How new FCA rules will impact investing in your business
Investors are looking to boost their returns after a period of poor stock market performance, and the impact of higher inflation, which has meant savings are not keeping pace with costs in real terms. As a result, the potential returns offered by higher-risk investment opportunities available through private markets have become more appealing.
This has led financial institutions to seek to ‘democratise access’ to these assets, enabling a wider range of investors to deploy their capital. Traditionally, private markets have been the exclusive preserve of ultra-high-net-worth clients and institutional investors. The administration of unlisted investments has typically been labour-intensive because most of the work – collating the deals, checking the appropriateness for investors, and promoting them to relevant clients – all needed to be done manually.
However, technological advances have helped to take much of the weight of administering private market transactions away from the people working within these businesses, freeing them up to provide other revenue-generating services to clients. It also reduces the likelihood of mistakes happening or regulatory checks being forgotten through human error.
This is increasingly important as the UK’s regulator – the Financial Conduct Authority (FCA) – has given notice that it will begin to shine a spotlight more brightly on these alternative asset promotions and transactions, after its own research found that too many consumers are investing in high-risk products without fully understanding the consequences of these decisions.
So, it is bringing in new rules to protect consumers from suffering both unexpected and significant losses, and to ensure the safeguards being put in place are specifically connected with the investment journey. Financial promotions must also be suitably clear, robust, and easy enough to understand. These changes should all help investors to make more informed decisions.
As a result, any organisation offering these products to clients needs to be absolutely sure it is promoting opportunities to the right people and, importantly, in a regulatory-compliant way. They must have robust governance procedures in place that are trackable and auditable. Missing any of these steps could result in a censure from the regulator – and not just in the UK either. The expectation is that greater regulatory scrutiny and tighter controls of alternative assets will happen on a global scale.
So, to ensure these processes are being dealt with correctly and their clients are not exposed to inappropriate investment propositions, technology will become a more important factor for companies operating in this sector. Digitisation will help to drive operational efficiency and prevent foreseeable harm to clients, an important aspect under the FCA’s Consumer Duty rules.
Technology can be used in a variety of ways to achieve this. It can provide quick and effective deal matching between appropriate investors and companies through an automated profiling system that will make sure only those clients considered suitable from a regulatory perspective are given access to deal information. As retail investors become increasingly active in private markets, the ability of firms to demonstrate they have taken suitable steps to inform investors of the risks prior to them committing to an investment will be vitally important.
The other major benefit of using technology is when it comes to a firm’s ability to demonstrate their compliance. Regulators are increasingly concerned about retail investors committing themselves to opportunities they do not fully understand. This makes sense, but there is a tension here as investors are also looking for more opportunities to invest in assets that could provide higher returns. But naturally, this means the risks are higher – the classic risk-return equation.
However, with more rules being implemented over the coming months up to and beyond July 2023, the distribution of these deals is becoming more complex. Without the use of technology to help strengthen compliance checks, there is a bigger risk that something could go wrong. The additional measures that digitisation enables include embedding the required cooling-off periods into workflows so investors and advisers cannot circumvent the governance frameworks that need to be in place.
The benefits of technology go further, too. For example, it enables the digital tracking and reporting of all operational processes undertaken through the platform, which increases regulatory transparency and limits the possibility of human error or ‘workarounds’ that increase the risk of non-compliance.
Under the FCA’s new rules, appropriate risk warnings must be presented front and centre of investment opportunities being presented to retail investors. This is something that could be overlooked in a face-to-face client meeting or could be forgotten or misunderstood by the client if the incorrect wording is used.
However, if the investment was being distributed via a digital platform, then a warning message (using the FCA’s own wording) could be configured to appear automatically at various stages before the client commits their capital. There is no risk of this message being misconstrued, and a requirement to accept that the warning has been read and understood can be built into the system. In turn, this creates an auditable compliance trail that can be presented to the regulator, should any query emerge in the future.
In addition, investors can also be subjected to an ‘appropriateness test’, which must be set at the same level as the investment proposition they are interested in. If the test is not passed, then a timescale is set before the test can be taken again – it is only possible to take the test 24 hours after the initial attempt, meaning that investors are effectively locked out from investing until they have demonstrated the required level of understanding. The FCA guidance also requires that the questions posed to investors are more sophisticated than requiring simple ‘yes or no’ answers, and if the investor does not pass the test, they cannot be told which questions were answered correctly and which were not.
Each of these elements would be very difficult to achieve without a digital delivery mechanism, and thanks to the new regulations, these checks and balances are not optional. So, any providers looking to expand alternative asset propositions to a wider pool of investors should consider the role that technology could play in keeping their clients and reputation safe.