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CFDs: Opportunities in a challenging landscape

17 May 2018

In 2015 the Swiss franc unexpectedly unpegged from the euro. The incident shook the FX market and brought the risks associated with CFD trading into sharp relief as some retail investors found themselves significantly in the red as their leveraged trades went against them. Since then regulatory interest in the products has been intense with UK and European regulators keen to protect consumers from potential harm.

It’s clear that CFD providers and distributors are a priority concern for the FCA. CFD firms have received two ‘Dear CEO letters’ in the years since the CHF unpegging. The first highlighted failings in client categorisation, suitability assessment and AML controls at firms the regulator had visited. The more recent letter described poor product governance, ineffective client categorisation processes and poor conflicts of interest management at the firms sampled.

In Europe, ESMA has decided to exercise its product intervention measures, newly-granted by MiFIR, in the CFD market. The measures are expected to take effect in August this year. Though temporary, the FCA has already indicated that it may inscribe the measures in UK law.

In this challenging environment, there are opportunities for firms to adapt to these changes and use them to demonstrate that CFDs are a useful and necessary product for the appropriate investors. As well as using CFDs to hedge their positions in other instruments, retail investors have been able to use them to gain exposure to the cryptocurrency market more safely. Cryptocurrency derivatives are regulated while the broader cryptocurrency market is not. There is a risk that ESMA’s measures have the unintended consequence of driving some investors seeking leveraged trading opportunities to providers based outside of the EU, effectively giving up the investor protection afforded them by the EU regulatory framework. CFDs are largely accessed online so investors may not be aware that such protections are no longer available to them until they’re required.

Essentially, the regulators’ concerns converge around:

  1. investors’ understanding; and
  2. suitability.

In the last year, two pieces of European legislation came into force that will, if implemented as intended, assuage these twin concerns. The Packaged Retail Investment and Insurance-Based Products (PRIIPs) requires firms to produce a standardised Key Information Document to help retail investors understand the risks associated with the product. MiFID II establishes clear product governance requirements, as well as stronger conflicts of interest management, greater transparency, etc.

We consider the following key areas for CFD firms, operating in the UK, essential in order to be compliant and competitive:

  • Effective governance and oversight with clear lines of accountability
  • Strong conflicts of interest management
  • Meaningful suitability testing and appropriateness assessments, for those retail clients seeking to opt-up to professional status
  • Robust product governance and identification of target market
  • Clear and comprehensive client communications
  • Rigorous financial crime policies and procedures.

We have extensive experience advising and supporting CFD firms adapting to regulatory change. If you need assistance navigating the emerging landscape, please get in touch.