The FCA has concluded that consumers are at "serious risk of harm" due to the poor practices of some providers and distributors of CFDs. The regulator will take further action against at least one firm in its latest crack-down on these "complex, high-risk" products.

We have previously reported on the FCA's concerns for consumers trading contracts for difference (CFD), and its expectations of CFD firms. The FCA's December 2016 proposals included imposing restrictions on CFD trading and were due to be put in place in Spring 2017, but were delayed in June after ESMA announced it was also reviewing the products. In its update of 15 December 2017 ESMA said it was considering measures to prohibit or restrict the marketing, distribution or sale of CFDs to retail clients, and would be conducting a public consultation in January 2018.

In November 2017 the FCA issued warnings to consumers about these high-risk products, which was followed this week by the issue of a "Dear CEO" letter to providers and distributors of CFDs following the FCA's 12-month review of the market. In it, the FCA noted that during the review period, 76% of retail clients lost money. One CFD provider's arrangements were so poor that the FCA will "take further action".

What's the difference?

CFDs are, essentially, gambles on the entry and exit prices of an underlying asset within a given time. The asset can be anything that has a financial value, for example a currency, stock or index. The payment to (or from) an investor with respect to a CFD depends on the actual difference in entry and exit price.

CFDs are banned entirely in a number of countries including the USA, Belgium and Israel. France has banned digital marketing of them.

Firms offering CFDs in the UK are regulated by the FCA, meaning that consumers are able to benefit from the protections provided by the FOS and FSCS.

Warning to consumers on cryptocurrency CFDs

Cryptocurrency CFDs allow investors to speculate on the change in price of a cryptocurrency such as Bitcoin, and are increasingly being marketed to retail investors.

In November 2017, the FCA warned consumers that the volatility of cryptocurrencies makes these products particularly high-risk. This is exacerbated by the leverage that some firms offer, which can make cryptocurrency CFDs especially attractive to consumers, but leaves them open to a significant risk of losing far more than their initial investment.

Warning to providers and distributors of CFDs

The FCA's review of the CFD market looked at the supply of these "complex, high-risk instruments" to retail customers on an advisory or discretionary portfolio management basis. The review was conducted over a 12 month period, and assessed 19 firms that provide CFDs to intermediaries and 15 firms which distribute the CFDs to retail consumers.

The FCA's areas of serious concern are:

  • target market identification;

  • communication, oversight and challenge;

  • process whereby providers take on new distributors;

  • the management of conflicts of interest;

  • the use of management information and key performance indicators;

  • client categorisation; and

  • remuneration arrangements

What next?

The FCA concluded that consumers may be "at serious risk of harm" as a result of the poor practices identified in its review. It reported that several of the firms it had investigated have said that they intend to stop providing CFDs to firms which distribute them to retail customers on an advisory or discretionary basis. The FCA has pledged to undertake further work on CFD providers and distributors.

In a response to the FCA's letter, Plus500, which operates an online trading platform for retail customers to trade CFDs, states that whilst the guidance is not directly applicable to their business model, they believe that "these and other changes will enhance the CFD trading landscape and ultimately reduce the number of providers to a core of higher quality operators".

This appears to be the result that the FCA is looking for; its approach is unlikely to have a big impact on CFD providers and distributors who are well-established in the market and have been following the rules.

However, a combination of increased scrutiny from the FCA and the threat of further requirements from ESMA may concern those smaller, more recent entrants to the market.