Know About the New FCA Restrictions for CFD Trading

The UK’s financial watchdog, the Financial Conduct Authority (FCA), is responsible for maintaining financial stability of the nation’s markets and protect the integrity of the markets and investor interests. On June 27, 2019, it introduced new norms regarding the trading of Contracts for Difference (CFDs), with an aim to protect retail customers and ensure that they are not sold products with high risk features.

The latest amendments to the FCA Handbook are known as Conduct of Business (Contracts for Difference) Instrument 2019.  It brings changes to the previous Glossary COBS 22, and has introduced a new section in its place, called COBS 22.5.

The proposed changes have been made to reduce the amount of unnecessary risk that retail traders are exposed to, while still allowing the sale of CFD instruments to them. Anyone who understands the risks of trading these instruments and is capable of handling the associated losses is free to choose CFD trading.

Rules of Sale of CFD and CFD-like Options to Retail Customers

The amendments have been made to the Consultation Paper, released in December 2018 (CP/18/38), in which the FCA has proposed permanent restrictions on firms selling CFDs. This is specifically with respect to matters like limiting leverage between 30:1 and 2:1 or closing out a client’s position when fund levels fall by 50% and more. Minor adjustments have been made, but more or less the previous laws are still applicable.

Under the new rules, the FCA makes permanent the temporary restrictions on the sale of CFD and CFD-like options to retail consumers, implemented by the European Securities and Markets Authority (ESMA). Now broker firms will be required to:

• Limit leverage between 30:1 and 2:1
• Close out a customer’s position when funds fall to the level of 50% of the margin required to maintain open positions on their CFD accounts
• Stop offering monetary and non-monetary benefits to encourage CFD trading
• Assure protection to clients, such that they do not lose more than the total funds in their CFD account.
• Provide compulsory disclosure regarding the amount of risk associated with trading an instrument. Firms are now required to inform potential clients regarding the total percentage of their retail CFD accounts that make losses.

The FCA has included CFD-like options in this category, so that brokerages will not be able to bypass these rules, by providing closely related products that are as risky as CFD instruments.  To achieve the desired results or efficient levels of governance, the FCA has clarified the scope of CFD-like options restrictions.

1. Firms that sell CFD-like options in other jurisdictions, where the product is sold through an intermediary outside the UK, are excluded from these restrictions.
2. Sales and distribution activities of EEA firms operating outside the UK are excluded from these rules. However, these firms cannot market such products to UK-based retail customers.

While similar laws are still in the temporary stage in the EU jurisdiction, the FCA has made these laws permanent in the UK, following news of extensive sale of risky financial products to retail consumers. The financial watchdog has been concerned about the use of extremely high-leverage products for trading for some time now and hopes that the new regulations will bring greater protection for a maximum number of investors. It is expected that retail consumers will end up saving between £267 million and £449 million per year, on account of these new rules.

The CFD laws have come into effect from August 1, 2019, while those pertaining to CFD-like options will be applicable from September 1, 2019.

Some Amendments to CP/18/38

After receiving feedback, the new amendment clarifies the scope and applications of certain products and services. Some of these are:

• The FCA clarified that unleveraged versions of CFDs and rolling spot forex contracts are not included within the scope of these rules.
• Structured capital-at-risk products are not included, as are warrants described as an option.
• In case a firm is dealing with a retail client from another EEA state, which already has stricter rules for the trading of these products, the FCA rules will not be applicable.
• Tiered volume fee discounts are not included in the clause for banning monetary and non-monetary inducements for encouraging CFD trading.
• Methodology for calculating loss-making accounts have been aligned with ESMA rules.
• Firms will now have to modify their standardised risk warnings to include CFD-like options as well, if the firm is involved in the sale of such products.

What are These CFD-Like Options?

CFD-like options have been defined in the handbook as “restricted options.” These include options with additional features like linear changes in price, with respect to value of underlying asset, exclusion of costs, charges and spreads.

Most common among these are “turbo certificates,” which are widely offered to clients in the EEA jurisdictions, through wholesale banks. Experts at the FCA suggest that there is very little demand for these products in the UK market, with only two FCA-licensed firms offering such certificates and their trading volume being significantly lower than that for traditional CFDs. But, trading results from these CFD-like options are similar to CFDs. The FCA says that 67% of retail consumers lost money while trading turbo certificates, which is why the measures for CFDs need to be applied to CFD-like options as well.

However, these laws are not applicable to the trading of traditional or “vanilla” options. Following considered feedback, the FCA has not extended these new rules to exchange-traded futures and similar OTC products, for now. However, that area is also under review and the regulatory body could change the dictum in the future.

In the coming months, there are possibilities of the FCA releasing similar guidelines related to the sale and marketing of cryptocurrency derivative products. The agency also mentioned that it is closely working with academic researchers to evaluate how effective risk warnings on web pages actually are. Does the average investor truly consider these warnings seriously? Are they positioned in the right manner? All such questions are being studied in detail.

Most importantly, the FCA is concentrating its future supervisory work on the treatment of clients by financial services providers, especially with regard to Brexit-related reshuffling. Both, firms and investors, should be diligent and keep a close eye on announcements.

Reference Links

• https://www.fca.org.uk/news/press-releases/fca-confirms-permanent-restrictions-sale-cfds-and-cfd-options-retail-consumers
• https://financefeeds.com/fca-makes-changes-handbook-regarding-cfd-offering-restrictions/
• https://www.fca.org.uk/publication/consultation/cp18-38.pdf
• https://www.lexology.com/library/detail.aspx?g=9cd96dae-e302-4892-9955-8da5352e31b5