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CFDs: Strict new rules on the horizon for Spread Bet Firms

6th December 2016

Improving Conduct of Business for CFD providers

The regulator has today entered into a Consultation to propose strict new rules in place for firms offering Contract for Difference (CFDs) to retail customers.

The FCA wishes to place limits on how much an individual can risk when they open an account with firms selling CFDs such as Spread betting firms.

The strict new rules will look to improve standards across this particular sector and help ensure that retail customers are appropriately protected.

Christopher Woolard, Executive Director of Strategy and Competition at the 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.”

He continued by informing that the FCA “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.”

• CP16/40 “Enhancing Conduct of Business Rules for firms providing Contract of Difference Products to Retail Customers.”

What products will be affected?

This Consultation will affect Firms that provide Contracts for Difference or CFD products to Retail Customers including Spread Bets and Rolling Spot Foreign Exchange (FX).

The FCA views these types of investment products as being far more complex for consumers to understand compared to others.

UK Providers of CFDs, Spread Bets and Rolling Spot FX

The FCA have identified within the firms it authorises, 97 specialist CFD firms whose primary activity is selling and distributing CFD products to retail clients. Plus there are a further 1,657 firms and individuals that are authorised to sell and distribute CFD products to retail clients. Those firms that are considered specialist CFD firms currently hold around approximately £3.5bn in client money.

FCA Concerns over CFD losses

Since the number of investment firms offering CFDs has increased in recent years (estimated to have doubled since 2010), the regulator is concerned that more and more customers have been able to open and trade CFD products without adequately understanding the risks involved for these ‘complex’ products.

To demonstrate this, the regulator has informed that a study of a representative sample of client accounts at CFD firms discovered that 82% of clients lost money by trading CFDs with the average amongst those customers analysed being a loss of £2,200 a year.

In addition, the FCA advises that other jurisdictions within the European Union have also seen similar figures of loss citing a study from October 2014 by France’s financial regulator – the Autorité des Marchés Financiers (AMF) – that found 89% of consumers lost money on CFD products, with investors losing on average €10,887 over four years.

Shortcomings of CFD Firms highlighted:

And it is not just these figures of consumer loss that has caught the attention of the regulator.

Earlier this year, the FCA wrote a Dear CEO letter to CFD and Spread Bet firms that highlighted a number of inadequacies found within a sample of CFD firms reviewed by the FCA in 2015. These included inadequate risk warnings, shortcomings in carrying out the appropriateness test and in anti-money laundering checks.

In addition, the FCA advised that it is not only recently that these issues have arisen – in fact their on-going supervision work since 2009/10 has continued to uncover instances of poor conduct and risks to consumer detriment within the CFD sector.

As a result of these continued findings within this sector, the FCA has now responded by proposing new conduct rules for CFD providers.

Proposed COB Measures for CFD providers:

The regulator’s consultation paper, CP16/40, is entitled “Enhancing Conduct of Business Rules for firms providing Contract of Difference Products to Retail Customers.”

Within this consultation the FCA proposes a number of measures that are intended to fortify consumer protection through limiting the risks of CFD products, in addition to ensuring that consumers are better informed.

These proposed new measures include:

 Calling a ban on any form of account opening benefit or bonus intended to promote CFD products or CFD platforms;

 Standardised risk warnings and mandatory disclosure of profit-loss ratios on client accounts by introduced by all CFD providers to improve illustration of the risks involved and of the historical performance of these products;

 For those retail clients with little experience of active trading in CFDs (i.e. 12 months or less) being set lower leverage limits with a maximum of 25:1; and

 For all other retail clients (i.e. the more experienced) placing a cap on leverage at a maximum level of 50:1 as well as introducing lower leverage caps across different assets according to risk.

The FCA noted that some levels of leverage currently being offered to retail customers by CFD Firms exceeded 200:1.

What next for CFD and Spread Bet Firms

Those providers of CFD products would do well to read the consultation and provide their feedback to the FCA to consider before they finalise their policies and issue the final rules.

The closing date for comments on the consultation is 7th March 2017.

In particular the regulator is looking for feedback to its Consultation on the following questions:

• Q1: What investment need(s) do CFDs fulfil for retail clients and would they be disadvantaged if they no longer had access to these products?
• Q2: Do you agree with our proposal to require enhanced disclosure requirements for CFD products?
• Q3: Do you agree with our proposal to require CFD firms to disclose the percentage of client accounts that are in profit or loss over the previous calendar quarter and over the last 12 months?
• Q4: Do you agree with the proposal to limit the risks of CFDs by taking steps to limit leverage for retail clients?
• Q5: Do you agree with the proposal to adopt different leverage limits for inexperienced and experienced retail clients?
• Q6: Do you agree with the proposed margin limits for inexperienced clients and experienced retail clients?
• Q7: Do you agree with the proposal to set a margin close out limit of 50% of initial margin required? In particular, we welcome feedback on the detailed drafting of this rule and whether it is compatible with standard market practices.
• Q8: Do you agree with our proposal to ban bonus promotions or other incentives to open accounts or trade?

Once the consultation has closed we can expect the FCA to issue the final rules within a Policy Statement next Spring.

Additional Topic of Discussion: Binary Bets

Within the FCA’s Consultation on improving conduct of business rules for CFDs, they have set out their vision on a range of policy measures for binary bets, which they believe would complement existing rules when these products are brought within the scope of the regulator (expected when MiFID II is implemented).

Within the Consultation Paper, the FCA’s most recent observations found that binary bets are not transparent enough for investors to adequately value them and have certain product features that are more similar to gambling products that those investments. In particular, it was noted that the short duration of a binary bet, some as short as 30 seconds, can lead to “potentially addictive ‘trading’ behaviours more associated with gambling” which the FCA does not believe meets “a genuine investment need”.

This position was further stressed by Mr Woolard of the FCA who stated that the FCA “has concerns that binary bets pose investor protection risks and question whether binary bets meet a genuine investment need.”

The FCA is therefore also calling for feedback of the following discussion points relating to Binary Bets with a view to consulting upon their proposed policies for Binary Bets at a later date:

• Q9: What investment need(s) do binary bets fulfil for retail clients, and do you agree with the risks we have identified?
• Q10: What are your views on limiting the marketing of binary bets to some retail clients?
• Q11: What are your views on the potential use of product intervention powers under MiFID II to restrict specific features of binary bets or place limits on the distribution or sale of these products for retail clients?
• Q12: Are there any alternative policy measures that we should consider to address our investor protection concerns in relation to binary bets?

Comments on these discussion points should also be returned to the regulator by the closing date of 7th March 2017.

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