|Of relevance to:||Firms providing or distributing CFDs|
|Key date:||ESMA’s public consultation closes on 5 February 2018|
On 10 January the FCA issued a ‘Dear CEO’ letter to firms either providing or distributing Contracts for Difference (“CFD”) to retail investors. The letter was issued off the back of the FCA’s recent work in this sector and, in particular, as a result of a thematic review carried out with a number of firms last year. The FCA review uncovered a number of areas of concern at a time when the CFD sector was already being subjected to additional criticism and scrutiny as well as the possibility of enhanced conduct rules introduced by CP16/40.
This is not the first time that the CFD sector has been issued with a ‘Dear CEO’ letter; the last one being in February 2016, with a follow up statement by the FCA in June 2017 relating to appropriateness and client take-on concerns raised following the thematic review.
The letter summarises the FCA’s findings from the recent review into both providers and distributors of CFD products and highlights particular concerns, with a familiar nod to appropriateness, with reference to the undertaking of adequate assessments of experience and knowledge; a sign that potentially firms had largely ignored the previous FCA guidance and statements in February 2016 and June 2017. The letter does however highlight new areas of concern.
The concerns expressed by the FCA relate to:
- The inability of firms to provide a satisfactory definition of their target market. CFDs are complex financial products, often highly leveraged (in some cases as high as 1,000:1). The FCA has encouraged firms to precisely define their target market to enable the firm to demonstrate that they have evaluated the suitability and appropriateness of the products, and matched that to the client’s needs.
- Retail investor’s money being lost. The FCA found that, on average, 76% of the retail investors in CFDs lost money between July 2015 and June 2016.
- Providers not being able to monitor distributors. The vast majority of the providers were unable to demonstrate robust due diligence processes that were carried out at the time of selecting distributors, nor were any ongoing reviews or monitoring of those distributors seemingly carried out. The FCA also noted a lack of assessments on the distributor’s knowledge and understanding of the product and the firm’s target market.
- Managing conflicts of interest. The FCA considered that there is, in general, poor management of conflicts of interest, with ineffective arrangements in place and firms failing to record even one instance where there was a conflict.
- Client categorisation. A number of firms couldn’t provide the FCA with robust assessments of a client’s expertise, experience and knowledge that would allow the client to opt up to “elective professional” status.
- Remuneration arrangements. The FCA discovered several areas of concern, including:
firms paying employees on a 100% variable basis;
lack of formal process and documentation regarding the firm’s remuneration policy and procedure;
some senior staff holding several roles; and
firms remunerating staff based entirely on revenue generated.
The FCA believes that the significant weakness found in the relatively small sample gave a good indication that firms throughout the sector were not paying heed to or meeting the FCA’s rules or expectations when providing or distributing CFDs to retail clients. The FCA concludes the identified poor practices indicate there is serious risk of harm to consumers.