Innovate Finance/36H Group Response to HM Treasury Consultation Paper “Financial promotion exemptions for high net worth individuals and sophisticated investors: A consultation” (December 2021)
Innovate Finance/36H Group is pleased to submit its response to the HMT Consultation Paper: “Financial promotion exemptions for high net worth individuals and sophisticated investors: A consultation” on behalf of the members of Innovate Finance. Our members include leading platforms in the peer-to-peer (“P2P”) (36H Group), equity-based crowdfunding and cryptoasset sectors.
The key points raised in our response are:
- This Consultation paper does not directly impact our members, who will either be authorised to issue financial promotions or will use an approval from an authorised firm, and as such not looking to use the Financial Promotion exemptions. However, if the proposals arising from this Consultation Paper are mirrored by the FCA in their Financial Promotion rules then our members will be directly impacted.
- We acknowledge that the financial thresholds for High Net Worth individuals have not been increased since their inception in 2001. we question whether the starting point in 2001 was properly justified given that they covered only 1% of the tax paying population. Increasing the threshold to £175,000 to re-benchmark to the top 1% of taxpayers (and £900,000 for net assets), will have a significant impact on the market size for High Risk Investment product providers with no accompanying analysis that indicates these are the appropriate thresholds to reduce potential harm to vulnerable customers. We suggest a link to inflation is the most sensible approach, as it links to a tangible financial comparator rather than an arbitrary percentage of the population
- The proposal to require firms to have a reasonable belief that a customer has correctly self-categorised their financial status is a positive longer term ambition for the UK market but currently is not viable to be implemented. Our members build on-line automated platforms which are low cost to their customers. Currently it is not possible in the UK on an automated basis to verify income for High Net Worth or Sophisticated Investors or net assets with any certainty. This would have to be a manual process, which renders the economics of an online platform unviable. We suggest that this proposal be held in abeyance for the time being, and that Government engages with industry as to how and when Open Finance solutions will be able to deliver this objective.
- If the FCA incorporates the proposals set out in this Consultation Paper into their Financial Promotion rules then it may render the investor categories of High Net Worth investor and Self-certified Sophisticated Investor contained in the FCA’s rules largely redundant for our members, and platforms covered by the FCA rules will default to Restricted Investor as the main investor category. We suggest that HM Treasury and the FCA should consider whether it is appropriate for changes in these Financial Promotions rules are necessarily appropriate for replication in the FCA’s Financial Promotion rules
- Lastly, we urge HM Treasury and the FCA to co-ordinate more on the rules arising from a number of open consultations which are inter-related. The current situation is creating uncertainty in the market which is detrimental to investment and innovation in the UK. These consultations are: Financial Promotions investor categorization (FCA CP 22/2), this HM Treasury Consultation Paper, and the introduction of the Financial Promotions gateway
About Innovate Finance
Innovate Finance is the independent industry body that represents and advances the global FinTech community in the UK. Our mission is to accelerate the UK’s leading role in the financial services sector by directly supporting the next generation of technology-led innovators. Innovate Finance’s membership ranges from seed stage start-ups and global financial institutions to investors, professional services firms, and global FinTech hubs.
The 36H Group within Innovate Finance provides a unified voice for P2P lending platforms. Named 36H Group to reflect that member platforms are fully authorised by the FCA under Article 36H of the Financial Services and Markets Act 2000, the Group focuses on policy and regulatory matters, as well as promoting the benefits the sector is delivering; including bringing choice, competition and transparency to the lending and investment markets.
Innovate Finance and our members are supportive of proportionate regulation for retail financial services products and ensuring that such products are appropriate for individual investors. We believe that a strong and coherent legal and regulatory framework is important both for investors and for the long term development of innovative financial products and companies in the UK.
We note that this Consultation Paper is not immediately relevant to many of our members because either they are authorised businesses and as such are not relying on the Financial Promotions Order (“FPO”) exemptions when making a financial promotion (P2P and equity-crowdfunding platforms) or they are outside of the scope (Cryptocurrency platforms). However, in all cases they are subject to the FCA’s regulations on financial promotions for High Risk Investments (once Cryptocurrency products have been brought within scope as proposed by HM Treasury1 and FCA consultation paper “CP 22/2”) which require investors in Restricted Mass Market Investments to be categorised as one of Restricted Investor, High Net Worth Investor, Self-certified Sophisticated Investor or Certified Sophisticated Investor. The FCA Consultation Paper notes (2.7) that if the conditions for the FPO exemptions are updated (as a result of this HMT Consultation) then the FCA may replicate some or all of these changes in its own Financial Promotions rules, and so Innovate Finance’s responses to this paper are submitted largely on the basis of the potential follow through to the FCA’s rules, which would directly impact our members.
We also urge HM Treasury and the FCA to provide coordinated consultations and responses to this proposed updating of the Financial Promotions rules. The current situation whereby there are several consultations running in parallel which overlap and interact is creating an uncertain business environment for FinTech companies and venture capital investors in the UK. Consultations that are currently open and which have significant inter-relations with each other are: this consultation on Financial Promotion rules, which is likely to impact firms vicariously through a subsequent FCA consultation; the FCA consultation on their Financial Promotion rules; and the FCA consultation on the introduction of the authorisations gateway. Embedded in all of these consultations is the impact of their first time application to cryptoasset firms.
Increasing the financial thresholds for high net worth individuals
We agree with the premise that the income (£100k) and net assets (£250k) thresholds should increase over time to reflect inflation. However we question whether the starting point thresholds set in 2001 were appropriate given that this represented only 1% of the UK tax paying population at that time. The equivalent thresholds today stated in the Consultation Paper – income £175k and net assets £900k – are a very large increase on the current thresholds, and members have expressed to us that they would expect this to exclude a large proportion of their investor base if set at these levels. Ultimately, if these thresholds are set too high they will exclude such a large proportion of the investor market that the exemptions will become redundant for the purposes of the FCA’s financial promotion rules. We estimate that over £15bn of loans have been provided to SMEs by P2P platforms over the last 10 years although the gradual erosion of the P2P investor base through narrower regulatory criteria will eventually feed back into lower SME lending in the economy.
The Consultation Paper acknowledges that there has been a significant shift in pension assets from Defined Benefit to Defined Contribution over the last 20 years. As a result we would expect investors are self-selecting funds in their Defined Contribution pension plans (or at least they have that option) and are fully aware of the value of the asset value they have in the pension plan, and so their pension plan is a transparent part of their net worth over which they have control of asset allocation, unlike 20 years’ ago. Therefore it would be coherent to include pension plans in the net asset calculation, otherwise the investor is penalised for prudent, tax efficient pension planning compared to an investor who chooses to leave their capital outside their pension plan.
Placing a greater degree of responsibility on firms to ensure individuals meet the criteria to be deemed high net worth or sophisticated
The proposal that a firm must have a reasonable belief as to why the individual meets the self-stated criteria is an attractive and laudable solution to determining an investor’s category. For our members, who build tech-driven automated platforms which are low margin and high volume, this proposal is only viable if it can be executed automatically using data from external databases via APIs.
It may be possible to verify income via a credit bureau search, although high net worth and sophisticated investors often have multiple income sources which may not be included in the credit bureau data, and so this is an unreliable solution. However, to verify net worth is almost certainly not achievable in today’s data environment. There are so many different sources of data that could be needed to verify an investor’s net worth – brokerage account (what about margin loans, open derivative contracts, short positions?), bank accounts (Open Banking only works with on-shore banks and each account needs separate customer permissioning), valuations of Buy-to-Let properties (and associated mortgages), overseas investments and loans, etc. To be definitive that the investor’s net worth exceeded £k threshold, the firm would have to be satisfied that there were no undisclosed loans or other financial liabilities. For example, an investor might disclose documentation supporting £500k of investment assets, but could have £450k of undisclosed loans against these assets. This type of verification exercise can only be conducted manually and would render the economics of many online platforms and products unviable.
The Consultation Paper states that it would be for the firm to determine how it reaches the conclusion that an investor meets the criteria for the category. Unless there is definitive guidance on this, there is an obvious risk of differing standards of proof; and that a few years hence there could be customer complaints which in turns leads to the Financial Ombudsman Service introducing their own criteria for what adequate information is for this belief.
The advent of Open Banking has been a regulatory and FinTech success for the UK in that firms can independently access a customer’s bank data (with permission) on an automated basis. We believe this is the first step on the road to full Open Finance whereby a customer’s entire financial position can be accessed on an automated basis, but the UK is still some years away from this aspiration. Therefore we believe there will be a point in the future when the proposals in this Consultation Paper for investor category verification will be viable on an automated basis, but that point is not today. Our suggestion is that these proposals should be retained for the future rather than scrapped entirely. We suggest the Government considers discussing with the industry a timeline for introducing these proposals in the future as a means to nudge the market towards building the necessary Open Finance verification tools.
From a customer behaviour perspective, we believe many Sophisticated and High Net Worth investors have investments across several equity crowdfunding and P2P platforms, and possibly in cryptocurrencies as well. We believe that it is unlikely that such customers will want to go through the process of providing each and every platform with a set of documentation to verify their financial position, and some may not wish to disclose their entire net worth to a 3rd party for the sake of making a relatively small investment.
Finally, there continues to be a frustration in the industry that in retail financial services law and regulation, individuals are not required to take responsibility for their own actions, i.e. if they lie about their income or net worth on a product application form should they not have to take responsibility for that? Should firms not be able to rely on information provided by a customer unless there is an obvious reason to doubt it? The Consultation Paper states that “the investor would still be required to sign the investor statement, so there would be a responsibility on both the investor and firm to ensure the relevant conditions had been met”. However there are no consequences for an investor of making a false statement and they have the same rights (to complain and for compensation) as an investor who makes a truthful declaration, and so this responsibility is moot, and under these proposals would fall entirely on firms.
Interaction with FCA rules
As stated above, our members are for the most part not directly impacted by the proposals in this Consultation Paper. However if the FCA enacted all of these proposals into their financial promotion regulations following on from CP 22/2 then our members would be directly impacted. The most likely outcome would be that the High Net Worth and Sophisticated investor categories would become largely redundant for investor categorisation by P2P, equity crowdfunding and cryptocurrency platforms, either because very few investors would meet the higher thresholds and/or firms would be unable to verify independently an investor’s category. As result, firms would potentially default most investors into the Restricted Investor category. HM Treasury and the FCA should consider whether it is necessary and appropriate that changes to the Financial Promotions rules within the scope of this consultation should be replicated in the FCA’s Financial Promotion rules given that, for example, P2P and equity crowdfunding platforms operate to a higher threshold of regulatory compliance through their requirement to have a Risk Management function.