FCA uncovers weak practices among CFD providers, notes importance of MiFID II compliance

The UK Financial Conduct Authority (FCA) has today sent a letter to all providers and distributors of contracts for difference (CFD) products to retail customers, underlining its concerns about the poor practices adopted by some firms operating in this market segment.

The FCA shared the findings of a recently conducted review of the sector that assessed 19 firms that provide CFDs to intermediaries which in turn distribute this product to retail consumers on either an advisory or discretionary basis. It also evaluated 15 firms that distribute CFDs on these bases to retail investors.

The regulator notes 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).

Across the sample, the FCA found the majority of CFD providers and distributors had a poor target market definition. Many relied on broad investor descriptions such as ‘experienced’, ‘sophisticated’ and ‘financially literate’, without defining 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.

There were also problems with regard to sharing information with distributors. Examples of the type of information providers could share with their distributors are: the product’s characteristics, including associated risks (or be able to evidence why this was not considered necessary), the product’s intended target market and whether the information they provide is or is not intended for the end-customer’s use. In FCA’s view, none of the 19 providers in the review were acting in line with The Responsibilities of Providers and Distributors for the Fair Treatment of Customers. Additionally, these firms could not demonstrate that they were acting with due skill, care and diligence.

Weaknesses were uncovered with respect to onboarding of new distributors. Only one of 19 providers in the FCA review was able to demonstrate robust due diligence during this process. The remaining 18 firms were unable to do so. In FCA’s view, a robust process enables providers to understand whether an intermediary has the necessary knowledge and experience to distribute the product. These failings increase the risk of poor outcomes for consumers, the FCA warns.

With regard to client qualification, the FCA identified a number of firms that accepted weak answers or asked inadequate questions to assess whether a client could opt up to elective professional status. The FCA emphasizes that it 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 gives them reasonable assurance.

• What’s next?

Given the significant weaknesses uncovered, the FCA believes there is a high risk that firms across the sector are not meeting its rules and expectations when providing and distributing CFDs. As a result, consumers may be at serious risk of harm from poor practices in this sector.

Following the 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 these bases to retail consumers.

This review also identified a CFD provider whose arrangements were so poor that the FCA intends to take further action.

The FCA reminds the CFD providers of the European Securities and Markets Authority (ESMA) announcement made 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 to retail clients. It is conducting a public consultation in January 2018 on this matter.

The FCA recommends that providers take into account its new Product Intervention and Product Governance Sourcebook (PROD). This implements MiFID II’s product governance requirements into the FCA Handbook as rules for firms who manufacture (ie provide) and/or distribute financial instruments.

When the FCA follow-ups on this topic in the future, it will assess firms’ arrangements against these new provisions.