Mark Kenkre, Partner and Head of the Investment Fraud and Mis-selling team, explores the FCA’s plans to replace its current financial promotions regime with one that is more consumer-friendly and rooted in behavioural science, in Compliance Monitor.
Mark’s article was published in Compliance Monitor, 4 April 2022, and can be found here.
The Financial Conduct Authority (FCA) has launched an important consultation that proposes a significant overhaul of its regulation of “the consumer journey into high-risk investments.” In particular, the FCA proposes to change the ways in which investment warnings are displayed to consumers. The consultation also discusses changes to the classification of high-risk investments; strengthening the role of firms approving and communicating financial promotions and changes to how the FCA’s financial promotion rules will apply to qualifying cryptoassets. The consultation process will inform a new FCA policy statement and final Handbook rules, which are set to be published in the summer of 2022.
The proposed overhaul to investment warnings is the more impactful of the changes proposed. These are based on recent FCA research which found the standard warning that “capital is at risk” has become mere “white noise” for consumers. Remarkably, the research found that 45 per cent of new self-directed investors were unaware that losing money was a risk at all. The proposals aim to “interrupt automatic behaviours” in consumers in order to place them in “a more deliberative frame, giving them time to pause, read and reflect.”
The consultation references an Opinium survey of 1,000 people aged 18 to 40 who invest in high-risk investment products, published by the FCA in October 2021. It found that “these investors were highly driven by emotional and social factors.” 76% said they “felt a sense of competitiveness when placing their money in an investment, wanting to beat their personal best as well as the returns of friends, family and acquaintances. Over two thirds (68%) likened it to gambling.”
According to the consultation, “a key part of the strategy is addressing the harm from consumers investing in high-risk investments that do not match their risk tolerance. This can lead to unexpected and significant losses for consumers and undermine wider confidence in investments, making it harder for all firms to raise capital. We do not want to restrict consumers who want to invest, but we do want them to be able to identify and access investments that suit their circumstances and attitude to risk.”
The FCA has carried out detailed research to determine the most impactful ways to approach consumer behaviour when it comes to making riskier investments, especially online. A summary of the three main papers underpinning the proposed changes was published in January 2022. The research and the resulting consultation represent a timely response to the recent growth in riskier investments such as cryptoasset investment and crowdfunding. This corresponds to a wider increase in online investing and online fraud seen during the pandemic.
The research summary document notes that “It’s never been so easy to invest your money – anyone can do it online in just a few clicks. Low interest rates and the increasing social media hype are driving more and more people in this direction. Over 1 million UK adults (6% of all UK investors) increased their holdings in high-risk products, or purchased new high-risk products during the first 7 months of the Covid pandemic – a time of increased consumer vulnerability.”
In this wider context, more impactful risk warnings are needed to warn consumers of the tangible risks that certain investments present. Behavioural economists have been commenting on this issue for some time. A summary of this topic notes that the “research used behavioural science to improve consumer understanding of the risks involved in high-risk investments, and reduce the numbers of people self-certifying as high net worth or sophisticated to more realistic levels.”
The FCA says that it “focused on how to achieve this through the use of ‘decision points’ – steps added to the consumer journey and designed to interrupt automatic behaviours. Decision points aim to put people back into a more deliberative frame, giving them time to pause, read and reflect.” The document says that “One way to do this is by providing information to consumers at a critical point in time, which we refer to as ‘disclosures.’”
The visual way in which information disclosures are presented was found to be important. The research found that “risk warnings that are more salient and informative for consumers and informed by behavioural science, significantly increase consumers’ comprehension and perception of the risks involved in high-risk investments. They also reduce consumers’ propensity to recommend the investment to a friend.” This latter point is significant since pyramid scheme “investments” are often known to spread through friendship and family networks. With the advent of the internet, social media is now an increasingly important factor in such contagion.
The FCA’s research suggests that certain presentation methods can make warnings more impactful. These include using a larger font and red colouring and creating sufficient space around the warning.
Another technique mentioned in the research summary is what the FCA calls “positive frictions,” which are defined as “processes designed to slow people down and make them consider their actions more carefully.” Essentially, when consumers are required to take positive actions before investing, they can be deterred. By way of example, the paper notes that “In a recent study, Twitter users were forced to open links and articles before tweeting them, with the aim of reducing the spread of misinformation. In another study, consumers were shown warning messages on their phones when pre-set credit card spending limits were reached, which had to be clicked away to spend more, resulting in lower spending levels.”
Proposed changes to reduce the number of people falsely claiming to be high-net-worth or sophisticated investors include requiring them to provide evidence to that effect, or adding an automatic time delay before the next step can be taken. This would amount to an enforced “cooling off period.”
The FCA concludes that its research “found that our behaviourally informed risk warnings improved participants’ understanding of risk across the board. Similarly, decision-points in the form of short FAQ-style information improved understanding of risk and improved assessments of how risky these investments are. We also saw that both the behaviourally informed risk warnings and decision points reduced the chance of participants recommending the investment to a friend.”
With these findings in mind, the consultation proposes that, before communicating a relevant financial promotion to a high-net-worth or sophisticated investor, the firm obtains the retail client’s full name and gives them a personalised pop-up warning such as, “[Client name] this is a high-risk investment. How would you feel if you lost the money you’re about to invest? Take 2 mins to learn more.” This is to be accompanied by a 24 hour cooling off period for a first-time investor.
The FCA has created a solid evidence base to support such proposals. This research is important in a world where consumers have easy online access to a growing range of investment opportunities and many struggle to differentiate between regulated, unregulated and fraudulent investments.
Fraud is a growing problem in the UK, particularly investment fraud. Bolder, stronger risk warnings are one way of dealing with this problem, but won’t be a silver bullet. Needless to say, online fraudsters do not follow regulatory advice and so addressing the fundamental issue of online and social media investment scams is crucial.
Action Fraud reported that £63 million was lost to such crimes in the UK in the financial year 2020/21. The Office of National Statistics reported a 44% increase in overall financial investment fraud in the year to April 2021. Action Fraud reported that, in the same 12-month period, 5,039 reports of investment fraud referenced a social media platform. There has also been a rise in “cloned company investment fraud,” where criminals create websites that realistically imitate those of legitimate financial services companies. One irony of such frauds is that, in order to appear legitimate, such fraudsters may have to imitate the FCA’s new “more salient” warnings, precisely in order to fool their victims.
Nonetheless, the changes proposed by the FCA seem likely to help prevent consumers from casually engaging in high-risk investments that are legitimate but unsuitable for them. There is little doubt that more needs to be done to warn unwary consumers of the risks inherent in various high-risk products, both pre-investment and at the financial promotion stage. This is particularly the case for self-directed consumers. However, such changes should not unduly burden legitimate financial services companies that offer high-risk products to genuinely sophisticated investors, capable of fully understanding the risks and absorbing any losses which arise. The consultation closes on 23 March 2022.