The FCA has published Consultation Paper 16/40: Enhancing conduct of business rules for firms providing contract for difference products to retail clients (CP16/40).
In CP16/40 the FCA sets out proposals to further regulate the provision of contract for difference (CFD) products to retail investors. Following an increase in the number of firms in the CFD market, the FCA has concerns that more retail customers are opening and trading CFD products that they do not adequately understand.
The FCA recognises that its consultation forms part of a growing trend across European regulators to impose new standards and restrictions on the marketing of CFDs to retail clients, following a warning by the European Securities and Markets Authority in July 2016 about the risks that complex products such as CFDs pose to retail clients who did not fully understand them. Already, regulators in Belgium have imposed a ban on leveraged FX and CFD products, the Netherlands has also taken steps to ban the marketing of CFDs, while the French government is considering legislation to restrict their promotion by electronic means.
The FCA proposes:
- the introduction of standardised risk warnings on client accounts by all providers;
- mandatory disclosure of profit-loss ratios on client accounts by all providers;
- limiting leverage for inexperienced retail clients (<12mths of active trading in CFDs), varying by product risk profile, but with a maximum of 25:1;
- limited leverage for all retail clients, varying by product risk profile, but with a maximum of 50:1;
- a ban on providers using bonuses to promote CFD products; and
- to regulate binary bets once these fall within the regulatory perimeter.
As regards firms passporting into the UK from the EU, these policy measures could not apply as investment firms operating on a services-only passport remain the sole responsibility of their national competent authority. However, any such firms which do not comply with the provisions of their own volition may be subject to a restriction on making financial promotions.
Information to clients – COBS 22 changes
The FCA is proposing to require firms to provide a:
- standardised risk warning which discloses sufficient and more effective information to retail clients. The proposed standardised risk warning must also meet the general requirements to ensure prominence and appropriate presentation to the client; and
- standard risk disclosure stating the percentage of client accounts that made a net profit or loss, both in the previous calendar quarter of trading activity and over the last 12 months. This disclosure must include actual profits or losses and the current level of profit or loss from equity in open trading positions.
The FCA is concerned about high levels of leverage with low levels of initial margin (such as 200:1 leverage, or 0.5% margin requirements), coupled with automatic close-out where a client’s margin falls below a certain required level – in volatile markets, this can lead to clients inadvertently having their positions closed out at a loss, particularly as the threshold tends to be 50% of required margin, which at 500:1 would mean a 0.1% change in the value of a position.
The FCA proposes that firms will be required to designate their clients as experienced or inexperienced, based on their recent trading history with CFDs or similar products. This must be evidenced by previous accounts and trading – firms cannot rely on self-certification from the retail client themselves.
- Clients with less than four quarters of trading experience in CFDs or similar investment products (such as options or futures) in the last three years (12 quarters).
- Experience cannot be accrued through ‘demo’ accounts.
- Inexperienced clients who eventually pass the ‘experience’ threshold can be reclassified by firms and offered higher levels of leverage, but before doing so a firm must clearly inform the client, and explain how it may alter the risk of losses and costs and charges on trades.
- Proposed leverage limits for inexperienced retail clients:
- margin of 4% for major FX pairs (25:1 leverage)
- margin of 5% for major stock market indices and gold (20:1 leverage)
- margin of 10% for minor indices and other commodities (10:1 leverage)
- margin of 20% for single stock equities and all other assets (5:1 leverage)
- margin close-out mechanisms are to be set at 50% for inexperienced retail clients – once a client’s net equity falls below 50% of the initial margin required, their position must be closed out. However, this will not be an obligation to provide a guaranteed stop-loss: during periods of excessive market volatility where firms may be unable to close out positions, the client could still lose their entire deposited fund or sustain losses exceeding their deposited funds. Nonetheless, the provisions will mitigate the risks for clients.
- Clients must have executed at least 40 trades over four quarters out of the last three years, and at least two trades per quarter, in order to be ‘experienced clients’.
- The leverage limit for these clients can be higher:
- margin of 2% for major FX pairs (50:1 leverage)
- margin of 2.5% for major stock market indices and gold (40:1 leverage)
- margin of 5% for minor indices and other commodities (20:1 leverage)
- margin of 10% for single stock equities and all other assets (10:1 leverage)
- Margin close-out mechanisms are also to be set at 50% for experienced clients
Ban on promotions offering bonuses and other incentives to open accounts or trade
The FCA proposes to ban bonus promotions or other incentives to open accounts or trade in CFDs. The FCA notes that there has been a marked increase in the use of ‘gambling-style promotions’ – the ability to win bonuses through trading, or the offer of bonuses when opening an account for CFD trading. This ties in with the increased marketing of binary bets, where clients are invited to bet on whether a particular instrument or index will be higher or lower than a fixed threshold at a future point in time. The FCA’s opinion is that these products do not appear to meet a genuine investment need, especially as they are so asymmetrical (the firm having much more relevant information than the client).
The deadline for comments on CP16/40 is 7 March 2017. Subject to the responses, the FCA will seek to publish a Policy Statement and final Handbook rules by late spring 2017.
In the meantime the FCA states that it expects all CFD providers to ensure that they are complying with the existing Handbook rules. In particular, as outlined in a Dear CEO letter in February 2016, the FCA expects all firms in this sector to assess whether they have adequate standards in relation to appropriateness assessments, anti-money laundering controls and client categorisation. The FCA also expects firms to ensure that they comply with the current disclosure requirements. In particular, risk warnings should be clear and not diminished by other statements or their overall positioning and prominence.
The FCA also states that it is conducting further supervisory work and are applying increased scrutiny during the authorisation process to all new applicants seeking to offer retail CFDs.