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Compound Growth

1st February 2017

FCA have uploaded a video related to their concerns about the CFD market

Of increasing concern and focus for the Financial Conduct Authority of late is conduct within the Contracts for Difference (CFD) and Spread Betting market.

Last week the FCA updated their CFD information page to include a video where FCA officials - Robert Taylor, Head of Asset Management Global Strategy and Gunnar Burkhart, Senior Adviser - discussed the regulator’s concerns and expectations, as well as what in particular the regulator will be looking to review next within the CFD sector.

Overview of the CFD Market

Previously, the FCA published a Consultation Paper (CP16/40) in December concerning conduct of business concerns within the CFD Market. The new FCA video reiterates some of their concerns as well as explain that these are largely born from witnessing a huge growth spurt within the CFD industry over the last few years, with a larger number of new providers entering the market. Of particular concern to the regulator is that they believe there has also been a decrease in the sophistication of customers becoming involved with CFDs.

FCA view of Inherent Risks within CFD Industry

Integrity, management, controls and a number of other factors are all taken into account by the regulator when looking at firms, advises Mr Taylor.

Most recently, the FCA has focused upon appropriateness and client on-boarding within the CFD sector, which was followed up by a Dear CEO letter to a number of CFD firms last year. Mr Taylor notes that robust procedures are required by firms and it is vitally important that customers understand the risks that are involved with CFD products, however, for the FCA, this has become an increasing concern.

Expectations from Senior Management

When asked about what the FCA expects from Senior Management within these types of firms, Mr Taylor informs that culture and governance and responsible leadership are all very important.

Across the financial services, there has been widespread change within businesses and the markets as a whole over the last few years. However, it is the FCA’s view that there has been less development towards responsible leadership within the CFD space, which they attribute to firms being invariably smaller, in addition to not having had much direct regulatory attention towards them until now which they may have needed to help drive up firms’ standards into a more professional managed operation – and one that the FCA would like to see.

Going forwards, Mr Taylor advised the FCA would like to see Senior Management within CFD firms being not only concerned with their P&L but also in particular to:

- All risks to the business;

- Customer outcomes;

- Health of platforms;

- Reputation; and

- Prudential Risks.

Mr Taylor touched briefly upon the Swiss Franc crisis last year that saw the CFD market experience a period of extreme stress which highlighted to the regulator that the industry was not as prepared to handle crisis scenarios as they would have expected.

Extension of Senior Managers Regime (SMR) “Accountability II”

It is well known within the Financial Services that the FCA and PRA are working together to roll out an extension of the Senior Managers Regime that currently applies to the banking sector to all other sectors in 2018. This extension of SMR is being referred to as Accountability II.

Thus, with all sectors being affected come 2018, the FCA has clarified that they expect those within Senior Management in the CFD sector to also fall in line with their requirements under the new regime.

Next FCA Target: Suitability

According to Mr Taylor, the FCA has a number of items in the pipeline for reviewing within the CFD sector. As mentioned previously, they have already touched upon Appropriateness & Client on-boarding (COBS 10), however next on their agenda is to look at the Intermediary space and the application of COBS 9 by firms – i.e. the Suitability of products for customers.

The FCA has concerns that a number of intermediaries are allowing client to participate in the CFD markets without adequately assessing the suitability of those products for the customer.

Risk Management of Prudential Health

Also discussed by Mr Taylor, was the risk management of CFD Firm’s prudential health. Mr Taylor stressed that the ICAAP document is an incredibly important tool for Senior Managers in this regards as it allows them to assess and understand the risks within their businesses. Of particular note is that the ICAAP has the ability to ‘think forward’ and thus see how future events may impact upon the firm and its business such as how it may affect the base capital.

However, Mr Taylor informs that the FCA are seeing that firms are failing or ‘forgetting’ to include calculations with regards to Counterparty Risk, as well as not thoroughly considering their Pillar II risks.

Thus, the FCA is concerned about Liquidity Risks within these firms’ balance sheets and ultimately, the FCA wants to make sure that CFD firms are prepared for the next down turn - meaning that they have done everything possible to prevent any drain on capital.

Wind Down & Recovery Planning

In the event that Prudential Planning fails, the FCA informs that firms must have in place a wind down and recover plan that I up-to-date, thorough and consistent. It must detail the costs of the plan and cover how any customer money will be returned.

Mis-managed Risks and Misconduct within CFD Firms

When asked about a scenario in which the FCA identify mis-anaged risks or misconduct at a CFD Firm, Mr Taylor advised that firms can expect the FCA to undertake a Skilled Persons Review – also known as a s166. Beyond that, the regulator would look at working with the industry in potentially placing special requirements on the firm and reviewing their authorisations, fitness and propriety.

The FCA, whilst they like to see this action as a last resort, can also refer both firms and individuals to the FCA’s Enforcement division as it is imperative that the industry improves and provides a professional service.

Other identified risks by the FCA

Beyond client on-boarding, some of the other risks and concerns highlighted in the FCA’s video interview are in relation to:

Financial Promotion: Not only is the FCA very concerned about how CFD products are being promoted, but also about how firms are presenting themselves in the market;
Client Assets & Client Money (CASS): The FCA has raised concerns about how client money is being held and how properly it is being held;
Anti-Money Laundering & Financial Crime: What are firms doing in the on-boarding process to ensure that no money laundering can take place, since the FCA stresses that firms with a large number of Retail Clients have to be very mindful of increased risks.

Summary of FCA Expectations for CFD Firms

Towards the end of the video, Mr Taylor provided a synopsis of the FCA’s view of the CFD sector and their views and expectations of Senior Management within these firms. In particular, senior managers must:

engage with the FCA;
understand the FCA’s objectives;
make certain that the products and services they offer are appropriate to the market places they are operating in;
be aware of the FCA’s publications and any issues they are looking at. Invariably whilst issues on the surface may not be directly applicable to the CFD space, all firms in any financial market sector are asked to reflect upon them.

The FCA’s current CFD Consultation Paper (CP16/40) is still open for comment and it is expected that a large number of those within the CFD markets will be responding to this. The deadline for response is by 7th March 2017.