On 6 December 2016, the UK Financial Conduct Authority proposed stricter rules for firms selling ‘contract for differences’ products (CFDs) to retail customers. The proposals follow heightened regulatory scrutiny on the sector across Europe, amid concerns that a growing number of retail customers are trading in CFDs without understanding the risks involved.
FCA Proposals
The FCA has published a consultation paper proposing a range of measures designed to enhance protection for retail CFD customers. The new measures aim to reduce the risks posed by CFDs and ensure that firms provide better information to customers. The proposals include:
- Enhanced disclosure requirements – the FCA is proposing that retail CFD firms must provide a standardised risk warning to their customers. In addition, the FCA plans to impose a requirement for firms to provide a disclosure stating the percentage of client accounts that made a net profit or loss in the previous calendar quarter and over the last 12 months.
- Leverage limits – the FCA will require firms to apply leverage limits for CFDs. The limits will be set according to both the volatility of the underlying asset and the experience of the customer, as follows
| Inexperienced retail clients | Experienced retail clients | |
| Major FX pairs | 25:1 | 50:1 |
| Major stock market indices and gold | 20:1 | 40:1 |
| Minor indices and other commodities | 10:1 | 20:1 |
| Single stock equities and all other assets | 5:1 | 10:1 |
To count as ‘experienced’, clients will be required to evidence that they have conducted at least 10 trades per quarter in four of the previous 12 quarters (or entered into at least 40 trades over the previous 12 months with at least two trades in each quarter); otherwise they will be treated as ‘inexperienced’.
Ban on bonus promotions – the FCA will prohibit firms from using any form of trading or account opening ‘bonuses’ or benefits to promote their retail CFD products and platforms.
The leverage limits and enhanced disclosure requirements will not apply directly to firms offering CFDs to retail clients in the UK under a cross-border services passport from another EU member state. However, the FCA proposes to restrict financial promotions for incoming firms that do not seek to comply.
Background
The FCA’s proposals are the latest in a line of regulatory interventions in the sector by the FCA and other EU regulators:
- In February, the FCA published a ‘Dear CEO’ letter reminding firms to look closely at their on-boarding procedures, including the quality of appropriateness tests and the adequacy of anti-money laundering checks.
- On a European level, the European Securities and Markets Authority has published and repeatedly updated a series of questions and answers on retail CFDs intended to foster better supervisory convergence among EU member states.
- In July and August, regulators in Belgium and France took aggressive measures to restrict the marketing or distribution of CFDs to retail investors.
- On 30 November, the Cypriot regulator, CySEC, announced its own restrictions.
CySEC Restrictions
CySEC’s measures are of particular interest as many firms that operate in the EU are authorised in Cyprus. Typically, these firms then use a MiFID services passport to offer CFDs to clients in other member states on a cross-border basis.
CySEC has introduced similar restrictions on bonus promotions and is also targeting the use of leverage, although its leverage restrictions are less severe than the FCA’s proposals. CySEC states that firms should offer retail clients a default leverage limit that does not exceed a cap of 50:1, but firms will still be able to give clients the option to change the default to a higher leverage.
Binary Options
The FCA consultation paper also addresses the FCA’s policy considerations in relation to binary options (which the FCA is terming ‘binary bets’). Binary options are currently treated as gambling products in the UK with providers licensed under the Gambling Commission, rather than being regulated by the FCA.
However, this is set to change as part of the UK’s transposition of MiFID II, when it is anticipated that binary options will be brought within the FCA’s regulatory perimeter. This will bring the UK into line with most other EU jurisdictions which already regulate binary options as regulated securities under MiFID. The FCA makes clear that it believes that binary options carry material consumer protection risks, on the basis that they:
- do not allow retail investors to make informed decisions and can lead to addictive behaviour akin to gambling;
- pose significant information asymmetries for clients; and
- lead to conflicts of interest for the firm which takes the other side of the client’s bet, there potentially being a strong commercial incentive for firms to manipulate expiry reference prices to avoid pay-outs to clients.
The FCA states that it is considering possible policy measures to address these risks, including a potential restriction on marketing binaries to certain retail clients and the future use of product intervention powers under MiFID II to address specific product features, marketing, distribution or sales techniques.
Consultation Details
The FCA is inviting feedback responses on its policy proposals set out in the consultation paper. The consultation will run until 7 March 2017. The FCA then aims to publish a Policy Statement confirming the final rules in spring 2017.
This is an area where there is considerable cross-border activity and where many providers use a MiFID passport to offer their services into the UK from elsewhere in the EU. Although the FCA proposes to restrict financial promotions for incoming firms that do not comply with its rules, it is difficult to see how the FCA will be able to police this in practice.
Since the FCA’s proposed leverage limits are more stringent than those of CySEC, there is a risk that the UK regulator is creating an uneven playing field which could drive operators to rely on authorisations from Cyprus or other member states – or to use entities regulated outside the EU, which typically do not offer the same level of client protections. Respondents to the consultation will likely focus on the consequent risk that the FCA’s measures may be counter-productive, in reality leaving UK retail customers more exposed.
As for binary options, the industry will welcome the opportunity to provide feedback to the FCA on a product that has languished in regulatory limbo over the past few years. However, it remains to be seen how far the FCA will go in imposing restrictions once binaries are finally brought within its purview.
by Berwin Leighton Paisner LLP – Matthew Baker and Anthony Williams
