The FCA is tightening its grip on high-risk investments in a move experts fear could hit trading platforms offering people on the street access to complex products.
The regulator put esoteric investments in its crosshairs in July. But on 15 September, it fleshed out its plan with a series of targets it wants to achieve that would indicate consumers are getting the right investments for them.
The most eye-catching pillar is the bold target to cut the number of consumers with high-risk investments who are vulnerable or have a low-risk tolerance in half by 2025.
The scale of the problem is substantial. According to an FCA survey, 6% of adults increased their holdings of higher-risk investments during the pandemic, but almost half of new self-directed investors were unaware that “losing some money” is a risk.
More than half of adults suffer from low financial capability, and the regulator’s research found that consumers only start to recognise that a promotion for an investment product is probably ‘too good to be true’ when the promised rate of return hovers above 30%.
“Firms should expect a tightening of regulatory standards and greater scrutiny at the gateway, across general supervisory activity and of their financial promotions,” EY financial services regulation partner Simon Turner says. “Firms must continue exploring new and innovative ways to work with incoming regulation, to ensure they are helping consumers to invest for their future using the most straightforward products.”
Eyes are now turning to the impact this could have not on the product providers themselves, but the trading apps that offer access to them.
Trading platforms can offer the very simple function of buying and selling shares. But they may also offer derivatives trading, contracts for difference, leveraged bets, foreign exchange plays, copycat positions and other complex products.
In the US, the likes of Robinhood generate a substantial proportion of their turnover from products that are often considered high-risk.
Taking Robinhood as an example, in the first quarter this year, options trading made up the largest share of its revenue at 38% — more than standard stocks at 26% — and cryptocurrencies at 17%, according to CB Insights. Fast forward to the second quarter, and cryptocurrency trading fees were up 50-fold on the same quarter a year earlier, and cryptocurrencies were being traded by more new customers than regular stocks.
In the UK, the commercial implications could also be significant if the FCA targets both options and cryptos as high-risk vehicles and takes steps to get some clients to cut their exposure in half.
Arguably, any platform operating on a payment-for-order-flow basis, where the company makes tiny margins on each individual trade, has more to lose from the FCA’s regulatory approach. Meme stocks tend to be traded more rapidly than others but are more volatile and thus riskier for vulnerable consumers or those who cannot afford to take risks, yet the platform has a continued financial interest in ensuring shares keep changing hands.
RockWealth head of client education Robin Powell says: “It’s very encouraging to see the FCA addressing high-risk investments. But it’s hard to see how it’s going to make a substantial difference in steering consumers towards making better decisions without getting tough on the big direct-to-consumer platforms.
“Some of these platforms talk a good game on investor education but their actions tell a different story. The bottom line is, they have a commercial interest in getting people to use their platform rather than someone else’s. They know that consumers are drawn towards high-risk investments, so they’re not doing anything to discourage them. That’s why we’re seeing platforms constantly tempting consumers with articles on the stocks that people are buying, the latest IPOs and so on.”
The FCA notes that in the first four months of this year, four trading app firms opened nearly double the amount of accounts as all other retail investment service firms put together. Half of those came in January, “driven by the surge in investments in GameStop and other meme stocks”.
“Retail investment platforms rely on volume — as they get paid for each order — hence there is an incentive to gamify the trading experience,” a compliance consultant who has worked with a number of trading platform clients says. “Some retail investment platforms have very sophisticated algorithms to nudge users to trade more, showing targeted ‘adverts’ within the application, giving prominence to ‘big return’ stocks. If the FCA cracks down further on high-risk investment products, this would absolutely hit investment platforms that offer CFDs, cryptos, and perhaps high-volatility meme stocks.”
Dan Moczulski, UK managing director at eToro, tells Financial News that 95% of the platform’s assets under administration are in “real assets”. But while this includes stocks and cash, the trading house’s definition also includes cryptoassets.
While the platform said it was unable to share specific figures on how much risky assets contributed to its bottom line, Moczulski said some esoteric offerings were a fringe part of its business.
“Products such as CFDs come with standardised warnings on our site but are far and away from a core part of our business, rather a niche product for more advanced investors,” he said. “We already have enhanced screening on the platform to ensure only those who understand leveraged investing have access to such products.”
Expect a real clampdown on how these are promoted to the wider world though; the FCA said it would “increase horizon scanning of emerging harms” and “be more pro-active in restricting the marketing of high-risk investments where we see harm.”
Along with the crackdown on high-risk investments, the regulator is also keen for those who can take risks to do so to build up their savings rather than have them eroded by inflation. Its target is a 20% reduction in the number of consumers with higher risk tolerance holding over £10,000 in cash by 2025.
This can be through straightforward products like stocks and shares in Isa wrappers. But if consumers are encouraged not to hold so much cash and dip their toes in markets instead, questions will naturally be asked over whether these individuals will push the envelope on risk in the process, given the lack of financial education the FCA highlights.
“The FCA has a difficult balance to strike — consumers want access to platforms that offer a broad range of investment options but the FCA wants to ensure they are not ending up in unsuitable products. The FCA’s own stats show that a large number of people are quite comfortable making their own decisions, and also enjoy the lower costs associated with non-advised investing,” Mark Turner, managing director in Kroll’s financial services compliance and regulation practice says. “However, for the FCA to cut access to high-risk investments that are not suitable by half, there may end up being some changes that impact choice and costs for investors in these types of product for whom they are suitable.”
The danger is that, when told they need to put their bank account to good use and invest their money, under-informed consumers will quickly revert to stocks that are being talked up at that moment in time as having the highest chance of success, even if they are not appropriate for them.
An industry consultant says: “If you believe [cryptos, options, CFDs etc] are suitable for the entire population, then fill your boots and market on the underground, football touchline etc. But if you decide your target market is more niche, and there are consumers for whom it is probably not suitable, then somehow they need to be turned away.”
Consumer campaigner Mark Taber says that the success of the campaign will depend on how the FCA defines high-risk investments.
“I have long argued that many they call high-risk investments are really frauds or scams where all investors’ funds are skimmed off, and there is no possibility or intention to deliver returns and return funds,” he says.
To contact the author of this story with feedback or news, email Justin Cash