CFDs under the spotlight March Financial Services PRECISE. PROVEN. PERFORMANCE.

Transcription

1 CFDs under the spotlight March 2018 Financial Services PRECISE. PROVEN. PERFORMANCE.

2 CFDs under the spotlight UK and European regulators, specifically the Financial Conduct Authority (FCA) and the European Securities and Markets Authority (ESMA), have for some time been focusing more keenly on regulating providers and distributors of Contracts for Difference (CFDs). How is the CFD industry responding? This paper draws on discussions and views shared at a recent breakfast forum organised by Moore Stephens. Participants included chief executives, heads of compliance and other senior representatives of CFD firms and brokers. Topics under the spotlight included the future of the CFD industry and regulatory developments. Participants were also asked a number of topical questions, with insights being shared by Moore Stephens and co-facilitators, Ashurst LLP. Are CFDs suitable for retail clients? No 24% Yes 76% The majority of participants (76%) accepted that CFDs are suitable for retail clients. However, an even larger majority (84%) believed the regulator holds the opposite view. This divergence in opinion reflects the high-risk nature of CFDs, as the FCA noted in its open letter in January 2018 to CEOs of firms that provide and distribute CFDs. The letter reinforces previous regulatory findings, and confirmed that during a 12 month period reviewed by the FCA, 76% of retail customers who traded in CFD products lost money. Does the regulator think CFDs are suitable for retail clients? Yes 16% No 84% 2 CFDs under the spotlight

3 MI & KPI weaknesses The FCA s January letter to CEOs of CFD firms focused on failings that could cause significant consumer harm. One important section of this letter addressed firms use of management information (MI) and key performance indicators (KPIs). The general consensus among participants was that MI and KPI weaknesses do exist within firms. Current systems may not be sufficiently robust and capable of capturing relevant MI, such as information showing how a firm s target market compares to actual recipients of CFD products. Some firms have not been gathering information to be able to consider such areas within their businesses, and the point was made by Moore Stephens and Ashurst that in this context, even basic trend data (for example, on first positions and complaints) should be seen as useful. The regulator is not always expecting a reaction to KPIs and MI, but they are expecting firms have this information, consider what it is telling them and decide whether any action is required. There was general agreement that firms are starting to take action in these areas and are working to improve their systems so they can provide boards with such information. 3 CFDs under the spotlight

4 MiFID II & inducements Do you consider that payments made to IBs and affiliates contravene the MiFID II inducement rules? 53% 23% 24% Yes. There is not sufficient practical guidance and clarity in this area to be able to come to a definitive conclusion. No. Firms can demonstrate that this enhances the quality of the relevant service. With MiFID II in force since 3 January 2018, firms must now pay greater attention to how they pay for certain services, including the provision of non-monetary benefits. This has restricted the way introducer brokers (IBs) are paid. Many firms are struggling to show their payments to IBs enhance the service they provide to clients. Therefore, traditional methods of paying IBs appear to contravene MiFID II (Article 24). The majority (53%) of participants accept that (traditional methods of making) payments to IBs and affiliates contravene the MiFID II inducement rules. This suggests that firms have heeded much of the professional advice offered to them in the run-up to MiFID II coming into force. However, the poll also surprised some participants, who anticipated a greater reluctance to accept this position. This may be because some firms are heavily dependent on IBs for gaining access to retail clients. Nevertheless, based on feedback shared by participants, firms are responding to the inducement requirements of MiFID II. Some are looking at how they can continue to engage with IBs and considering different remuneration options. Some are looking at cost per acquisition (CPA) modelling or establishing contracts where IBs are paid a fixed amount over a specific period, with the arrangement subject to periodic review and not being linked to business volumes. Some firms have moved their IBs to become Appointed Representatives and some firms have taken the more drastic measure of terminating their relationships with IBs. 4 CFDs under the spotlight

5 Restructuring ahead? Do you currently operate through other European jurisdictions? Yes 46% No 54% Brexit could have a substantial impact on many CFD firms if passporting rights are lost. Many firms currently have a regulated office in Cyprus and perhaps one or more other offices in jurisdictions where regulations are aligned with ESMA. At the moment, some firms appear to be delaying any decisions on restructuring until the post-brexit position and the availability of passporting rights is clarified. Some are also waiting until there are conclusive outcomes from ESMA. There are, however, firms that have considered life post-brexit, having taken action by implementing the necessary contingency plan. consultation on proposed product intervention powers is a warning signal to firms that future regulatory change is likely. Restructuring could also be a route firms could take to try to mitigate the impact of tighter FCA and ESMA regulation of the CFD market. For example, some firms have considered opening up operations in jurisdictions outside the European Economic Area (EEA), and some have already set up in locations such as the Cayman Islands and Seychelles. Based on the views expressed during discussion, only a few firms appear to have considered Brexit risk as part of their internal capital adequacy assessment process (ICAAP). This is an area firms are likely to need to address, as is future potential regulatory change. For example, ESMA s recent CFDs under the spotlight

6 Other issues Given the FCA s focus on protecting retail clients, some firms may consider the possibility of reclassifying some clients as elective professionals. However, the FCA has made it clear it still expects firms to undertake an adequate assessment of a client s expertise, experience and knowledge. It seems unlikely that, for example, a client could be considered sufficiently experienced or knowledgeable simply because they had been using CFDs for some years. Similarly, some firms are known to be considering moving their dealing onto a multilateral trading facility (MTF). However, the FCA has indicated that although a firm using an MTF would be technically beyond ESMA s scope, it would still be expected to meet ESMA s regulatory requirements. Conclusion Looking ahead two years from 2018, it s likely that there will be far fewer participants in the CFD market in London, with a suggestion that this could reduce by up to three quarters. Many firms are expected to cease their CFD business or move to jurisdictions outside the reach of the FCA and ESMA. This is despite the fact that the FCA is considered to be perhaps more sympathetic to CFD firms than ESMA. Firms are aware of the tightening regulatory environment and considering their options, but most still see a market for CFDs among the right retail investors. For more details or to discuss any of the topics further, please contact our regulatory consulting team. Contact information Lorraine Bay Partner T +44 (0) lorraine.bay@moorestephens.com Andrew Jacobs Director T +44 (0) andrew.jacobs@moorestephens.com Lucy Gallagher Managing Consultant T +44 (0) lucy.gallagher@moorestephens.com 6 CFDs under the spotlight

7 Moore Stephens LLP, 150 Aldersgate Street, London EC1A 4AB T +44 (0) We believe the information contained herein to be correct at the time of going to press, but we cannot accept any responsibility for any loss occasioned to any person as a result of action or refraining from action as a result of any item herein. Printed and published by Moore Stephens LLP, a member firm of Moore Stephens International Limited, a worldwide network of independent firms. Moore Stephens LLP is registered to carry on audit work in the UK and Ireland by the Institute of Chartered Accountants in England and Wales. Authorised and regulated by the Financial Conduct Authority for investment business. DPS39748 March CFDs under the spotlight