Regulatory update: FCA ‘Dear CEO’ letter - contracts for difference

Posted: 22nd January 2018

Background

The latest Dear CEO letter was issued following the recent publications from both the ESMA and the FCA, which stated their concerns about the industry.

Since February 2016 there have been ongoing concerns raised regarding the Contracts for Difference (CFD) market.

Over the past two years, the FCA alone has issued the following publications regarding the CFD market:

• FCA (January 2018): Dear CEO letter: Providers and distributors of CFD products
• FCA (December 2017): Statement on ESMA’s ongoing work on possible product intervention measures applicable to retail CFD and binary option products
• FCA (June 2017): CFD firms fail to meet our expectations on appropriateness assessment statement
• FCA (June 2017): Statement on contract for difference products and update on CP16/40
• FCA (December 2016): Consultation Paper on enhancing conduct of business rules for firms providing contract for difference products to retail clients (CP16/40)
• FCA (February 2016): Dear CEO (February 2016): client take-on

Key Findings

The FCA’s latest letter provides further detail on the findings from CP16/40. The review assessed both the conduct of firms which provide CFD trading services and the organisations that distribute the product and deal with the end customer.

The review highlighted serious concerns covering the following areas:

• Target market identification - most providers and distributors in the review were unable to offer a satisfactory definition of their target market.
• Communication - firms displayed a wide range of communication, monitoring and challenge practices by providers over their distributors, many of which were ineffective and did not meet the FCA’s requirements.
• Risks of CFDs - given the level of risk of these products, it is important firms comply with the FCA rules. The FCA note 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).
• Process to take on new distributors - most of the sample providers had flawed due diligence processes for taking on new distributors.
• Managing conflicts of interest - ‘weaknesses in the conflict of interest management arrangements at all the distributors that were assessed were identified.
• The use of management information - most firms were noted to have MI and monitoring structures in place. However, flaws meant firms did not have the effective oversight they needed to robustly challenge poor conduct or control failings.
• Client categorisation - several distributor firms had problems with their processes and the criteria they consider acceptable when categorising clients as elective professionals.
• Remuneration – the quality of remuneration arrangements at CFD distributors was mixed. While some demonstrated good practices, many firms had significant room for improvement. Distributors need to improve their remuneration structures and how they identify and manage the associated risks. Many distributors failed to provide satisfactory evidence that they complied with the remuneration code where relevant or had considered the FCA sales incentives guidance.

The findings indicate that CFD providers and distributors may be failing their activities in accordance to the FCA Principles for Business, the Clients best interest rule (COBS 2.1.1R) and SYSC.

The FCA stresses the importance that all firms must ensure that they are compliant with their requirements when providing or distributing CFDs.

CONSIDERATIONS FOR FIRMS

The CFD sector has been under scrutiny for some time now, firms should be actively considering the areas for concerns drawn out in the publications against their procedures. The FCA has highlighted a number of oversight and control arrangements which could be improved.

In particular:

• Product Governance (PROD): Firms should consider conducting a review of their existing product governance arrangements against the FCA’s requirements. The FCA has stated that firms should use the new PROD sourcebook, which came into effect on 3rd January 2018, to consider their arrangements against these new provisions going forward.
• Systems and controls: Firms should review their current systems and controls and take stock as to how they measure up against the FCA’s requirements. The FCA highlighted in its review that some firms displayed weak systems and controls and an independent view on these high-risk areas should be sought.
• Monitoring and Oversight: The review highlighted that the majority of firms assessed had inadequate structures, with weak or non-existent management information and key performance indicators. Firms should review their current arrangements and highlight whether they have any weaknesses that require addressing

REGULATORY Next Steps

The FCA concluded that consumers maybe “at serious harm” as a result of the poor practices identified in its review.

The FCA has highlighted that they will be undertaking further work on CFD providers and distributors in the near future.