Background and Purpose of Q&A
On 8 April 2016, the European Securities and Markets Authority (ESMA) published a new Q&A10 in relation to the application of the Markets in Financial Instruments Directive (“MiFID”) to the marketing and sale of financial contracts for difference (“CFDs”) and other speculative products to retail investors. The Q&A is designed to be relevant to both MiFID in its existing form and to the new regime that will come into effect under the revised and recast MiFID and the new Markets in Financial Instruments Regulation (collectively referred to as “MiFID II”), which are now expected to be implemented with effect from 1 January 2018.
ESMA notes that in looking to enhance returns, many investors consider investing in complex speculative financial instruments, including CFDs, binary options and rolling spot forex contracts. It notes that although these are complex products and it may be difficult for a majority of retail investors to understand the risks involved, they are widely advertised to the retail mass market (often via online platforms) by a number of firms.
ESMA states that the purpose of the Q&A paper is to promote common supervisory approaches and practices in the application of MiFID and its implementing measures to certain key aspects that are relevant when CFDs and other speculative products are marketed and sold to retail clients. It notes that national competent authorities (“NCAs”) must not grant authorisation to any firm to carry out a relevant financial activity or service unless and until fully satisfied that the applicant complies with all its MiFID obligations. The Q&As are intended to help NCAs obtain and consider relevant information as part of their procedures for granting and refusing requests for authorisations from firms offering CFDs and other speculative products to retail investors.
The first set of Q&As are designed to assist NCAs in ensuring that the relevant firm can be effectively supervised by the relevant NCA, including that the NCA can obtain adequate information from the applicant firm and persons with whom such firm has close links and that the firm is ready and willing to engage with the NCA in an open and cooperative way. ESMA also states that, when considering an application for authorisation, an NCA should ensure that the applicant firm’s resources are appropriate in relation to the activities that the firm intends to carry out. Such firm’s financial and nonfinancial resources must be sufficient for the firm to operate the business effectively and meet its MiFID obligations. ESMA also gives substantial guidance to NCAs in ensuring that consideration is given to whether the business plan that an applicant firm has provided within its programme of operations offers sufficient information about what the firm is planning to do and how and where it will operate in accordance with MiFID requirements.
Conflicts of Interest
The Q&As also consider issues around conflicts of interests, particularly in relation to firms providing CFDs or other speculative products by dealing on own account where there is a direct correlation between the profit or loss made by the client and the profit or loss made the firm. ESMA notes that the extent of the conflict of interest and the ability of the firm to manage it will be impacted by the firm’s business model and that this should be a key area of focus by the NCA. It draws a distinction between circumstances where the firm is a direct counterparty of its client but then hedges its exposure, and situations where the firm does not hedge (or only partially hedges) such exposure.
Finally, the Q&A considers online platforms that remunerate sales staff based on the volume and value of CFD transactions executed by retail clients on the platform. ESMA states that pursuant to its guidelines on remuneration policies and practices under MiFID, it is unlikely that such firms could in such cases demonstrate compliance with MiFID conduct of business or conflict of interest requirements. It goes on to provide examples of good and bad practices in the design of remuneration policies and practices under MiFID in the context of the provision of CFDs and other speculative products.