Of Relevance to:
Firms involved in CFDs and similar speculative products such as binary options and rolling spot forex and to firms in general that need to undertake appropriateness testing.
Following on from PRIIPs (see previous article), ESMA has published an updated version of its Q&As (2016/1165) concerning the “provision of CFDs and other speculative products to retail investors under MiFID”.
In addition to CFDs, the paper also references binary options and rolling spot forex and reminds the reader that these products will require a KID (key information document) from January 2017 when they are made available to retail investors. Note that binary options are not currently regulated by the FCA.
Although the Q&As are aimed at competent authorities, they will also help firms by providing clarity as to the content of the MiFID rules. In addition, elements of the paper e.g. ‘appropriateness’ will be of interest to firms in general including those that are not involved in CFDs etc.
One new section that has been added concerns the importance of ‘appropriateness’ and endeavours to answer the question as to what information a firm should gather to assess the appropriateness of such products. As firms will be aware, the purpose of the appropriateness test – which is derived from MiFID – is to determine whether the client has the necessary experience and knowledge in order to understand the risks involved in relation to the product (or service) to be provided (see COBS 10 for further details).
Firm’s using a ‘questionnaire’ approach to determine appropriateness are expected to tailor the questions to the specific product in question.
Bad practices that have been observed include:
- Questions that are too reliant on the investor’s self-assessment about knowledge and experience, rather than gathering sufficient information to allow the firm to assess whether the response can be regarded as accurate.
- Using simple yes/no answers e.g. “do you understand the risks associated with trading CFDs?” without collecting sufficient, if any, supplementary information.
- Asking questions that are too broad such as experience in trading financial instruments in general rather than the particular product in question.
To counter this, some observed good practices are also mentioned including, not surprisingly, the use of questions to test a client’s understanding of a product rather than relying on the client’s self-assessment.
Where the firm’s assessment is that the client has ‘failed’ the appropriateness test then best practice, we are told, would be for the firm not to allow the client to proceed. However, under the MiFID appropriateness rules, it is possible for a firm to decide to allow such a client to proceed, subject to them providing the client with a warning (see COBS 10.3). ESMA suggests that the competent authorities should monitor those firms adopting this approach to ensure the required warning is not simply a ‘tick-the-box’ exercise and instead could be designed so as to be an actual disruption in the transaction process e.g. having a ‘cooling off’ period after the warning is given so that the client can consider the information in the warning before deciding whether to proceed.
Firms will also be interested in Question 4 which addresses the methods that could be used by e.g. FCA to assess whether appropriateness testing is being performed correctly.
It may be recalled that inadequate appropriateness assessments were also a concern highlighted in an FCA’s ‘Dear CEO’ letter published in February this year (see Regulatory Roundup 73). The letter arose following a review of new client take-on procedures in a sample of ten firms that offered CFD products (a term which will also include spread bets and rolling spot forex).
For the avoidance of doubt, any references to MiFID are to the current regime and not to MiFID II. However, we are cautioned that the principles and requirements underpinning the content of the paper will remain unchanged under MiFID II.