FCA makes changes to Handbook regarding CFD offering restrictions

Maria Nikolova

The changes to the rules aim to reduce harm to retail consumers by ensuring that CFDs and restricted options are not sold with excessive risk features.

Following consultation in Consultation Paper (CP) 18/38, on June 27, 2019 the Board of the Financial Conduct Authority (FCA) made changes to the Handbook concerning the offering of CFDs to retail customers.

The amendments related to the Consultation Paper released in December 2018. In that paper, the FCA proposed permanent rules to require firms to:

  • limit leverage to between 30:1 and 2:1 by collecting minimum margin as a percentage of the overall exposure that the CFD provides;
  • close out a customer’s position when their funds fall to 50% of the margin needed to maintain their open positions on their CFD account;
  • provide protections that guarantee a client cannot lose more than the total funds in their CFD account;
  • stop offering monetary and non-monetary inducements to encourage trading, and
  • provide a standardised risk warning, which requires firms to tell potential customers the percentage of their retail client accounts that make losses.

The legislative piece which results in the latest amendments to the FCA Handbook is called Conduct of Business (Contracts for Difference) Instrument 2019. It amends Glossary COBS 22 and adds a new section to the Handbook: COBS 22.5.

In summary, this instrument makes changes to the Handbook to reduce harm to retail consumers by ensuring that CFDs and restricted options are not sold with excessive risk features, while still allowing sales to retail consumers who understand the risks and are capable of bearing potential trading losses. Retail consumers are expected to save between £267 million and £449 million per year from these measures.

The proposed interventions are the same in substance as ESMA’s, although the FCA is also proposing to apply its rules to closely substitutable products (the measures for CFDs will thus be applied to CFD-like options).

The FCA Handbook will define CFD-like options in line with a proposed new glossary definition of ‘restriction options’, which is intended to catch CFD-like options. The glossary definition covers options that include additional product features, which ensure the value of the option changes in a linear manner with the value of the underlying asset, excluding costs, charges, and spreads (ie the difference between the bid-price and ask-price). The scope is not intended to capture traditional or ‘vanilla’ options.

The most commonly traded CFD-like options are so-called ‘turbo certificates’. These products are more widely offered in other EEA jurisdictions by large wholesale banks. While they are similar to the CFDs typically offered in the UK market, they differ in that they:

  • may qualify as transferable securities and are sold with a prospectus that complies with the Prospectus Directive
  • are commonly traded on a trading venue, and
  • typically limit client’s losses to the amount initially invested.

FCA’s market intelligence suggests that there is currently little demand from UK consumers for these products. Only two FCA-authorised firms offer access to turbo certificates in the UK and there was £289.5 million in annual trading volume in 2017, which is relatively small compared to retail CFD trading volumes in the UK. Client outcomes from trading these products are similar to CFDs. According to firm data, 67% of retail client accounts lost money trading ‘turbo certificates’ and the average outcome from trading was a loss of £2,620.

Other CFD variations, which UK CFD providers have recently started offering, include ‘knock outs’ and ‘delta one options’.

A restricted option defines is defined as an option:

  • that is in the money at the point of sale;
  • where the value is determined by one-to-one fluctuations in the value or price of the underlying asset; and
  • for which the value is not significantly affected by the time to expiry.

The definition of restricted speculative investments after the amendments includes:

  • (1) contracts for differences;
  • (2) spread bets; and
  • (3) rolling spot forex contracts (other than a future in limb (a) of the Glossary definition of rolling spot forex contract).; and
  • (4) restricted options.

Part 1 of Annex A (amendments to glossary of definitions) and Part 1 of Annex B (amendments to COBS) of this instrument come into force on 1 August 2019 and Part 2 of Annex A and Part 2 of Annex B of this instrument come into force on 1 September 2019.

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