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The recent regulatory focus on the retail Contracts for Difference (CFD) trading industry is not going away. Firms who offer CFDs and binary options to retail customers will need to assess whether their current permissions are still suitable as a result of a negative balance protection which is aimed at limiting retail clients’ liability.
The measure aims to move the risk from the client to the firm in the event of a market gap. Firms trading as principal should consider how this impacts the risks they are currently exposed to along with how it affects the capital and liquidity they need to hold.
As a result, for IFPRU 125k firms trading as matched principals, we advise reviewing whether offering a negative balance protection is compatible with their Part 4a Permission as their ability to take on market risk will be limited by the Matched Principal Limitation and IFPRU 1.1.12R. For IPFRU 730k firms trading as principal, we do not anticipate any variations to your permission needed. Firms should also assess the consequences of the restrictions and the potential impact on their business model if their risk profile changes as part of the ongoing updating of their ICAAP.
This all comes from the European Securities and Markets Authority (ESMA) having agreed a set of temporary intervention measures which prohibit the provision of binary options and also restrict the provision of CFDs including rolling spot forex and financial spread bets in order to protect retail investors.
ESMA has specifically agreed to the prohibition on the marketing, distribution or sale of binary options to retail clients and have placed restrictions on the marketing, distribution or sale to retail clients of CFDs, including rolling spot forex and financial spread bets.
The restrictions applied to CFDs are:
- leverage limits on the opening of a position between 30:1 and 2:1, depending on the price volatility of the underlying asset
- a 50% margin close out rule applied on a per account basis
- negative balance protection, limiting retail clients’ liability to the funds in their CFD trading account
- a prohibition on firms offering monetary and non-monetary benefits (excluding research and information tools) to retail investors, and
- a standardised risk warning, including firm-specific figures on the percentage of client accounts that have lost money trading CFDs.
Whilst ESMA have yet to announce a timeline for these measures, they have indicated that they intend to adopt the agreed measures in the official language of the EU in the coming weeks and at that point they shall also publish an official notice on their website. Firms will have one month to implement the prohibition on binary options and two months to implement the restrictions on CFDs following their publication in the Official Journal of the EU. Whilst the measures issued by ESMA are temporary, there is a possibility the FCA may take the approach to permanently approach it.
How can Bovill help?
Our sole activity is the provision of high-quality, technically-focused advice and consultancy services on all aspects of financial services regulation. We are subject matter experts, and are currently working with clients as they get to grips with the regulatory challenges of offering CFD trading services to retail customers. We have helped a number firms to remediate their entire compliance framework on the back of FCA supervision and enforcement, so we have the right experience to help.
Along with helping you to review whether your firm needs to apply for a variation of permission to vary its Part 4A Permission (and assist with the application process) and/or if it can comply with the prohibitions and restrictions being introduced by ESMA, we can help you to mitigate the rising compliance risk associated with being a retail CFD broker.
