On 29 June 2017, the European Securities and Markets Authority (ESMA) announced that it is considering using its forthcoming temporary product intervention powers under MiFID II to impose conditions on the way contracts for differences (CFDs) and financial spread bets, binary bets and other speculative products are sold and marketed to retail clients in the EU (link). On the same day, the Financial Conduct Authority (FCA) announced that it has put its own work in this area on hold, pending the outcome of ESMA’s discussions (link). In December 2016, the FCA had proposed significant interventions in the UK’s retail CFD market, including imposing maximum leverage limits, capping client losses and introducing stricter requirements for “inexperienced retail clients” (see our earlier update here). ESMA has now confirmed it is considering similar tough interventions on an EU-wide basis.
Practically speaking, the FCA will delay the publication of its final conduct rules for UK firms providing CFDs to retail clients (which were due to be published by late spring 2017), until the outcome of ESMA’s work in this area becomes clear. However, as MiFID II will not come into force until 3 January 2018, ESMA cannot exercise its powers until that time at the earliest. Nonetheless, the FCA has indicated that if ESMA does not make a decision within the first half of 2018, it will look to implement its own measures without waiting for ESMA.
In any event, both the FCA and now ESMA are considering significant interventions in this market. Whether or not ESMA takes action on 3 January 2018 (or even provides a further update on its intentions well in advance of then), it is likely that firms offering CFDs to retail clients in the UK will need to plan and prepare for significant changes in the first half of 2018.
These announcements come against a backdrop of tough action on CFDs by regulators across the EU (e.g. on 8 May 2017, the sale of CFDs with additional payment obligations to retail clients was banned in Germany, link), and both ESMA and the FCA have long expressed concerns over the marketing and sale of CFDs to retail clients.
The FCA set out its own proposals for wide-ranging reform as part of a consultation launched on 6 December 2016 (CP16/40, see our update here). The FCA had proposed significant interventions, including imposing maximum leverage limits, capping client losses and introducing stricter requirements for “inexperienced retail clients.” The FCA also suggested that it could prohibit the marketing and sale of binary bets to some retail clients altogether. In addition, following a “Dear CEO” letter issued in February 2016, the FCA recently conducted a review on the sale of CFDs and firms’ appropriateness assessments. On 29 June 2017, the FCA stated that, despite its Dear CEO letter, firms’ arrangements for assessing appropriateness were inadequate (link). As a result, the FCA stated that it continued to have “serious concerns about the distribution of CFDs to retail clients” and would consider enforcement investigations and other action as appropriate.
ESMA appears to have also adopted a tough stance, indicating in its statement that it is considering adopting “measures that have been adopted or publicly consulted on by EU National Competent Authorities” (e.g. capping client losses, as consulted on by the FCA).
Product intervention powers
ESMA and the FCA’s forthcoming product intervention powers derive from Title VII of the Markets in Financial Instruments Regulation (600/2014), which will apply from 3 January 2018. (We note that the FCA already has wide-ranging powers to introduce rules in relation to financial services and products under the Financial Services and Markets Act 2000, and could intervene in the UK’s retail CFD market in advance of 3 January 2018, provided that its measures were compatible with the current MiFID I regime. It is likely that the FCA has held off for now in order to ensure any measures it adopts are consistent with ESMA’s approach and its obligations under the forthcoming MiFID II regime.)
Under Article 40 MiFIR, ESMA may temporarily prohibit or restrict in the EU the marketing, distribution or sale of certain financial instruments and types of financial activity or practice. ESMA can only exercise its intervention powers if:
- the proposed action relates to a significant investor protection concern or a threat to the orderly functioning and integrity of markets/financial stability in the EU;
- existing regulatory requirements under EU law do not address the threat; and
- the relevant national competent authority/authorities (NCA/NCAs) have not taken sufficient action to address the threat.
ESMA’s product intervention powers are only temporary and will need to be renewed every three months. If a measure is not renewed, it will expire after three months. (This is in contrast to the FCA’s powers and the powers of other NCAs under MiFIR, which will be permanent, though must only remain in force so long as the initial conditions for their introduction are met.)
ESMA will not need to obtain the agreement of NCAs before taking such action, though it will need to notify them in advance. Action taken by ESMA will prevail over any previous action taken by NCAs. In practice this means that, were the FCA to take action before ESMA and ESMA decided to implement tougher measures down the line, those stricter measures would take effect and firms in the UK would be bound by them so long as they remained in force.
Under Article 42 MiFIR, NCAs have similar powers to prohibit or restrict the marketing, distribution or sale of certain financial instruments or financial activities or practices in their home states. The exercise of these powers are slightly more tightly controlled (e.g. an NCA must consult other NCAs that may be affected by the action, notify EMSA in advance and explain itself if it decides to take action despite ESMA issuing an opinion to the contrary).
In practice, we would expect the FCA to press ahead and exercise its product intervention powers in 2018. If ESMA does adopt temporary intervention measures, the FCA may nonetheless adopt permanent measures, which will continue to have effect in the event ESMA decides not to renew any particular measure. On that basis, and considering ESMA and FCA’s united, tough stance on the issue, we anticipate that firms will need to prepare for significant changes in the first half of 2018. Regardless as to whether the legal basis for the powers is a decision by ESMA or new rules in the FCA Handbook, firms should begin to plan and prepare for the introduction of measures such as maximum leverage limits and capping client losses.