FCA CFD Review January 2018
The FCA has written to all advisory and discretionary providers and distributors of contracts for different products to retail customers after discovering market failings which “may cause significant consumer harm”. The Dear CEO letter is issued here.
CFDs are complex, high-risk instruments sold to retail investors on either an advisory or discretionary (including limited power of attorney) portfolio management basis. The FCA recently conducted a review of the market and assessed providers and distributors to see if CFDs were reaching their intended target market and if companies were treating customers fairly.
The FCA said the majority (76%) of retail customers who bought CFD products on either an advisory or discretionary basis lost money during the period it looked at. It added that many of the firms it reviewed had decided not to continue selling these products, and it found one CFD provider whose arrangements were so poor that the FCA would “take further action”.
In a letter to providers, the FCA said: “The review uncovered areas of serious concern that we want to highlight to firms across the industry.”
The regulator said it had visited 19 large, medium and small firms that provide CFDs to intermediaries, which in turn distribute these products to retail consumers on either an advisory or discretionary basis. It also evaluated 15 such firms that distribute CFDs on this basis to retail investors. It reviewed processes, policies, controls and oversight arrangements at sample firms and compared them against FCA rules.
The review included an assessment of:
- Firms’ identification of a target market and their ability to explain how the CFD product is aligned to this group’s needs
- Providers’ processes for taking on new distributors
- How effectively providers communicate, monitor and provide the relevant degree of challenge over how distributors sell the product
- Use of management information (MI) and key performance indicators (KPIs)
- Whether distributors identify, manage and mitigate potential conflicts of interest
- Distributors’ client categorisation processes
- End consumer gain/loss data from July 2015 to June 2016
- Distributors’ remuneration arrangements and controls
It found that most providers and distributors in the review 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. This issue is covered by the FCA’s RPPD regulatory guidance found here.
It was commented that “many [firms] relied on broad investor descriptions such as ‘experienced’, ‘sophisticated’ and ‘financially literate’, without setting out what these terms actually mean in practice. Most firms were also unable to adequately explain how the nature and risks of the CFD product was aligned to their target market”.
The FCA letter said: “Given the level of risk of these products, it is important firms comply with our rules. We note that 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).”
The FCA said it saw a wide range of communication, monitoring and challenge practices by providers over their distributors, “many of which were ineffective and did not meet our expectations”.
Most sample providers had flawed due diligence processes for taking on new distributors, the FCA said. It added: “We identified weaknesses in the conflict of interest management arrangements at all the distributors we assessed.” Several firms failed to record a single instance of a conflict of interest affecting their business, and a number of others claimed there were no potential conflicts of interest.
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, according to the regulator.
It said the quality of remuneration arrangements at CFD distributors was mixed. While some demonstrated good practice, many firms had “significant room for improvement”. Some firms were found to pay their employees on a 100% variable basis. This arrangement significantly increases the risk of mis-selling, since staff may feel pressured to achieve minimum sales targets, regardless of whether this delivers good outcomes for customers.
Finally, several distributor firms had problems with their processes and the criteria they consider acceptable when categorising clients as elective professionals. In particular, firms asked clients poor ‘qualitative’ questions to assess, with a reasonable level of assurance, whether they had sufficient knowledge and experience. This raises concerns of potential non-compliance with this rule. The FCA expects firms to go beyond asking clients for their own opinion of their knowledge and experience, as this is inevitably subjective and is unlikely to be reliable, at least on its own. Firms should request facts and information to support their assessment of a prospective client’s expertise, knowledge and experience in ways that give them reasonable assurance, given the nature of the planned transactions or services, that the client is capable of making their own investment decisions and understands the risks involved.
The FCA said the findings pointed to CFD providers and distributors failing to conduct their business in line with regulatory principles. It said: “Consumers may be at serious risk of harm from poor practices in this sector.” In this connection, the FCA comments;
“You should consider the issues we raise in this letter against the conduct of your firm as a CFD provider or distributor. If, when reviewing your arrangements, you identify any areas of concern, we expect you to have regard to the applicable rules and guidance in this letter and take action to ensure compliance”.
The letter added that, following FCA feedback to them, several firms have said they intend to stop providing CFDs to firms that distribute this product on an advisory or discretionary basis. Others are no longer distributing this complex, high-risk product on this basis to retail consumers, while another faces further action from the regulator.
Similar issues had previously been highlighted in the February 2016 Dear CEO letter here.
The provision and distribution of CFD products and delivering good customer outcomes in this sector will remain areas of focus for the FCA. It will undertake further work on these topics and may ask firms to take part in a follow-up review to assess how firms have responded to this feedback. Where the FCA identifies breaches of its rules, it will take appropriate action, including appointing investigators to examine specific firms, individuals or practices.
It is to be noted that 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 surrounding the provision of CFDs. In particular, ESMA is considering measures to prohibit or restrict the marketing, distribution or sale of CFDs and binary options to retail clients. It is conducting a public consultation in January 2018 on this matter. Details of this are here.
Any product intervention measure adopted by ESMA under Article 40 of MiFIR can have an initial duration of up to three months and is renewable.
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Thistle will continue to keep this area under review and will issue further updates where necessary.