UK regulator responds to ESMA’s opinion on rules for CFDs and CFD-like options

Further to the publication of ESMA’s Opinion on the UK rules for restricting the offering of CFDs and CFD-like options to retail investors, the Financial Conduct Authority (FCA) has made a statement regarding its points of disagreement with the pan-EU watchdog.

On July 1, 2019, the FCA published Policy Statement (PS)19/18 and finalised rules that restrict the sale, marketing and distribution of CFDs and CFD-like options to retail clients in or from the UK.

Today, ESMA published an Opinion concluding that overall the FCA’s proposed national measures are justified and proportionate, with the exception for its decision to:

• Not apply our sales and distribution restrictions to CFD-like option providers authorised in other EEA Member States other than a UK branch or tied agent.
• Setting leverage limits for CFDs referencing certain government bonds to 30:1 (compared to 5:1 under ESMA’s measures).

The FCA explains that CFD-like options pose the same risk of harm as CFDs because they have a similar pay-out structure to CFDs, and share common product features (i.e. they allow retail consumers to gain exposure to a wide range of assets for a fraction of the value of an asset). By capturing CFD-like options, the FCA rules aim to ensure that UK firms do not seek to avoid the FCA’s CFD measures by offering closely substitutable products.

Under the FCA’s final rules, UK retail clients will be able to continue to open accounts to trade unrestricted CFD-like options with product providers established in other EEA Member States (other than through a UK branch or tied agent), provided that these providers have not actively marketed the products in the UK. The FCA did not think it would be proportionate, practical or effective to seek to apply its rules to overseas firms not supervised by the FCA and subject to different rules in their own jurisdiction.

Therefore, where a UK-based client contacts an overseas firm on their own initiative, that firm may still sell those products, if they are permitted in their own jurisdiction. CFD-like options are not commonly traded by UK retail consumers, nor are they commonly sold by UK firms.

The FCA notes that it is not allowing EEA firms outside the UK to sell CFDs to retail clients in the UK, if a UK retail client approached that firm at their own initiative because there is a greater risk of harm. That is because they are more commonly sold on a cross-border basis and used by UK retail consumers to speculate on financial markets.

The FCA considers that limiting its scope in this manner is justified and proportionate.

Regarding leverage limits, the FCA notes that, under its rules, UK firms must limit leverage for CFDs and CFD-like options referencing certain government bonds to 30:1 (compared to 5:1 under ESMA’s measures). To ensure its leverage limits are appropriate and proportionate, the FCA utilised the methodology used by ESMA in setting its leverage limits. Using historical price data, the regulator concluded that a 30:1 leverage limit was consistent with leverage limits set for other asset classes, considering the historic volatility of certain government bonds.

The FCA has also considered whether its proposed leverage limits could result in regulatory arbitrage and have a significant effect on the markets of other Member States or result in harm to retail consumers located in other EEA jurisdictions. UK firms will however, need to limit leverage to 5:1 for CFDs referencing certain government bonds when selling CFDs to retail clients located in other EEA jurisdictions that have adopted the same rules as ESMA.

As noted by ESMA, 30:1 does not exceed the highest leverage limit for other asset classes in ESMA’s measures The FCA agrees that this mitigates competition amongst providers that are subject to a stricter leverage limit.

As retail consumers are afforded protections by the rules of other National Competent Authorities (NCAs), the UK regulator concluded that its rules will not impact the markets of other Member States or result in harm to their consumers.

Having considered this feedback, the FCA believes that a 30x leverage limit is justified and proportionate for CFDs referencing certain governments bonds.