On 25 May 2023, the European Securities and Markets Authority (ESMA) published a statement highlighting the risks arising from the provision of unregulated products and/or services by investment firms. ESMA is concerned that the practice of investment firms offering products and services that are not regulated gives rise to both investor protection and prudential risks. Therefore the statement sets out some of the risks that may arise and the issues that investment firms should pay particular attention to when providing unregulated products and/or services. The statement does not consider detailed risks arising from specific products and services.
ESMA has observed that the following risks may apply to unregulated products and/ or services:
- Potential for investors to be misled as to the level of protection they get, especially if the unregulated products and/or services are provided on the same webpage as regulated ones (where the investment firm’s website is unclear and confusing for investors as to the regulatory status of the products/services being sold).
- Potential for investors to not be fully aware of the nature of the product and/or service, and their risks.
- Potential for investors to be confused or mis-sold products (investors may rely on a recommendation from the investment firm, even though the MiFID requirements such as suitability and appropriateness assessments only apply to investment services, in relation to financial instruments).
- Some investment firms may encourage the confusion between regulated and unregulated products and services.
Investment firms engaging in unregulated products and/or services such as the ones mentioned above may also face reputational risks.
The statement goes on to set out ESMA’s view as to how the above risks may be mitigated. In particular, ESMA states that in its view, given their regulated status, investment firms offering unregulated products and/or services that may be considered as alternatives to investing in financial instruments should act in the best interests of their clients. ESMA also recommends that investment firms:
- Take all necessary measures to ensure that clients are fully aware of the regulatory status of the product/service they are receiving.
- Clearly disclose to clients when regulatory protections do not apply to the product or service provided.
ESMA also describes in the statement certain behaviours that it expects of investment firms when they provide, together with investment services, unregulated products and/or services to investors to ensure no confusion exists with the regulated offering. This includes that the information provided explicitly states what investor protections are lost/not applicable when investing in a product and/or service deemed to be out of scope of financial regulation.
ESMA also reminds investment firms that they:
- Should have a full understanding and comprehensive view of the risks connected with both their regulated and unregulated activities, including the risks to clients, to markets and the risk to the investment firm itself.
- Be particularly careful in all those cases where the scale of unregulated activity might have material impact on their overall risk profile.
- Be able to demonstrate the measures taken to ensure that unregulated activities do not affect their ability to fully comply with requirements applicable to the provision of investment services.