Smaller asset managers and alternatives business model review: our findings

High-risk investments (HRIs), such as RMMIs and NMMIs, carry a higher risk of capital loss that can expose investors to a significant risk of harm if not aligned with their risk tolerance.  

Under COBS 4, the marketing of HRIs to retail clients is subject to stricter rules due to the greater risk they pose to consumers.  

Our review focused on how relevant firms, such as UK AIFMs, approached financial promotions in respect of HRIs and adhered to the COBS 4 rules. This included firms that offered NMMIs, such as unregulated collective investment schemes or speculative illiquid securities (COBS 4.14.20R), and RMMIs, such as a non-readily realisable security. 

Financial promotions and HRI marketing restrictions

Consumers often rely on financial promotions to understand the risks associated with an investment and the regulatory protections they are afforded.

Many of our relevant rules on financial promotions and communications, including marketing restrictions for HRIs, are set out in COBS 4. The overarching requirement for all financial promotions and communications is to be ‘fair, clear and not misleading’ (COBS 4.2.1R).  

Firms need to carefully target the distribution of HRIs to ensure compliance with applicable marketing restrictions and their obligations under the Consumer Duty. This targeting should be based on:

• effective product governance
• robust client assessment and categorisation processes

We strengthened the rules around the promotion of HRIs in 2022 (PS22/10). Our rules are designed so firms communicating and approving HRI financial promotions to retail clients do so to a high standard, so consumers can make effective, well-informed investment decisions. These rules seek to minimise the risk of unexpected and significant losses for consumers which may undermine confidence in investing more widely, making it harder for firms to raise capital.

When promoting an HRI to a client, including to a non-advised retail investor, we expect firms to have a clear understanding of the consumer journey. This includes the use of:

• risk warnings
• banning incentives to invest
• cooling-off periods
• effective client categorisation
• appropriateness assessments
• preliminary assessment of suitability (PAoS)

For more guidance, including good and poor practice, see our review findings, Financial promotions for high-risk investments (December 2024).  

Our review focused on how relevant firms adhered to these strengthened rules, aimed at protecting consumers from unsuitable HRIs inconsistent with their risk appetites. Our questionnaire sought more information from firms offering RMMIs and NMMIs with reference to applicable rules (COBS 4.12A and COBS 4.12B respectively). 

Of the firms we contacted for an in-depth assessment, we considered how they had approached financial promotions, product and investor categorisation, and had applied the relevant restrictions and controls for HRIs promoted to non-advised retail investors during the investor journey.

Elective professional clients (EPCs)

Our review assessed how firms undertaking opting-up processes adhered to our requirements. We sought further information from firms to understand the assessment of the client’s expertise, experience and knowledge (the ‘qualitative test’) they must undertake and, where applicable, the application of the ‘quantitative test’ criteria as set out in COBS 3.5.3R(2). We also assessed the wider processes firms had established to ensure compliance with client request requirements, the issuing of clear risk warnings to clients of the protections they may lose and client confirmation that they are aware of the consequences of losing such protections as detailed in COBS 3.5.3R.  

Sound opting-up processes are important to ensure clients are only opted up if protections are in place, and customers are subsequently offered a broader range of products, when that is right for them. We have had feedback that these requirements are not currently as well scoped as they could be (see also Consultation Paper CP24/24, The MiFID Organisational Regulation (2024). However, notwithstanding this firms should have robust processes in place.

Most firms assessed had a clear understanding of their investor base, including if any retail or EPCs formed part of it. However, some firms used qualitative assessments with a limited number of questions; unclear pass and assessment criteria; or overly simplistic, confirmatory questions when onboarding EPCs. While most firms sought formal client declaration and consent as part of their processes, the appropriate action a firm would take when it became aware that a client no longer fulfils the conditions that formerly made them eligible for categorisation as an EPC was not always clear.  

We expect firms that onboard EPCs to review their processes and procedures to ensure they are effective and meet the quantitative and qualitative tests and required client consent under COBS 3.5.  

We generally expect firms to:

• Use structured assessments to evaluate EPC criteria.
• Clearly document all testing, risk warnings and declarations prior to onboarding.  
• Have post onboarding processes in place to ensure they meet their obligations should they need to (further to COBS 3.5.9R) re-categorise investors or clients as retail clients and send relevant notifications of their new categorisation status.  

Poor investor categorisation can lead to investor harm via the sale of inappropriate or complex products.

Appropriateness assessment and preliminary assessment of suitability (PAoS)

Our review found some smaller firms offering HRIs to non-advised retail investors lacked sufficiently robust processes for these assessments or misunderstood their differences and applicability.  

Most firms applied the necessary 24-hour cooling-off periods and understood that investors could not immediately resit the assessment after the second attempt. Some of the assessments we reviewed, however, were insufficiently challenging or omitted questions tailored to the investment’s risks. For example, a UK AIFM that provides venture capital investment but did not adequately assess prospective investors on their knowledge and experience of Enterprise Investment Schemes.

For some of the assessments, we found examples with uncertain or substandard pass mark criteria, such as a prospective investor only having to pass three yes/no questions. We also found situations where firms had bypassed their controls to support investors in passing an assessment.

For the PAoS, scoring matrices often lacked clarity, detail or evidence, making it difficult to assess knowledge, experience and alignment with client needs. We saw examples where firms conducting these assessments did not clearly differentiate between wealth and sophistication. For example, prospective investors who meet the criteria for ‘certified high net worth’ but not for ‘certified sophisticated’ may be unable to properly understand and evaluate the risks of the NMMI in question.

Clear, structured processes are essential for both assessments to ensure compliance, protect investors and maintain trust in HRIs.

Good practice: high-risk investments

The rules for managing conflicts (for example, in SYSC 10 of the FCA Handbook) require firms to take all reasonable steps to identify, prevent and manage conflicts that may arise in the course of their business.

Smaller firms tend to have more condensed business model arrangements, resulting in senior staff sometimes taking on more than 1 role. This means that conflicts of interest can often be more pronounced. Our review looked at such arrangements to ensure that, where conflicts cannot be prevented, they are managed through effective governance and conflict mitigation policies, and, where required, appropriate disclosure is made to investors. Effective management of conflicted positions across the asset management and alternatives sector is therefore integral to:

• Ensure good consumer outcomes
• Enhance market integrity
• Instil consumers with the confidence to invest and support economic growth.

Of the firms we contacted for an in-depth assessment, conflicts management was a common risk.

Most smaller firms did keep a conflicts register. However, these were not always maintained to log conflicts, mitigation strategies and explain ongoing monitoring arrangements. Others did not appear to have clear identification and assessment capabilities in place to identify all potential conflicts.

Similarly, smaller firms where senior staff held overlapping roles and responsibilities did not always think about potential conflicts. Where one individual holds all senior management functions, firms must assess compliance with our ‘Appropriate resources’ threshold condition to avoid governance and control weaknesses.

While most smaller firms had a conflicts policy, some lacked tailored procedures for their business models, investment strategies, underlying product structures, or individual and third-party involvement.

Where conflicted positions could not be avoided, we did not always see these being disclosed clearly to investors.

Several firms did, however, ensure that governance and oversight was established so that senior management and compliance teams regularly review and discuss conflicts management and, in some cases, had an independent conflicts committee to oversee high-risk areas.

The Consumer Duty applies across the distribution chain to firms involved in the manufacture, promotion and distribution of, and advice relating to financial products and services for retail clients.  

Some of the firms we assessed were involved in manufacturing products or services, some were involved only in distribution, and others did both.  

There are different requirements under the Duty for firms depending on their role (see FG22/5 for more information). In particular, an asset manager that manufactures HRIs, but does not undertake direct distribution, still needs to consider their responsibility in the value chain to ascertain that these products are distributed appropriately. This includes the need for a target market and distribution strategy for their products (see PRIN 2A.3 and PROD 3). 

The Duty is underpinned by proportionality in application. While all firms should be able to monitor customer outcomes, take actions and implement a business strategy that aligns with the Duty to ensure those outcomes are good, what we expect of firms will be based on what is reasonable. Firms will have different capabilities depending on their size, activities and available resources, but all firms need to act to deliver good customer outcomes.  

While the Duty doesn’t apply to customers who elect to be treated as professional clients under the relevant COBS rule, it does apply to the process a firm uses to categorise clients. A firm that encourages a customer to seek a ‘professional client’ classification simply to avoid giving the protections afforded to retail clients or allow going into an HRI would breach the Duty. Firms that deal with EPCs therefore risk falling into scope of the Duty, if they do not have adequate investor categorisation procedures in place.  

We found that some firms had not considered the application of the Duty and, where it applies, had not made changes to their processes. This could lead to firms breaching our rules and causing consumer harm. Such firms should already have reviewed the nature of their involvement with financial products and services, especially if they deal with any retail clients or investors or are part of a retail distribution chain and have a material influence over retail customer outcomes. Where they haven’t yet undertaken this analysis, they must do so urgently.

A firm’s board or governing body/senior management has a responsibility for ensuring that the Duty is properly embedded within their firm and must assess annually whether the firm is delivering good outcomes for its customers in alignment with the Duty.  

For the firms that recognised the Duty applies to them, there was mixed practice in how they were complying with it. While we identified some better practice, some smaller firms were unable to provide meaningful Consumer Duty reports, even when taking proportionality into account. Where there was a lack of formality around the production, review and approval of Consumer Duty board reports, this risks firms’ management being unable to assess, understand and act on the outcomes their retail customers are receiving.

Some firms lacked content detailing what good and bad outcomes looked like for investors, and any actions that may need to be taken as a result. Similarly, some firms could not provide evidence demonstrating effective challenge from governing bodies and senior management on their Consumer Duty board reports. However, we did find good examples of firms using quality management information and metrics to support their report.  

Read our findings on Consumer Duty board reports, published in December 2024, for further guidance, good practice and areas for improvement.

For firms where the Duty applies, putting right foreseeable harm to retail customers caused by acts or omissions by the firm includes acting in good faith and, where appropriate, providing redress. We expect firms to act accordingly and will consider regulatory steps where we see:

• Investment products offering poor value.
• Firms not acting to deliver good investor outcomes.

This remains an area of focus for us. Observations such as these have led us to take supervisory action, such as agreeing restrictions on firms’ regulated activities, fee adjustments, or product withdrawals; or initiating an orderly product wind-down.

We will continue to consider appropriate steps where we identify poor practice in firms that risks consumer harm, undermining the integrity of the market, which may deter future investment and harm economic growth.