On the 31st of March 2017, the European Securities and Markets Authority (ESMA) updated its Q&As on 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 clients, such as binary options and rolling spot forex.
The Q&As include the new Section 10 (page 84-97) which sets out ESMA’s views in respect of:
- Passporting and the cross-border provision of services by investment firms offering CFDs and other speculative products to retail clients outside their home member state without the establishment of a branch or tied agent;
- Assessments of the use of third parties by investment firms; and
- Examples of poor practice observed by National Competent Authorities (NCAs) in respect of the use of third parties by investment firms.
The establishment of a physical presence is a prominent NCA concern. In some cases, the physical presence is achieved through representative offices without the establishment of a branch or tied agent. Despite representative offices being only permitted to conduct market research and promote the brand of the firm, numerous NCAs have observed instances of representative offices acting unlawfully by providing regulated services.
“Introducing brokers” or “affiliates” are widely used to facilitate the cross-border distribution of CFDs and other speculative products with promotional, marketing and client services activities on behalf of investment firms. This is unlawful as a non-authorised third-party customer support function should not provide any form of investment advice, or any trading strategies or signals.
The risk associated with this activity is the creation of ambiguity for retail clients who are more likely to be unable to understand or distinguish the activities performed by an unregulated third party and those of an authorised firm.
NCAs have observed poor practice in regard to the use of third parties by investment firms including third parties being remunerated on the basis of the number of clients introduced, the volume of client trading, or the value of client deposits. ESMA notes:
“Third parties are often remunerated on the basis of client trading volumes or net client losses, creating a potential material conflict of interest which it is unlikely the investment firm can effectively manage in an objective and demonstrable manner.“
Other examples of poor practices include:
- Authorised firms being unable to demonstrate meaningful oversight of the activities of third parties. This includes call centres and sub-affiliates; and
- Arrangements with third parties not being formally documented.
ESMA will consider whether further work is needed, such as in relation to the application of product governance requirements and product intervention powers, both MiFID II requirements that will apply in January 2018.
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