and global markets).
Wider market impact on crypto firms and on P2P and equity based crowdfunding is inadequately addressed. Nor is there any attempt to assess the overall impact in conjunction with other changes to the financial promotions regime (i.e. the HM Treasury proposals to amend the exemptions under the Financial Promotions Order, extension of the financial promotions regime, and the proposed introduction of the s. 21 regulatory gateway).
Several P2P platforms have exited the P2P sector as a result of the regulatory changes in December 2019 and the proposals contained in DP 21/1, making it no longer cost effective to maintain a retail P2P platform (see Annex A). Instead these loan assets are now purchased by institutional investors. We query whether the FCA has assessed loss of direct access to this yield-based investment to retail investors. For example, a portfolio of P2P loans now purchased by an asset manager on behalf of a pension fund will produce the same risk return profile for the end retail consumer (in their pension fund), but with the deduction of manager fees en route.
Innovate Finance believes that the key regulatory changes that have protected customers in crowdfunding came through the introduction of the Risk Management Framework and SM&CR in December 2019, plus the focus on wind down planning in 2021. These ensured a professional approach to the origination and diligence of potential borrowers, if not already embedded in a platform’s procedures, and it is notable that the platforms in administration all ceased trading ahead of the implementation of these rules. The key to minimising investor losses is the origination of good quality loans rather than preventing access to the product, which the proposed changes to the financial promotion rules are designed to do.
Lastly, we consider that the CP22/2 proposals do not have regard to the FCA’s duty to promote effective competition in the interests of consumers. The proposals will reduce competition in capital investment markets. It will also reduce sources of funding for SMEs and for small house builders.
Consultation paper questions and responses
Chapter 3: Classification of high risk investments
Q1: Should we rationalise our financial promotion rules in COBS 4 by introducing the concepts of ‘Restricted Mass Market Investments’ and ‘Non-Mass Market Investments’?
Innovate Finance considers that the FCA’s newly defined RMMI category is not sufficiently nuanced and has conflated a number of issues, including the risk profile, volatility and illiquidity of assets. Our members do not consider that P2P, equity crowdfunding or crypto firms should be included together within the category of RMMI.
A lower-risk category should be created for P2P and equity crowdfunding, which adopts the customer journey proposals as set out in CP 22/2, and then permits these firms to communicate direct offer financial promotions without the precondition that this marketing be limited only to HNW, sophisticated investors and restricted investors.
- P2P is an income-producing loan investment amortising over one to five years with return typically in the 3-7% p.a. range. Investors may select different types of loans they would like exposure to. Investing is not time critical: if there is a loan yielding 5% available today, then it is likely that there will be another similar loan yielding 5% available tomorrow.
- Equity crowdfunding is a higher-return equity investment with a duration of three to ten years. Investors, in reviewing potential investments, have access to presentations and diligence documents.
- Crypto-assets are not a single homogenous asset class: voucher tokens, asset-backed stablecoins, public market security tokens, and more speculative crypto currencies are all very different types of digital asset. Investors trade quickly, sometimes daily. Crypto assets need to be more tightly defined to focus on the specific characteristics of high risk — leaving other assets outside of this categorisation.
Successive tightening of the UK’s regulatory framework is impacting innovation and domestic and international competition
While Innovate Finance is very supportive of the FCA’s intended policy aim to minimise customer harm, it is clear that successive tightening of the regulatory framework is having a material, adverse impact on the viability of the retail operations of our members. Further details are set out in Annex A.
By being placed in the proposed RMMI category, our P2P, equity crowdfunding and crypto members with products designed built for mass market distribution now find themselves severely restricted in their target markets. Additionally, HM Treasury’s proposals to amend the FPO exemptions will further reduce the available pool of retail investors for these products, and we anticipate this will be a precursor to a number of firms exiting the UK market. This has significant ramifications for innovation and competition in UK markets, and in relation to the international competitiveness and attractiveness of the UK as a place to do business.
New category and regime for crypto assets
We recommend that the FCA creates a new category for crypto — separate to other investment products within the RMMI category — which is appropriately tailored to the risks related to the asset class.
This regime should provide a credible pathway for crypto firms’ financial promotions to be approved by third parties under the proposed s. 21 regulatory gateway and/or provide a route for crypto firms to be authorised to approve their own financial promotions — for example, by allowing those firms with e-money licences to approve their own financial promotions.
This is not a rationalisation of rules
In one sense, it is hard to see how these proposals amount to ‘rationalisation’. In practice, the FCA is simply proposing to change the title of the existing categorisation and adding crypto-assets to the category of RMMI.
The 10% of assets limit for restricted investors is no longer appropriate
According to HM Treasury data, only the top three percent of earners (2019 data) would qualify under the HNW investor criteria i.e. minimum income £100,000. This means that the majority of investors are likely to qualify as restricted investors, and as such be subject to the 10% limit for all RMMI. Many investors sign up and invest on multiple platforms, for example they invest across several P2P platforms or more than one equity crowdfunding platform or purchase more than one crypto-asset. This platform diversification is in itself a sensible investment strategy.
The main change this brings about will be to increase the number of types of assets for which the majority of retail investors (restricted investors) are limited to 10% net asset. In other words, for restricted investors, any crypto-assets will now count towards the 10% limit on their net assets alongside P2P and equity crowdfunding. This brings a wide range of very different assets with different risk profiles into the 10% asset limit, which unduly restricts investment and prevents a diversified portfolio. We would recommend that at a minimum, ‘restricted investors’ should be able to invest 10% in each of the different asset classes within the proposed RMMI.
Chapter 4: Strengthening the consumer journey for high-risk investments
Q2: Should we introduce stronger risk warnings, as outlined in paragraphs 4.20 – 4.27, for all ‘Restricted Mass Market Investments’ and ‘Non-Mass Market Investments’?
In general, we support in principle the strengthening of the consumer journey for high-risk investments. However, we query whether all the assets in scope are in fact high risk and whether the warnings are appropriate. The FCA’s ‘one-size fits-all’ risk warning is not appropriate for a number of assets.
The FCA proposes that all RMMI have the same warning:
“Don’t invest unless you’re prepared to lose all your money invested. This is a high-risk investment. You could lose all the money you invest and are unlikely to be protected if something goes wrong.”
Innovate Finance research estimates that over the last ten years the annualised return on P2P loans for the industry as a whole was c. 4.9% p.a. after fees and losses excluding platforms in Administration, or 3.7% p.a. including platforms in administration. The estimated annualised loss rate for the industry was c. 2.7% p.a. excluding platforms in administration or 3.5% p.a. including platforms in administration. Our data suggests that returns for the industry have been consistently positive despite the high profile platform failures. In addition, several P2P platforms have a track record such that no investor has ever lost money on their platform since inception. Arguably, it would be misleading to describe this as a high-risk investment. As noted above, it may be more appropriate to note in the risk warning that the investment is illiquid — ‘you will not be able to cash in your investment quickly and easily’.
The indiscriminate approach of the FCA proposals makes these warnings nonsensical. They will also undermine the warnings — such strong warnings are simply not true for some types of assets that would be in scope. The danger is that this will lead people to make light of these and ignore similar warnings on genuinely higher-risk assets. Different risk warnings are needed for P2P, equity crowdfunding and crypto-assets. A ‘one-size-fits-all’ approach does not work, and it fails to provide appropriate and accurate risk information to consumers.
As a final point, we understand that the proposed risk warning would not be required where this does not work practically. Specifically, when communicating financial promotions in an environment where character limitations exist, for example via Twitter. We would urge the FCA to make this clear within the final rules.
Q3: Should we ban inducements to invest e.g. refer-a-friend bonuses, for all ‘Restricted Mass Market Investments’ and ‘Non-Mass Market Investments’?
In principle, this is an appropriate measure which we would welcome if applied to the correct categories of assets.
Equity crowdfunding platforms highlighted that some companies raising funds through their platforms offer shareholder benefits — for example, discounts on products. This is common in the equity market (some listed companies offer shareholder discounts) and they would not want to see this banned under these new rules. We would therefore strongly urge the FCA to make clear that rewards provided by a fundraising company are not subject to the ban on inducements.
Q4: Should we introduce a personalised risk warning pop up for first time investors in ‘Restricted Mass Market Investments’ and ‘Non-Mass Market Investments’?
In principle, this is an appropriate measure which we would welcome if applied to the correct categories of assets.
Whilst we agree that a pop-up for first time investors is reasonable, the proposed method of personalisation may be counterproductive. Internet users who see their names auto-populated may instinctively view the message as a form of spam; likewise, phrasing the warning as a question has the feel of a ‘cold-call’ solicitation. A pop-up that simply follows and reinforces the language of the risk warning at paragraph 4.21 may be more effective.
Q5: Should we introduce a 24 hour cooling off period for first time investors in ‘Restricted Mass Market Investments’ and ‘Non-Mass Market Investments’?
This proposal would seem unnecessary considering first time investors are only able to access an investment opportunity (a direct offer financial promotion) following client categorisation and appropriateness tests. Under existing rules, first time investors on an equity crowdfunding platform are currently only able to access the website without the ability to view a full campaign page. Implementing the cooling-off proposal in addition to existing positive frictions already in place means that investors would not know or understand what they were “cooling-off” from, other than whether or not they wish to view a direct offer financial promotion.
We strongly believe that there are other sufficient and effective positive frictions in existence. For example, as well as client categorisation and appropriateness, a seven-day cooling-off (or “cancellation”) period has been in existence since equity crowdfunding platforms received authorisation. This cancellation period allows all (not specific to first time) investors adequate time to consider whether the investment decision made is appropriate for them. This is much more effective than the twenty-four hour cooling-off period proposed in driving the FCA’s desired outcome of retail investors accessing investments that are perfectly suited for their risk appetite and ability to bear losses, whilst "not… unnecessarily restricting consumers from investing if they want to" (paragraph 4.1).
We believe that this proposal may cause a huge burden to regulated firms without providing the FCA’s desired outcome. Instead, we believe it will (i) lead many investors to not access, and therefore invest in, investment opportunities that are perfectly suited to their risk appetite and diversified portfolio and (ii) make fundraising for early-stage businesses vastly and unnecessarily more difficult.
In addition, the proposal that the twenty-four hour cooling off period would not apply to existing users of platforms, websites and crypto exchanges may create some competition barriers — incentivising consumers to stay with those they have used before. In relation to crypto-assets, FCA research on UK consumer adoption of crypto already shows relatively broad market penetration on crypto-asset ownership: adding cooling-off periods unilaterally will likely incentivise consumers to keep trading on their existing accounts rather than opening up new accounts where temporary restrictions apply — again a disincentive for competition and new market entrants, as consumers will be ‘stickier’. Consumers also open up crypto trading accounts without necessarily knowing the jurisdiction of the platform from which they are buying. Adding restrictions to trading may incentivise UK consumers towards platforms which do not have restrictions i.e. away from UK-registered exchanges.
Q6: Should we change the investor declaration form for ‘restricted’, ‘high net worth’ and ‘sophisticated’ investors to introduce an ‘evidence declaration’ and simplify the declaration?
We support the use of plain English definitions and simpler declarations. In principle, requiring the consumer to provide an evidence declaration is also a positive step.
However, we note the link to the parallel HM Treasury consultation on FPO exemptions. We do not support proposals by HM Treasury to require a firm to come to a reasonable belief that investors met the conditions of the exemptions. This is not practical or possible on a digital platform and would have the effect of making unviable all P2P platforms, online crypto exchanges and crowdfunding platforms. We made these points in our response to FCA DP21/1.
We strongly urge FCA not to pursue any requirement for firms to secure a ‘reasonable belief’ that investors meet the client categorisation they have declared.
It is unclear how restricted investors could evidence that they correctly sit within this client category (particularly the forward-looking element of the definition), and we would invite the FCA to consider whether this is practical.
Q7: Should we make changes to our rules on appropriateness to ensure all investors in ‘Restricted Mass Market Investments’ must pass a robust assessment of their knowledge and experience?
In principle, this is an appropriate measure which we would welcome if applied to the right categories of assets.
There is strong evidence and data to suggest that the current use of appropriateness tests within the crowdfunding sector is effective in (i) educating investors of the risks associated with the asset class and (ii) ensuring the investment opportunities are appropriate for their risk appetite and needs. Therefore, we are supportive of the requirement to have a robust appropriateness test in place. However, we would welcome further clarification as to how this would sit alongside the proposed Consumer Duty. Arguably, the Consumer Duty should drive good customer outcomes that will in itself incentive firms to strengthen existing appropriateness tests, without the need for additional, prescriptive rules on appropriateness tests.
We would urge the FCA to consider, and possibly test, whether the proposal of requiring multiple versions of an appropriateness test will result in the questions being weaker and therefore easier for an investor to pass. Furthermore, for crowdfunding platforms with multiple product types, there would be a considerable number of appropriateness test versions required, which could add a significant burden to firms.
We agree with the FCA’s view that consumers who have failed the test should not be encouraged to retake if they have not attempted to do so on their own initiative, as this may undermine the objective of the test. However, as the appropriateness test forms part of a journey that is effective in educating consumers on investing in this asset class, some of our members have opted to divert the consumer to educational material for consumers to read more about investing, including the associated risks. We do not believe this to be encouraging investors to retake the test and is an effective tool for encouraging consumers to think about whether the investment is appropriate for them.
Q8: Should we introduce record keeping requirements for firms to monitor the outcome of the consumer journey for ‘Restricted Mass Market Investments’ and ‘Non-Mass Market Investments’?
In principle this may be an appropriate measure which we would welcome if applied to the correct categories of assets.
We welcome the FCA’s indication that the new Consumer Duty would not apply in full to firms who do not have a direct relationship with the retail investor; however, we would invite the FCA to provide further clarification on the interplay of the Consumer Duty outcomes and the proposals in CP 22/2.
The Consumer Duty will require firms to monitor and maintain records of consumer outcomes, so it is unclear how the CP22/2 record keeping proposals sit alongside the Consumer Duty proposals.
We urge the FCA to avoid duplicating or adding layers and complexity to firms’ record keeping requirements. The FCA should have a single set of rules on monitoring outcomes — not multiple approaches. We would recommend the FCA implements the Consumer Duty record keeping proposals and — in the short- to medium-term — avoid adding additional requirements for record keeping to monitor outcomes of the consumer journey in relation to CP 22/2.
Q9: Do you agree with our proposed approach to implementation of our consumer journey proposals for investments already subject to our financial promotion rules?
These proposals will be implemented alongside other FCA regulatory changes, including the new Consumer Duty, and is set against a backdrop of other financial promotion rules changes such as the introduction of the s. 21 regulatory gateway and the HMT FPO exemptions amendments.
We would urge the FCA to be mindful of the cumulative impact of regulatory and legislative change for firms. Piecemeal implementation of the above described changes, over a short three month period, will create undue pressures on firms and unnecessary additional costs.
A single, unified change programme may be more effective and efficient for firms, and in terms of outcomes, FCA should allow a longer implementation period and enable implementation of the various different new requirements to be developed together. The FCA should give firms the time and space to develop unified change programmes.
Q10: Do you have any suggestions for how we can monitor the impact of our consumer journey proposals?
We would encourage the FCA to leverage its behavioural economics team and supervisory technology to monitor impacts of these proposals in relation to the customer journey.
In addition, we would welcome an ex-post review on the impacts of CP 22/2 proposals in terms of innovation and competition in the UK’s P2P, equity crowdfunding and crypto markets.
The FCA acknowledges in the consultation paper:
"We are conscious that some of the interventions, such as the new risk warnings and positive frictions, may become less effective over time as consumers adjust their behaviour. We will use our consumer research and the record keeping requirements to monitor the impact of our proposals and consider whether further changes are needed."
While we appreciate the concern that the FCA is seeking to address here, we do not think it is helpful or indeed viable to have a constant treadmill of new frictions every time existing ones are perceived to become ‘stale’, and we are aware of no other area of financial regulation that takes that approach. Any system should be set up with a view to it being permanent, with improvements proposed when needed but not with the expectation that there will need to be constant change.
Q11: Do you agree with our proposed approach to implementation of our consumer journey proposals for crypto-assets?
In principle this is an appropriate measure which we would welcome if applied to the correct categories of assets.
Chapter 5: Strengthening the role of authorised firms communicating and approving financial promotions
Q12: Do you agree with our proposed changes to COBS 4.5 to clarify the obligation regarding the name of the s21 approver?
Q13: Do you agree with our proposal for s21 approvers to ensure that approved promotions include the date of approval in the financial promotion?
Q14: Do you agree with the introduction of a competence and expertise rule to apply to all authorised firms when approving or communicating financial promotions?
We agree with the principle of introducing a competence and expertise rule. However, we would strongly urge the FCA to make clear that this requirement relates to the investment product, rather than with respect to the underlying asset. In the context of equity crowdfunding, where a firm is approving financial promotions for unlisted equities, requiring competence and expertise in the field of unlisted equities is appropriate. However, given the diversity of industries and sectors raising funds via crowdfunding platforms, it is not practical for the s. 21 approver to possess competency and expertise within all sectors or industries. If a firm is approving a financial promotion for an unlisted farming business, for example, then it would be entirely unsustainable for the firm to have competency and expertise in the field of farming as well as in the field of unlisted equities.
In relation to crypto assets, the approach will not work. Only authorised firms — i.e. those that fall within the definition of an authorised person under s. 31 FSMA — can approve promotions. But crypto firms are largely outside the regulatory perimeter, and there are currently no proposals to materially extend the UK’s regulatory perimeter to capture all crypto-related firms and activities. Crypto firms cannot, therefore, apply for Part 4A FSMA permissions, which would do away with the need for reliance on third-party approvers for their financial promotions.
Further there are no third parties that are willing, able (in terms of competence and expertise) and not conflicted that can approve crypto promotions. We have consulted our members, law firms and other professional services firms widely, and no one has been able to identify a single third party approver for their crypto financial promotions. This would leave crypto firms unable to run any otherwise compliant financial promotions.
In effect, UK-based crypto firms would no longer have a viable business and would have to close UK operations. Consumers in the UK may seek out less scrupulous and unregulated crypto exchanges overseas. This makes mockery of HM Treasury’s proposal to apply financial promotion rules to qualifying crypto assets. Rather than strengthening consumer protection, it will close down UK firms and drive UK consumers into the arms of unregulated overseas providers.
We would recommend exploring potential solutions to provide a credible pathway for crypto firms’ financial promotions to be approved by third parties under the proposed s. 21 regulatory gateway and/or provide a route for crypto firms to be authorised to approve their own financial promotions — for example, by allowing crypto firms with e-money licences to approve their own financial promotions.
Alternatively, HM Treasury and the FCA should develop a bespoke authorization for crypto-asset firms — this might incorporate elements such as SM&CR and appropriate assurance of fitness to approve promotions — to enable approvals of financial promotions by crypto-asset entities.
Either way, this new authorisation route needs to be in place before the financial promotions regime is extended to qualifying crypto-assets.
Q15: Do you agree with the proposed approach to firms assessing competence and expertise?
Q16: Do you agree with our guidance to firms on the competence and expertise requirement?
Q17: Do you agree with our proposal for a new ongoing monitoring requirement for s21 approvers?
We agree with the principle of ongoing monitoring of financial promotions. However, we do think it is necessary for the FCA to make a clear distinction between general and direct offer financial promotions, and that it should be considered in the context of the financial promotion itself.
In the context of equity crowdfunding, where a campaign page is a live direct offer financial promotion, which can be run for a period of weeks, the FCA’s concerns could be addressed via a “bringdown” before the investment is completed. In other words, if a promotion is made, investments are collected (but not released to the investee), and then before completion the promotion is reviewed again, that should be sufficient. If, on that final review, it is determined that the promotion is not fair, clear and not misleading, and so the investment is cancelled and investors’ money is returned. This approach will have the same impact as being monitored on a constant and real-time basis.
Furthermore, in order to avoid the unintended consequence of scope creep, we would strongly urge the FCA to clarify that this relates to the time that the financial promotion is live only, and does not extend to after the investment is complete. For example, where an unlisted company includes the intended use of proceeds of the investment funds within a financial promotion, the s. 21 approver must consider whether this is fair, clear and not misleading at the time the financial promotion is live. It is not feasible to expect a s. 21 approver to monitor a private business’ use of proceeds following completion of the investment. We believe that this could be addressed with a disclaimer within the financial promotion to explain that due to the nature and type of business presented, the stated use of proceeds is aspirational but likely to change over time.
Q18: Do you agree with our guidance on ongoing monitoring for s21 approvers?
We refer to our response to question seventeen. We invite the FCA to amend the guidance on ongoing monitoring for s. 21 approvers in line with our above recommendations.
Q19: Do you agree with our proposal to require s21 approvers to obtain attestations of no material change from clients?
Q20: Do you agree with our proposal to extend conflicts of interest requirements to s21 approvers?
This proposal is woefully inadequate in addressing the issue the FCA notes about crypto firms mainly sitting outside the regulatory perimeter and therefore needing to seek approvals for financial promotions from third party firms.
The proposals do not address the risk of firms refusing to provide approvals for crypto firms’ financial promotions. Nor do the proposals provide any robust safeguards against anti-competitive behaviour. The only solution is to bring more crypto firms into the regulatory perimeter in some way.
Q21: Do you agree that s21 approvers of ‘Restricted Mass Market Investments’ should take reasonable steps to ensure that the relevant processes for appropriateness tests comply with our rules on an ongoing basis?
Q22: Do you agree with our expectations on what reasonable steps may look like when complying with the appropriateness test?
Q23: Do you agree with our proposed guidance to firms on conducting appropriateness tests?
Q24: Do you agree with our proposed guidance for firms approving financial promotions for ‘Non-Mass Market Investments’?
Chapter 6: applying our financial promotions rules to crypto-assets
Q25: Do you agree with our proposal to apply the financial promotion regime to crypto-assets and classify them as ‘Restricted Mass Market Investments’?
As noted in our summary, above, this proposal is fundamentally unworkable and inappropriate whilst crypto firms remain largely outside the regulatory perimeter and are unable to secure approvals for any financial promotions.
The s. 21 regulatory gateway regime mean these rules will not work
In CP 22/2, the FCA states:
“Neither crypto-asset firms which are registered with the FCA under the AML/CTF regime, nor firms authorised under e-money or payments regulation can communicate or approve financial promotions (as defined by S.21 FSMA), unless they are also authorised persons within the meaning of S.31 FSMA. This is set in legislation and cannot be modified by our rules.”
Additional FCA rules on financial promotions should not be introduced until a solution is found and implemented to enable crypto firms to be authorised to approve financial promotions. This should await legislation if necessary.
The existing and proposed rules on approvals for financial promotions simply do not work for crypto firms whilst they are outside the regulatory perimeter. Only authorised firms — i.e. those that fall within the definition of an authorised person under s. 31 FSMA — can approve promotions. But crypto firms are largely outside the regulatory perimeter, and there are currently no proposals to materially extend the UK’s regulatory perimeter to capture all crypto-related firms and activities. Crypto firms cannot, therefore, apply for Part 4A FSMA permissions, which would do away with the need for reliance on third-party approvers for their financial promotions.
Further there are no third parties that are willing, able (in terms of competence and expertise) and not conflicted that can approve crypto promotions. We have consulted our members, law firms and other professional services firms widely, and no one has been able to identify a single third-party approver for crypto financial promotions. This would leave crypto firms unable to run any otherwise compliant financial promotions.
The FCA acknowledges this in CP 22/2:
“As crypto-assets currently sit outside the financial promotion regime, there is unlikely to be an existing population of s. 21 approver firms. We recognise that the population of authorised firms with sufficient competence and expertise to approve crypto-asset financial promotions is likely to be limited at first.”
In fact it is not so much ‘limited’ as non-existent.
This leaves crypto firms unable to run any otherwise compliant financial promotions. In effect, UK based crypto firms would no longer have a viable business and would have to close UK operations. Consumers in the UK may then seek out less scrupulous and unregulated crypto exchanges overseas. This makes mockery of HM Treasury’s proposal to extend financial promotion rules to qualifying crypto-assets. Rather than strengthening consumer protection, it will close down UK firms and drive UK consumers into the arms of unregulated overseas providers.
We would recommend exploring potential solutions to provide a credible pathway for crypto firms’ financial promotions to be approved by third parties under the proposed s. 21 regulatory gateway and/or provide a route for crypto firms to be authorised to approve their own financial promotions — for example, by allowing those firms with e-money licences to approve their own financial promotions or develop a bespoke crypto-asset authorisation.
Definition of crypto assets remains unclear and risks applying the rules to an extremely diverse and wide ranging group of assets
In CP 22/2, the FCA notes that:
“The scope of ‘qualifying crypto-asset’ in the Treasury consultation response is any cryptographically secured digital representation of value or contractual rights which is fungible and transferable. The Treasury intends to exclude from this other controlled investments, electronic money under the Electronic Money Regulations 2011, and central bank money, as well as crypto-assets that are only transferable to one or more vendors, or merchants in payment for goods or services.”
Whilst this definition does appear to exclude some forms of crypto-assets (like Non Fungible Tokens (“NFTs”) and some utility tokens) it is not entirely clear where the boundary lies in terms scope for other crypto-assets.
It is difficult to assess the FCA’s proposed rules when the final definition of what is in scope has yet to be agreed by HM Treasury. The HM Treasury response to its consultation on extending the financial promotions rules to qualifying crypto-assets outlines:
”The government considers that, in order to develop a regulatory framework that responds to identified risks and provides legal clarity, a clear legal definition is required…the final drafting for that definition is still under development”.
In CP22/2, the FCA notes that “any definition is provisional and subject to change before the statutory instrument is laid before Parliament”. It cannot be understated that definition is fundamental to the application of these rules. Greater clarity on definition is needed before proceeding with the CP 22/2 proposals for crypto firms — we cannot assess the proposals and their impact without having a clear and future-proof definition from HM Treasury. A more focused definition may be needed to target those crypto-assets that have significant risk characteristics: in terms of volatility, value and liquidity.
Q26: Do you agree with our proposed approach to exemptions for crypto-assets?
We welcome the proposal by the FCA to allow direct offer financial promotions for crypto-assets to be communicated to HNW investors within the context of FCA rules on RMMI. We agree that this aims to prevent the regime from being too restrictive to those more able to absorb losses.
We also note that CP 22/2 states:
“We do not propose to create a ‘self-certified sophisticated investor’ exemption for crypto assets, based on that specified in Article 50A of the FPO. The current criteria for self-certification of sophistication are based on the investment relating to an unlisted security and includes criteria, such as being a member of a syndicate or business angel network, that is not suitable for demonstrating sophistication in relation to crypto assets”.
Some Innovate Finance members have indicated that they consider that there is a case for creating a ‘self certified sophisticated investor’ for crypto and we would welcome further discussion of whether and how this could be defined.
Annex A: P2P Retail Market: impact to date of UK financial promotion rules
In December 2019, two P2P platforms (LandBay and Thin Cats) left the P2P sector in favour of institutional funding — rather than operate a retail P2P platform under the new rules following the publication of the FCA’s Policy Statement (PS 19/14) — with both firms stating that it would no longer be cost effective to maintain their P2P operation. Since the publication of DP 21/1, three of the largest P2P platforms (Funding Circle, Lending Works and Zopa) have announced their exit from P2P in favour of alternative funding methods. These P2P firms issued press statements commenting that it was no longer cost effective to operate a P2P platform:
Zopa (7 December 2021):
“…over the last few years, customer trust in P2P investing has been damaged by a small number of businesses whose approach led to material losses for retail investors.
Linked to this, the changing regulation which followed raised the operational costs of running a P2P business, as well as the cost of attracting new investors to the Zopa platform. To offset these increased costs and ensure we have a sustainable and profitable business, we’d need to reduce investor returns to a point where they’d no longer be attractive and commensurate with the risk that investors take on.
For these reasons, we have decided to fully focus our attention on our Bank.”
LandBay (5 December 2019):
"We have taken the decision to close the retail P2P funding element of our business and become a solely institutional marketplace lending platform. This is not a decision that we have taken lightly. The fact of the matter is that we would not have been able to get to where we are today without the retail business. However, it has been hard to see how to scale this part of the business on commercial terms that make sense."
Thin Cats (9 December 2019):
“Following a thorough review, we have concluded it is no longer cost effective and practicable to raise funds in this way, so have decided to close the P2P platform to new business and initiate a run-off process for existing investors.”
Lending Works (14 December 2021):
“…the dynamics of the P2P market have changed markedly in recent years, with retail investor participation steadily waning. This has been exacerbated by the Covid-19 pandemic, to the extent that we no longer feel it is large enough to support a mainstream lender such as Lending Works. We now need to utilise alternative funding sources to ensure that we can provide our loan customers with the service they need.”
Funding Circle said (10 March 2022):
“Finally, after two years of the platform being paused for new investment from retail investors as we focused on supporting SMEs through CBILS and RLS, we have taken the decision to permanently close the retail platform for new investments.
While this was a difficult decision, retail lending today represents only c.5% of our total loans under management as we have diversified our investor base over the last decade. Broader changes within the industry mean we do not believe we could also continue to operate a sustainable retail investment product.”
Annex B: Historical investor returns and loan book losses for the P2P sector
Innovate Finance has collated data on annual loan volumes, loan book returns and loan book losses for the underwriting years 2013 – 2019.
“Underwriting year” data means, for example, the loan book return today on the loans written in 2019 is the current expected return today taking account of performance since 2019 i.e. taking account of the impact of losses to date and impact of the Covid crisis.
The data is mostly from public sources, supplemented with some data provided privately by platforms. We estimate our sample covers c. 95% of the sector by volume.
We calculate for the sector the average loan book returns and loan book losses for loans written in this period.
There are six platforms in administration/CVA (c.9% of the sample by loan volume). There is limited data available on their loan book performance, and we have estimated losses based on public data prior to their administration together with information contained in the update reports from administrators.
Results and analysis
We show data for (1) all platforms, (2) all platforms excluding platforms in administration, and (3) continuing platforms. This allows the user to see the impact that the platforms in administration had on returns, and to see the returns of the remaining continuing platforms given that several platforms have exited their retail P2P operations voluntarily.
Loan book returns: Innovate Finance estimates investor returns for the P2P sector on underwriting year loan cohorts from 2013 to 2019 have averaged 4.9% p.a. when platforms in administration are excluded, or 3.7% p.a. including the platforms in administration.
Investor returns are broadly similar between SME loans, property loans and consumer loans.
Loan book losses: These returns are net of loan book losses estimated at c. 2.7% p.a. when platforms in administration are excluded, or 3.5% p.a. including platforms in administration.
Note that the Platforms in Administration all ceased writing loans prior to December 2019, when the current crowdfunding rules were introduced.
The Continuing Platforms, which represent the investment product available to P2P investor going forward, have slightly higher historical returns and slightly lower loan book losses than the historical market as a whole
Investor returns: Investors on nine of the top twenty platforms have experienced zero losses since inception, and at two other platforms 99% of investors who had a diversified portfolio had experienced zero losses. Three platforms have initiated voluntary wind downs, and these firms are on track to return 95-100% of investor capital.
Together, these fourteen platforms wrote c.76% of the sector loan volume (note that zero investor losses doesn’t necessarily equate to zero loan book losses).
Is there other evidence to corroborate the risk profile of the sector?Loanclear until June 2019 published a monthly index (formerly the AltFi/BRISMO P2P returns index) of net returns and loan book losses for a sample of the largest P2P lenders, which they calculated using loan level cash flows on a twelve month trailing basis provided by the platforms.
From 2011 to 2019 their published investor return index averaged 6.0% p.a. net of losses, and loan book losses averaged 1.2% p.a. These returns are consistent with the Innovate Finance findings.
Summary of analysis
P2P loans are an investment product and not a risk-free savings product akin to a bank deposit account or gilts. Therefore it is to be expected that some investors will not make a positive return. The Innovate Finance analysis shows that the P2P sector has generated steady, positive returns over several years, with relatively low loss rates. It can be inferred that investors in the vast majority of P2P loans have earned positive returns.
The failed platforms are well known to all stakeholders and have generated significant negative publicity. However, while individual investors will have suffered losses at those platforms, their impact on overall sector returns was not significant. The introduction of extended regulatory rules in 2019 is regarded by some commentators as having successfully hastened the departure of the failed platforms.
Overall we conclude that while some investors may have incurred losses individually, investors as a whole in P2P loans have earned positive, low risk returns.