Funds

The FCA published earlier this month, a Consultation Paper (CP18/38) which will seek to restrict further the availability of CFD products to retail customers. In the FCA’s view, too many customers for these types of products are losing money and it wants to build on the temporary product intervention powers introduced earlier by ESMA. The FCA wants to try and reduce the perceived harm to retail investors.

The extent of the market

The FCA states that CFD market has been growing. The FCA suggest that there are over 800,000 funded retail client accounts in respect of CFDs with 270,000 retail clients trading on average each month in 2017. It references innovations such as “off the shelf” trading platforms and the introduction of automatic margin close out, as being factors that have contributed to the increase in trading in these products. The FCA also refers to the use of social media and other media to mass market CFDs to the wider public.
The FCA argues that all this activity has resulted in firms selling CFDs outside their appropriate target market. The FCA expresses concern at the type of client who is trading these instruments, noting that some of the products were not always appropriate for the type of customer taken on board with some customers on comparatively low incomes. Customers were also encouraged to trade by incentives on offer. The FCA presents some sobering statistics as to its estimate as to how much many retail clients are losing from these products.
The FCA summarises the feedback from its previous Consultation paper (CP16/40) with two of its main proposals, namely the imposition of leverage limits and margin close out rules generating quite a degree of pushback. Since then of course ESMA has implemented its own temporary restrictions on trading in CFDs which restrict leverage and require positions to be closed out when margins reach certain levels.

What is the FCA proposing?

There are several measures that the FCA is proposing to introduce:

  •  Limiting leverage to between 30:1 and 2:1 by collecting minimum margin as a percentage of overall exposure;
  • Close out a client’s position when their funds fall to 50% of the margin needed to maintain open positions;
  • Provide protections that means that a client cannot lose more than the amount that they have in their account;
  • Prevent firms offering monetary and non- monetary inducements to encourage trading; and
  • Provide a standardised risk warning- which will highlight the percentage of a firm’s clients who make losses.

The bottom line, and what comes out clearly from the Consultation Paper, is that previous actions and regulatory enforcement measures have not been successful in addressing areas of concern so stronger measures are necessary.

What products are caught

The main product lines caught will be CFDs, spread bets, rolling spot forex contracts and CFD lite products- the FCA identify these as “turbo certificates”, “knock out options” and “delta one options”. For those slightly mystified by these terms, the FCA provides an explanation of the characteristics of each of these new products. It is creating a new definition of “restricted option” to capture these more esoteric creations.

Leverage and margin

The CP sets out what the new proposed leverage limits will be, with the highest leverage limits and lowest margin applied to certain government bonds and lowest leverage and highest margin to cryptocurrencies. However the FCA notes specifically that it will be consulting early 2019 on a possible ban on sales of all derivatives referencing crypto currencies to retail customers.
Margin Close out
Firms will be required to close out a retail client’s position when funds fall to 50% of the margin needed to maintain their positions. The FCA’s approach is that this limits the level of losses retail clients will suffer as it should mean they do not suffer the loss of all their investment.

Negative Balance Protection

Firms will also be required to guarantee that retail clients cannot lose more than their funds in their CFD trading account. The FCA has highlighted the concern that in major market events, any close out price may be such that the client suffers greater losses than sums deposited. It wants to avoid this happening. It cites one UK retail client losing more than £2.7million when the Swiss Franc decoupled from the Euro, based on a deposit of £200,000.

Ban on monetary and non- monetary benefits

Again the FCA are proposing an outright ban on benefits of this type which incentivise retail consumers to trade CFDs but excluding information and research tools. The FCA notes that representations had been made to maintain volume discounts but these also will not be permitted under the FCA proposals. However price discounts will be allowed where offered to the entire retail client base

Standardised Risk warning

Finally firms will be required to provide a standardised disclosure to retail clients which will highlight risks involved with CFDs. This will require disclosure of the percentage of loss making accounts in the previous 12 months.
At the same time as tabling proposals for reforming CFD market, the FCA poses some questions for future consideration on the wider derivative market as it affects retail consumers.

Summary

The market will react to these proposals over the next 8 weeks. However, it is clear that the FCA is keen to reduce the customer detriment which they consider many retail customers experience. Perhaps there is also an element of requiring firms to take more steps to protect those customers from themselves.

Frank Doran