The FCA has published a Dear CEO letter addressed to CFDs providers and distributors, which follows its review of CFDs market and raised concerns for significant harms to consumers. The FCA’s review assessed 19 firms that provide CFDs to intermediaries which, in turn, distribute this product to retail consumers on either an advisory or discretionary basis. The FCA also evaluated 15 firms that distribute CFDs on these bases to retail investors. Processes, policies, controls and oversight arrangements of the sample firms (from small to large in terms of customers base) were reviewed and compared against relevant requirements in the FCA Handbook, particularly the Conduct of Business Sourcebook (COBS), Senior Management arrangements, Systems and Controls (SYSC) and Principles for Businesses.
The main issues the FCA highlighted relate to: poor target market identification; communication, oversight and challenge; the process for taking on new distributors; managing conflicts of interest; the use of management information (MI) and key performance indicators (KPI); and client categorisation.
- Most providers and distributors were unable to offer a satisfactory definition of their target market or to explain how they align the needs of this group to the CFD product they offered. Many relied on broad investor descriptions such as ‘experienced’, ‘sophisticated’ and ‘financially literate’, without setting out what these terms mean in practice.
- The majority (76%) of retail customers who bought CFD products on either an advisory or discretionary basis lost money over the 12-month period under review (July 2015 to June 2016).
- A wide range of communication, monitoring and challenge practices by providers over their distributors were ineffective and did not meet the FCA’s expectations.
- Most sample providers had inconsistent due diligence processes for taking on new distributors. Only one of 19 providers was able to demonstrate robust due diligence.
- Weaknesses in the conflict of interest management arrangements were identified at all the distributors, with these arrangement in place but ineffective. Most firms failed to record a single instance of a conflict of interest. It was found that in one firm the CEO was also Head of Compliance.
- Most firms had MI and monitoring structures in place. However, flaws in these tools meant firms did not have the effective oversight they needed to robustly challenge poor conduct or control failings. Some firms were unable to offer any evidence of MI or KPIs, which is likely to result in manufacturers’ failure to have effective oversight of the distribution of their CFD products and in distributors’ inability to distribute these products honestly, fairly and professionally and in the best interests of the clients.
- The quality of remuneration arrangements at CFD distributors was mixed. While some demonstrated good practice, many firms had significant room for improvement. Some firms keep paying their employees on a 100% variable basis or according to the revenue they generate, increasing the risk of mis-selling
- Several distributor firms had problems with their processes and criteria they consider acceptable when categorising clients as elective professionals. Several firms were found to accept weak answers or to ask inadequate questions.
In light of the significant weakness found, the FCA is concerned about the high risk that firms in the sector do not meet rules an expectation and that CFD providers do not manufacture and distribute CFD products to the intended target market paying due regard to the interests of customers and treating them fairly. The FCA also states that it intends to take further action against a CFD provider whose arrangements have been identified as especially poor, including appointing investigators to assess specific firms.
Following the FCA’s feedback, several providers have indicated that they will stop providing CFDs to firms distributing CFDs on an advisory or discretionary basis.
Firms are expected to consider the Dear CEO letter, whether they comply with the FCA’s requirements for providing and distributing CFD products and take into consideration relevant guidance. Other than MiFID II (and product governance requirements), also the PRIIPs regulation is part of the equation, (in relation to target market, appropriateness, inducements (conflicts) and product governance).
This is another important reminder for firms in the CFDs industry of FCA on how critical is prove effective compliance with FCA rules and expectations. This statement of seriousness of intents from the FCA comes soon after the European Securities and Markets Authority (ESMA) announced on 15 December 2017 that it is considering the use of product intervention powers to address risks to investor protection in relation to CFDs, binary options and other speculative products. In particular, ESMA is considering measures to prohibit or restrict the marketing, distribution or sale of CFDs to retail clients.
2018 seems to be not an easy time for this industry.