CFDs – Enhanced Conduct of Business Rules

Of Relevance to:
Firms providing and/or distributing retail CFD products (and binary options)

Given the concerns that the FCA has previously expressed on the distribution of contracts for difference (“CFD”) – see Regulatory Roundup 73 – it probably comes as no surprise that it has issued Consultation Paper CP16/40 “Enhancing conduct of business rules for firms providing contract for difference products to retail clients”.

Work undertaken by the FCA reveals that over 80% of clients lost money on CFDs (the term also captures spread bets and rolling spot FX) over a year, with the average result per client being a loss of £2,200.

The unease that the FCA has about CFDs and retail clients is not unique to the UK. Aside from the recent ESMA update of its Q&As on ‘the provision of CFDs and other speculative products to retail investors under MiFID’ (see Regulatory Roundup 81), the paper advises us that several EU member states, including Belgium, France and the Netherlands, have already introduced (or announced an intention to introduce) a ban on the financial promotion of CFD products.

The FCA’s proposed changes include (note that any references below to Handbook rules are to those contained in Appendix 1 to CP16/40 and should assist firms in their understanding of the detailed requirements):

  • The need to categorise all retail clients as either an ‘experienced retail client’ or ‘inexperienced retail client’. This categorisation impacts on how other elements of the proposal apply. It is recommended that firms look to the Glossary in Annex A of Appendix 1 to familiarise themselves with the definitions of ‘active trading experience’ (being either the execution of at least ten relevant trades in a calendar quarter or at least forty such trades in a continuous period of twelve months with at least two trades carried out per calendar quarter) and the definition of ‘experienced retail client’ (a retail client with ‘active trading experience’ of at least a continuous period of twelve months or four calendar quarters within the twelve calendar quarters prior to the current trade). Any client not meeting the definition will by default fall into the ‘inexperienced retail client’ category. Note the need for evidential records (i.e. no ‘self-certification’) to be received by the firm and that the use of demonstration or training accounts is to be ignored for the purposes of determining ‘active trading experience’ (COBS 22.4.17 – 22.4.20).
  • A requirement for a prominent standardised risk warning which will include details of profits/losses made by the firm’s retail clients over the last quarter and four quarters respectively. Where a firm’s website or mobile application is used then this warning must remain fixed on the screen even when the (retail) client scrolls up or down (COBS 22.4.3 – 22.4.4).
  • The provision of standardised point of sale risk warning. The firm must require the retail client to acknowledge receipt (using prescribed wording) of this standardised point of sale risk warning – which must be separate to any acknowledgement of terms and conditions – before a trading account can be opened (COBS 22.4.5 – 22.4.9).
  • Initial margin requirements are determined by the client’s categorisation as either ‘experienced retail client’ or ‘inexperienced retail client’ and ranges from 2% to 20% (COBS 22.4.10 – 22.4.13).
  • Margin close out requirements oblige a firm to ensure that the retail client’s net equity (as defined in the rules) does not fall below 50% of the initial margin requirement, otherwise the client’s open positions must be closed ‘as soon as market conditions allow’. Note that the retail client must be informed as to how their margin close out level is calculated and triggered. Firms are also reminded of their ‘best execution’ obligations when e.g. closing a retail client’s position (COBS 22.4.14 – 22.4.16).
  • Restrictions on financial promotions likely to be received by a retail client will prohibit offering a monetary or non-monetary incentive or a bonus offer contingent on opening a trading account (COBS 22.4.21 – 22.4.23).

Firms should note (chapter 5) that during the consultation period the FCA expects all CFD providers to ensure that they are complying with the existing rules and in particular draws attention to appropriateness assessments, AML controls and client categorisation – reference to February’s ‘Dear CEO’ letter will assist here – and risk warnings. We are also informed that the FCA is conducting further supervisory work and are applying increased scrutiny during the authorisation process to applicants seeking to offer retail CFDs.

The Consultation Paper also briefly touches on what it refers to as binary bets (which is the term that will be used in the Handbook Glossary although they are more commonly referred to as binary options). These are currently regarded as gambling products, although HM Treasury has consulted on bringing them within the scope of FCA regulation in the light of the European Commission opinion that they should be considered as MiFID financial instruments. It is stated that any formal proposals and draft Handbook rules in relation to these products would be consulted on in Spring 2017.

The consultation period ends 7 March 2017.

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