FCA crackdown on high-risk retail investment products

Announcement is a "clear signal" the FCA wants to end high-risk retail investing according to BDO

by | May 7, 2021 | bobsguide

The UK’s Financial Conduct Authority (FCA) is stepping up its efforts to protect retail investors by  encouraging caution around “inappropriate high-risk”.

As a result, the FCA released a discussion paper seeking market views on the classification of high-risk investments, the segmentation of the high-risk investment market and the responsibilities of firms which approve financial promotions.

Matt Hopkins, head of digital banking and fintech at BDO says an increased activity among retail investors has forced the regulator to act quickly and is a “clear signal” that the regulator wants to bring high-risk investing to an end for retail investors.
Hopkins says online brokers that offer higher-risk products like contracts-for-difference (CFDs) and spread betting facilities will soon have to bolster their internal controls.

“We’re not quite at the finalisation stage,” Hopkins says. “But I think they’re going to have to improve their internal controls and procedures by making sure that the person investing is financially capable of withstanding it [if things go wrong].”

Self-certification controls needed

One area of particular concern for Hopkins is the self-certification process whereby retail investors simply declare that they are “sophisticated” and therefore capable of understanding the risks involved with high-risk products.

“At the moment all you need to do is tick a box to say you’re sophisticated or a high net worth individual, that’s all you need to do.

“The FCA has accepted self-certification of investors isn’t fit for purpose. Just as affordability checks led to the effective demise of the UK payday lending industry, a similar system for sophisticated investors will impact the availability and shape of riskier investment products,” Hopkins adds.

A spokesperson at investment platform Freetrade said in an email that they were glad to see the FCA beginning to take action as they saw a number of worrying issues in the market.

“We are especially concerned to see further rules implemented to restrict the harm that is done to retail investors through the sale of leveraged derivative products, including CFDs and spread-betting.

“These products serve no purpose in a diversified retail investment portfolio and overwhelmingly benefit the firms offering them at the expense of unwitting customers, yet they are often available to retail customers after they pass a laughably straightforward qualifying assessment.”

Alex Lambert, external relations manager at Hargreaves Lansdown has called for a “proportionate” response by the regulators.

“The tightening of regulation on high-risk investments will be a helpful protection for retail investors, and we hope to see a proportionate approach applied for those more experienced,” he said, in an email.

Online broker business models under threat

The direction of travel signalled by the FCA’s discussion paper presents online brokers with a threat to their business model. Hopkins believes the tightening of regulations in products like CFDs could make those models unviable in a similar manner to the demise of the payday lending industry.

Unlike investment platforms like Hargreaves Lansdown and Freetrade which charge a small fee for using their service, online brokers are typically free to invest in but make a profit through charging fees on CFDs, derivatives and spread betting – the higher risk products that could soon be clamped down upon.

“For the payday lending industry, the reason why they were so successful in the early days was because the affordability checks were limited. When that [regulation] became more stringent, it became almost impossible for those business models to succeed,” Hopkins says.

In the case of online brokers, Hopkins doesn’t think the consequences will be as extreme, but says it’s “definitely going to cause some restriction”.

Etoro and Trading 212 declined to comment.

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