Following an earlier consultation last December, on 1 July the Financial Conduct Authority (FCA) published a Policy Statement (PS19/18) with final rules restricting how Contracts for Differences (CFDs) and CFD-like options are sold, marketed, and distributed to retail consumers. The intent is to address poor conduct by firms and to limit the sale of CFDs and similar products with excessive risk features that result in harm to retail consumers. The measures include:
- Limiting leverage to between 30:1 and 2:1, depending on the volatility of the underlying asset
- Closing out a customer’s position when their funds fall to 50% of the margin needed to maintain their open positions on their CFD account
- Providing protections that guarantee a client cannot lose more than the total funds in their trading account
- Stopping offering current and potential customers cash or other inducements to encourage retail consumers to trade
- Providing a standardised risk warning at the top of the webpage, telling potential customers the percentage of the firm’s retail client accounts that make losses
The new rules in the FCA Handbook apply from:
- 1 August 2019 for CFDs
- 1 September 2019 for CFD-like options
According to an FCA independent analysis, leverage limits will save consumers between £259m and £443m per year, and the negative balance protection is expected to save retail consumers £6m per year.
As per new rules (to be found in COBS 22.5 of the FCA Handbook), the relevant risk warning must be:
- Contained within its own border, and with bold and unbold text as indicated
- If provided on a website or via a mobile application, statically fixed and visible at the top of the screen, even when the retail client scrolls up or down the webpage
- If provided on a website, included on each linked webpage on the website
- Proportionate, taking into account the content, size and orientation of the marketing material as a whole
- Published against a neutral background
The FCA is currently working with academic researchers to assess the effectiveness of the prominence of risk warning via webpages, and will consider amending current rules if this research concludes that risk warnings provided at the top of the webpage do not improve investors’ understanding, and memory of risk factors associated with certain investment products.
The FCA clarified that the inclusion of CFD-like options will ensure that firms refrain from offering similar products, which might pose the same risk of harm that the rules seek to avoid. “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. Note: There is no restriction on firms that sell CFD-like options in other jurisdictions, where the product is sold through an intermediary outside the UK, and on the sales and distribution activities of EEA firms outside the UK. Nevertheless, these firms are still prohibited from actively marketing unrestricted CFD-like options to UK retail consumers.
Whether certain products are caught by the rules and definition of CFDs and CFD-like options, will need to be determined on a case by case basis, as it will depend on the precise nature of a product.
To justify the new rules, the FCA has argued that the introduction of ESMA’s leverage limits has not improved client outcomes, noting:
- ESMA’s leverage limits did not reduce the percentage of loss-making client accounts
- Consumers profiting from CFD trading, made lower profits following the introduction of lower leverage
- Continued demand for higher leverage limits will drive retail consumers to either:
- seek out unregulated entities or firms based in third country jurisdictions to trade unrestricted CFDs, losing regulatory protection offered, or
- opt-up to become an elective professional client, resulting in consumers receiving fewer protections
- It was too early to analyse the impact of ESMA’s interventions
- Incorrect assumptions were used to set leverage limits
Apparently, several respondents also argue that the FCA should re-instate a previous proposal (in CP16/40) to create an “experienced” retail client category that allows retail consumers with 12 months CFD trading experience to trade at higher leverage levels than inexperienced clients. Feedback to CP16/40 suggested that, despite checking the experience of clients being costly and burdensome to implement, respondents said the costs were acceptable.
The FCA acknowledges that the number of active retail clients trading with UK CFD providers has decreased since ESMA’s intervention in August 2018, and the risk that a proportion of these clients may have moved to third country providers to access higher leverage. However, opines the FCA, the existence of lower conduct standards in third country jurisdictions does not justifies lower conduct standards in the UK.
The FCA announced that their supervisory work will focus on the following areas of the restrictions:
- Firms’ prudential soundness including their management of negative balance protection
- Firms’ treatment of clients in the course of Brexit-related restructuring
- If applicable, the conduct of inward passporting firms operating under the temporary permissions regime
- Attempts to circumvent the new rules by, for example, inappropriately opting up clients to become elective professional clients, moving them to associated non-UK entities, or not complying with financial promotion requirements, including the prominence of standardised risk warnings
The FCA will continue to monitor developments in the retail market for futures and other leveraged derivatives for any harm to retail consumers relating to exchange-traded futures and similar OTC products, and intervene if there is evidence of harm. In case of the UK leaving the EU with no implementation period, and of the passporting regime falling away when the UK leaves the EU, EEA firms that currently passport into the UK, and wish to continue operating in the UK, will be subject to the temporary permissions regime.
The new rules and their permanence do not really come as a surprise. Only 28 responses were received to the consultation, and this low number is perhaps indicative that firms were not expecting a different outcome. It is not clear how the FCA has calculated the amount retail clients are expected to save once these measures, which have been in place since 1 August 2018, will be made permanently active. It is, nevertheless, clear that the FCA is determined to ensure that these rules are implemented by the sector.
If you require any assistance in understanding how the new rules might apply to your business, please do not hesitate to contact us.