Employee co-investment and the Consumer Duty: can you opt up to opt out?

Firms offering their employees co-investment opportunities often “opt up” employees, so that they can be treated as elective professional clients.

This has a number of benefits, including the ability to fall outside the complicated marketing rules that apply to such vehicles, and not having to prepare a key investor document under the highly prescriptive UK (and EU if relevant) PRIIPs Regulation requirements.

However, the “opt up” process has been the subject of renewed concerns on the part of the regulator – and a particular hot topic is whether firms need to be revisiting their “opt up” processes for employee co-investment schemes given the FCA’s incoming Consumer Duty rules and guidance.

The Consumer Duty rules and guidance (published in July this year) confirm that the Duty applies to the process used by firms to determine a client’s status, that the Duty’s standard will not be met where a firm encourages investors to opt up to hold elective professional client status to avoid having to comply with consumer protection rules.

Furthermore, in August, the FCA published its Dear CEO letter to alternatives portfolio firms, telling firms to review their processes for onboarding retail or elective professional customers and check they are effective.

There are a few key points here:

• The well-trodden path of co-investment as a perk of the job for employees and their families could now be more slippery underfoot. The employment relationship does not absolve firms from recognising that investors will need to be treated as a regulatory client and the Consumer Duty will apply either to the “opt up”, where applicable, or to the investor relationship as a whole.
• The FCA has clearly “zoned in” on professional client opt-up processes as an area that needs further scrutiny, and firms should take the opportunity to review their existing procedures to make sure they are robust, and properly ensure the relevant qualitative and quantitative criteria are met.
• Where firms have employee co-investment vehicles with employees that are not “opted-up”, due consideration needs to be applied to how firms will comply with the Consumer Duty in respect of those employees, and ensure that those employees have all the information they need, when they need it, with regard to the relevant co-investment.
• Firms with employee co-investment vehicles that include “retail” employees or other investors may need to review their PRIIPs obligations, particularly if co-investing employees may be outside the UK, given the divergence between the UK and EU regimes.
• Co-investment opportunities may not only present risks from a regulatory perspective, but also from an HR perspective. Given the heightened sensitivities that accompany situations where an employee relationship sours, firms without a robust and well-communicated process for employee co-investment may find themselves in difficulties which could have been avoided if action had been taken earlier.

It is also worth bearing in mind that the UK rules which impact firms’ ability to market co-investment vehicles which meet the regulatory definition of “non-mainstream pooled investment” are changing in December. While certain of the exemptions that firms might be relying on currently will be preserved, others are changing and new, potentially onerous, requirements will apply. This additional complication should also be factored in when firms are doing their reviews.

The FCA deadline for firms to have in place a board-approved implementation plan for the Consumer Duty was 31 October, and firms should now be moving from preliminary scoping discussions and step plan preparation to practical implementation of the necessary changes. Firms holding the view that they are “opting out” of the Consumer Duty by “opting up” any prospective clients or employees should use this opportunity to take stock of their processes, to ensure they are able to guard against any future challenge on this front.