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Try going to Options > Mercurial. If you are using Embedded Mercurial, there should be a button to upgrade. If you are using system Mercurial, it's up to you.
To get past the warning message Check the box for Don't ask me again then click close. You will then find your self in SourceTree. My experience was that if I didn't check the box the software would close and I was left wondering what to do. Seth's instructions take care of updating the embedded Mercurial.
On my machine (Win10 x64) when I click "Close" (weather or not having checked "Don't ask me again") I see a SourceTree crash report window (i.e. ST seems to have crashed) and never actually see the ST window. In other words, the mercurial problem is completely locking me out of ST.
@Matthias Stevens ~ There is an update to SourceTree (released on/around 29th July) that addresses problems with the Windows 10 Anniversary Update. If you've installed that Win10 update, try grabbing the latest ST. (See this thread on Reddit for a possible workaround if for some reason you don't want to or can't update ST.) I haven't had this problem personally (still on Win7) but saw your comment and thought I'd mention this.
It seems a bit silly that SourceTree bugs the user about this, while not offering any hint on HOW to do the update (or offering to do the update, or actually doing the update as part of updating SourceTree - I got the very latest SourceTree version). I never heard about Mercurtial either... it seems I am using Git only.
I found the Options... Mercurial tab, and used the "Updated embedded Mercurial" button. I had to then restart SourceTree to get rid of the cryptic pop-up.
@Johan E. Bengtsson - If you think something should be changed, submit a bug report or feature request to jira.atlassian.com. Everyone who has participated on this question is a user like you. We might fully agree with you, but we can't do anything about it.
If you do submit on jira, post a link here, and the others who have had a similar issue can find it and vote it up.
I would except it doesn't work, it might be due to the proxy, but the application has proxy settings done for its other stuff Sourcetree reminds me each time there is an update so that works. It doesn't seem to be able to handle downloading and installing the update behind the proxy
Follow below steps to resolve this issue
You are all SET.