What has happened?
Following its December 2018 consultation, the Financial Conduct Authority (FCA) has published its final rules restricting how contracts for difference (CFDs) and CFD-like options are sold, marketed, and distributed to retail consumers. The FCA's policy statement summarises the consultation feedback that it received and outlines its final policy and Handbook rules.
What is the FCA's objective?
By introducing these new rules, the FCA hopes that fewer retail consumers trade CFDs and CFD-like options.
Ultimately, it seeks to reduce the total losses from retail customers trading in CFDs and CFD-like options, and ensure that those who do trade in them are more experienced and more capable of bearing potential trading losses.
Who is this relevant to?
The new rules are of relevance to MiFID investment firms, including Capital Requirements Directive credit institutions as appropriate, and UK branches of third-country investment firms, that are marketing, distributing or selling CFDs and CFD-like options in, or from, the UK to retail clients.
What does this mean?
The FCA proposed new rules following the application of temporary product intervention measures by the European Securities and Markets Authority (ESMA).
The FCA is making ESMA’s temporary intervention measures permanent, but with some differences to ESMA's measures, such as applying them to a wider range of products.
CFD-like options have a similar pay-out structure to CFDs and share common product features. Specifically, the FCA notes that they allow retail consumers to gain exposure to a wide range of assets for a fraction of the asset’s value. The FCA believes that this presents the same actual and potential harm to retail consumers.
The FCA is implementing the rules substantially as it consulted on (in CP18/38), with some amendments. The FCA requires that firms that offer CFDs and CFD-like options to retail consumers:
- limit leverage to between 30:1 and 2:1 depending on the volatility of the underlying asset;
- close out a customer’s position when their funds fall to 50% of the margin needed to maintain their open positions on their CFD account;
- provide protections that guarantee a client cannot lose more than the total funds in their trading account;
- stop offering current and potential customers cash or other inducements to encourage retail consumers to trade; and
- provide a standardised risk warning, telling potential customers the percentage of the firm’s retail client accounts that make losses.
Having considered the feedback, the FCA has decided not to extend the scope of its measures to exchange-traded futures and similar 'over-the counter' products.
The FCA will keep this area under review and reconsider if it sees evidence of harm.
What has changed from CP/18/38?
After taking into consideration the feedback it received in response to its consultation, the FCA made some amendments to clarify the scope and application to certain products or practices, as follows:
- It clarifies that unleveraged versions of CFDs, spread bets and rolling spot forex contracts are not within scope of the rules. "Leveraged" products in this context means products that provide exposure to an asset for a fraction (i.e. less than 100%) of that asset’s value. This ensures that certain types of CFD that are commonly offered without leverage, such as interest rate swaps, are outside the new rules.
- In its feedback, the FCA also confirms that structured capital-at-risk products are outside of the regime, constant leverage certificates are within scope, and warrants, described as an option that is affected by the time to expiry and the volatility of the underlying asset, are not in scope of the rules.
- To avoid firms being subject to conflicting obligations, the FCA amends the rules to ensure that, if a firm is dealing with a retail client in another EEA state that has adopted rules covering the same activity, the FCA rules do not apply where the other state’s rules are stricter.
- The final rules are amended to exclude firms that sell CFD-like options to retail clients when the product’s sale is intermediated by another firm outside of the UK. This is because the FCA does not intend the regime to apply to firms that manufacture CFD-like options for sale through intermediaries where the firm does not have a direct regulatory relationship with the client.
- The FCA clarifies that its rules do not apply when a UK-based client contacts an overseas firm on their own initiative (although the overseas firm will be subject to its local regulation). However, it will continue to monitor the impact of this and consider amending its rules to apply them to all firms selling to UK-based clients if there is evidence of harm.
- The FCA has amended its guidance so that tiered volume fee discounts are not included in its ban of monetary and non-monetary incentives.
- The rules for the standardised risk warning are also amended to:
- align the methodology for calculating loss-making accounts with ESMA’s rules, meaning if an active retail account does not change in value over a period, it will be counted as a profit-making account);
- align the risk warning for new firms with the Austrian Finanzmarktaufsichtsbehörde (FMA) risk warning which the FCA considers better reflects the risks of trading CFDs and will avoid any unnecessary implementation costs for firms;
- require firms to modify the standardised risk warning to include CFD-like options’ if the firm sells these products alongside CFDs.
What happens now?
The new rules apply from 1 August 2019 for CFDs and 1 September 2019 for CFD-like options.
The FCA will shortly publish a consultation on a potential ban on the sale to retail clients of derivatives and certain transferable securities that reference cryptoasset.
Should it decide to proceed with a ban following that consultation, those rules would replace its final measures restricting how CFDs referencing cryptocurrencies are sold to retail clients.
In addition, the FCA mentions that it is working with academic researchers to assess the effectiveness of risk warnings on webpages. It will consider amending its rules if this research indicates that the positioning of the risk warning under these rules does not improve investors' receptiveness to risk warnings.
Future supervisory work
The FCA forewarns firms that its future supervisory work in this area will focus on:
- firms’ attempts to avoid the effect of the new rules by:
- inappropriately opting up clients to become elective professional clients;
- moving clients to associated non-UK entities; or
- not complying with financial promotion requirements, including the prominence of standardised risk warnings;
- firms’ prudential soundness including their management of negative balance protection;
- firms’ treatment of clients in the course of Brexit-related restructuring; and
- if applicable, the conduct of inward passporting firms operating under the Temporary Permissions Regime.
With this clear notice, firms should be diligent.
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