Posted: 13th December 2016
On the 6th December 2016, the FCA published its consultation paper on enhancing conduct of business rules for firms providing contract for difference (CFD) products to retail clients.
A CFD is a contract between a consumer (the investor) and a business. At the end of the contract, the investor receives the difference between the opening and closing price of an asset (or pays the difference if negative).
The UK has been providing retail CFDs dating back to 1970s and 80s. Typically, they were marketed at the more sophisticated retail investors. The FSA (and later, the FCA) conducted supervisory work and reviews in this area as far back as 2009, and has found increasing instances of poor conduct and risks of consumer detriment across the CFD market. The most recent thematic review on CFD providers in 2015 indicated shortcomings in risk warnings and anti-money laundering (AML) checks across all of the firms in the sample.
The FCA also collected data from the sample of firms as part of its work. The data indicated that over 80% of clients lost money on these products over a one year period. The average loss per client was £2,200; other European Union jurisdictions have seen similar figures.
Over the past five years there has been an increase in entrants to the market, which indicates effective competition exists. It is worth noting that the CFD sector has also seen firms extending the target market for these products to retail clients, for whom the products may not be appropriate. Typically, terms have significantly increased risk and the probability of losses.
Based on the FCA’s concerns about the risks related to these products from a consumer protection standpoint, it has set out this consultation paper with a view to addressing these issues with a policy measure.
Christopher Woolard, Executive Director of Strategy and Competition, FCA, said:
“We have serious concerns that an increasing number of retail clients are trading in CFD products without an adequate understanding of the risks involved, and as a result can incur rapid, large and unexpected losses. We are introducing stricter rules for CFD products to ensure the sector addresses the shortcomings identified, and that firms make sure that retail clients are aware of the high risks involved in trading these complex products.”
Key Points from CP16 / 40
The FCA wishes to address how they limit the risks of CFD products whilst ensuring customers are better informed. In order to do this effectively, they have proposed a range of measures:
- Introducing standardised risk warnings and mandatory disclosure of profit-loss ratios on client accounts by all providers to better illustrate the risks and historical performance of products
- Setting lower leverage limits for inexperienced retail clients who do not have 12 months or more experience of active trading in CFDs, with a maximum of 25:1
- Capping leverage at a maximum level of 50:1 for all retail clients and introducing lower leverage caps across different assets according to their risks. Some levels of leverage currently offered to retail customers exceed 200:1
- Preventing providers from using any form of trading or account opening bonuses or benefits to promote CFD products
Binary betting is growing in popularity due to its high profit potential, the small trading capital required and the flexibility for high leverage. It is referred to as binary because there are only two possible outcomes at expiration; nothing or a fixed outcome. They are usually categorised into two types: cash or nothing option and asset or nothing option.
The FCA asserts that binary bets are not transparent enough for investors to be able to adequately value them, and have product features which are more akin to gambling products than investments. Therefore, the FCA is also setting out its range of policy measures for binary bets that would complement existing conduct of business rules, once these products are brought into regulatory scope.
Regulatory Next Steps
The FCA would like feedback on the proposals in the publication by the 7th March 2017. The regulator intends to publish its policy statement in Spring 2017, with an intention of the rules coming into force shortly after.
Considerations for firms
Firms currently in the market should be considering their responses to the consultation paper, as this will of course allow them to influence the shape of the final rules.
They should also proactively seek to understand what the prospective changes might mean to their business, including:
- Considering their current financial promotions to ensure they are fair, clear and not misleading
- Thinking about how the operational environment might need to change in order to effectively embed new rules (for example, the process for issuing risk warnings)
- Utilising scenario planning to think about any additional training or resource that might be required for the issuing of risk warnings and mandatory disclosure of the profit-loss ratio on client accounts
Before committing to definitive action, however, firms may wish to continue to monitor developments in this area and ensure their reaction to final rules is proportionate.