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Significant failings identified
The FCA have issued their second ‘Dear CEO’ letter in the space of two years to firms involved in the Contracts for Difference (CFD) market.
The letter leaves little room for doubt that the FCA have serious concerns about the industry. They identify the high risk of mis-selling on the back of poor product governance, inadequate systems and controls, and management failings as some of the most worrying findings. The regulator reports that due to the “significant weaknesses found…there is a high risk that firms across the sector are not meeting our rules and expectations”.
Plenty of bedtime reading
This latest publication comes amidst a flurry of recent pieces issued by both the FCA and ESMA, none of which were particularly complementary about the industry. These include the tougher than expected statement from ESMA in December 2017 on ongoing work on possible product intervention measures applicable to retail CFD and binary option products. Indeed, the FCA have stated that “retail CFD products have been a focus of intensive discussion at ESMA”. Since February 2016 the following (growing) list details the publications that have been issued regarding the UK and EU regulators regarding their concerns about the CFD market demonstrating the intense regulatory focus on the sector currently:
- FCA: Dear CEO letter: Providers and distributors of CFD products (January 2018)
- FCA: Statement on ESMA’s ongoing work on possible product intervention measures applicable to retail CFD and binary option products (December 2017)
- ESMA: Statement on ongoing work on possible product intervention measures applicable to retail CFD and binary option products (December 2017)
- FCA: CFD firms fail to meet our expectations on appropriateness assessments statement (June 2017)
- ESMA: Statement on preparatory work in relation to CFDs, binary options and other speculative products (June 2017)
- FCA: Statement on contract for difference products and update on CP16/40 (June 2017)
- FCA: Consultation Paper on enhancing conduct of business rules for firms providing contract for difference products to retail clients(CP16/40) (December 2016)
- ESMA: Warning on sale of speculative products to retail investors (July 2016)
- FCA: Dear CEO letter: Client take-on (February 2016)
The latest warnings from the UK regulator come after it has written to all providers and distributors of CFDs to retail customers offering CFDs on an advisory or discretionary basis. Although this review specifically looked at the advisory and discretionary portion of the market, the FCA have made clear that it expects all firms in the CFD sector to take note of the findings.
Scope of the review
In the review, the FCA looked into 19 firms offering CFDS on an advisory and discretionary basis and also at 15 firms which provide CFDs directly to customers. A number of serious areas of concern were identified by the FCA during the review. The executive director of supervision at the FCA, Megan Butler, warns in her letter to chief executives that the failings identified across the industry pose a risk of ‘significant harm’ to customers.
The purpose of the latest review was ensure that firms:
- deliver CFD products to the intended customer target market, and
- pay due regard to the interests of customers and treat them fairly.
In their review, the FCA looked at firm’s processes, policies, controls and oversight arrangements against the relevant rules in the FCA handbook. Specifically, the regulator looked at the following:
- firms identification of a target market and ability to explain how the CFD product is aligned to this group’s needs
- providers’ processes for taking on new distributors
- how effectively providers communicate, monitor and provide the relevant degree of challenge over how distributors sell the product
- use of management information (MI) and key performance indicators (KPIs)
- whether distributors identify, manage and mitigate potential conflicts of interest
- distributors’ client categorisation processes
- end consumer gain/loss data from July 2015 to June 2016, and
- distributors’ remuneration arrangements and controls.
Key review findings
The FCA found “areas of serious concern” that they wished to highlight to the industry as a whole. The letter also reiterates many of the FCA comments regarding the CFD market from previous publications that CFDs are high-risk, complex financial products that put individuals at risk of losing significantly more than their original stake. The FCA have re-stated again the high-risk nature of these products and that due to the “level of risk of these products”, and the fact that from July 2015 to June 2016, 76% of retail customers who bought CFD products (on an advisory or discretionary basis) lost money, firms must better comply with the relevant rules.
Furthermore, the FCA identified an inability for retail CFD firms to:
- properly define their target market for product governance purposes
- demonstrate adequate conflicts of interest management systems and controls; and
- have adequate due diligence processes for taking on new distributors.
The regulator also identified that firms did not have adequate procedures in place to accurately assess the knowledge and experience of clients, and often marketed and sold CFDs to unsuitable customers. Similarly, it was discovered that the majority of firms reviewed had inadequate monitoring structures backed up by weak or absent management information and key performance indicators.
Also of concern to the FCA, were inadequate client categorisation assessments (re elective professional clients), and the remuneration arrangements of many firms, which sometimes included 100% variable pay. Variable pay to this extent increases the risk of mis-selling due to pressure to hit sales targets putting at risk good consumer outcomes and the key FCA tenet of treating customers fairly.
What next
The FCA have confirmed that they will be undertaking further work on these topics in which firms will be assessed for responses to this latest feedback. One firm was identified by the FCA as having such poor systems and controls in place that they will be subject to further supervision.
The letter also highlights that firms should have arrangements in place to comply with the new Product Intervention and Product Governance Sourcebook (PROD) that implements the product governance rules under MiFID II. The FCA’s subsequent follow up work on this topic will include assessments of firm’s provisions in this regard.
FCA future focus
The FCA have set out the following as the key areas they will be focusing at CFD providers going forward:
- appropriateness testing
- product governance
- conflicts of interest and remuneration
- prudential requirements: ICAAP, recovery and resolution plans
- client money
- senior managers and certification regime
- financial promotions
- best execution
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 firms to remediate their entire compliance framework on the back of FCA supervision and enforcement so we have the right experience to help.
We can help you to mitigate the rising compliance risk associated with being a retail CFD broker:
- We can run a gap analysis. We can help you to identify the areas such as product governance requirements where you are falling short and that will have the greatest impact for your business, and shape a plan to deliver the required change
- We can perform compliance-focused reviews on specific areas of concern or undertake large-scale compliance health checks. We can review the work you have done so far, project plans, proposed solutions and operating models to help you determine whether you are compliant with FCA rules and guidance
- We can provide change resources – our teams of compliance and change experts can be deployed to address specific projects and work streams – supplementing your existing resources, and tackling some of the trickiest compliance issues
- We can embed experts within your change teams – experts on the ground, working alongside change professionals, can be a powerful tool in assuring that compliance is delivered effectively. We can work with your change teams to ensure that the regulation is interpreted correctly, and the right outcomes are achieved from both a compliance and business perspective.
