On Dec. 13, UK FCA issued Dear CEO letter re contracts for difference.
FCA issued Dear CEO letter setting out its views on the key risks from contracts for difference (CFD) providers and areas it plans to focus on over the next 2 years.
Follows UK FCA Dec. 2022 Dear CEO letter re contracts for difference, see #155069.
Portfolio
Sector primarily consists of CFD providers trading as principal to their clients at firm or group level, but also contains small number of distributor firms acting as introducers to providers which might also provide ancillary services, firms of different sizes.
As this the case not all the issues raised in the letter are applicable to all firms.
FCA strategy for next 2-year cycle will build on previous work, further reduce potential harm CFDs present when marketed inappropriately or with inadequate controls.
Letter sets out the regulator's current planned proactive work for this portfolio.
Consumer Duty
CFD firms should particularly focus on ensuring that: only target customers who are able to absorb losses, given high percentage who lose money trading CFDs.
Customers fully understand and accept the risks they face trading CFDs; consumers are not inappropriately opted-up to elective professional status, where firms do opt-up, these consumers fully understand the regulatory protections they will have lost.
Vulnerable consumers are identified and well-supported, given possibility of addiction.
FCA plans to conduct a multi-firm review focusing on Duty's price and value outcome.
Will consider if firms able to demonstrate consideration and delivery of fair value in areas such as spreads, overnight funding charges and commissions (where applicable).
Market Abuse
CFDs remain high-risk product for financial crime, mostly relating to insider detailing, but also used for market spoofing activity such as narrowing spread on illiquid stock.
Firms should consider this when designing surveillance arrangements and parameters.
FCA will continue to act assertively against perpetrators of market abuse and ensure firms have robust systems in place to identify and report trade activity of concern.
Will include work designed to improve identification of market abuse in the portfolio.
Firm-specific targeted reviews of surveillance arrangements will continue, and FCA will also focus on transaction reporting, firms should monitor updates in Market Watch.
Reducing Harm from Firm Failure
FCA focuses both on adequacy of firms' capital and liquidity and arrangements for holding client funds, whether in segregated accounts or title transfer arrangements.
On capital and liquidity, FCA will continue to assess firms' implementation of the investment firms prudential regime (IFPR), act if sees weaknesses or misreporting.
Oversee progress of smaller firms on their MIFIDPRU capital glide paths, and act if identifies material weaknesses in firm's consideration of capital and liquidity needs.
In recent work identified inadequate consideration and quantification of liquidity risks and failure to implement dynamic forward-looking daily stress testing.
On client assets, will continue to follow-up with firms that have potential weaknesses.
FCA is concerned about potential over-reliance on title transfer collateral arrangements (TTCAs) to fund hedges in manner that is non-compliant or creates counterparty risk.
Firms should ensure not using TTCAs in way that breaches/circumvents FCA rules.
Halo Firms
Around 20% of firms in portfolio seem to be conducting little or no activity, thus not using their permissions enough to justify their continued authorization.
Some of these appear to exist purely to provide an FCA halo to wider groups, giving false comfort to global retail clients who see FCA association, but contract with an offshore group entity not the UK authorized firm, without UK regulatory protection.
FCA will continue to monitor halo firms, including by monitoring changes in control.
Diversification
Small number of firms in portfolio have diversified their product offerings, moving into stocks to provide lower minimum-account-size access to investment markets.
FCA notes that many new customers are young investors with lower levels of financial literacy and resilience, is concerned when sees inappropriate marketing of zero commission, gamification, inadequate consideration of Consumer Duty obligations.
Will continue to ensure that fast-growing firms hold adequate capital and liquidity, and monitor their systems and controls are commensurate with growth/anticipated growth.
Is also exploring business models of a sample of firms - not just CFD providers - that use mobile apps to facilitate trading by retail clients.
Distributors and Appointed Representatives
Previous work on distributors and appointed representatives (ARs) led to significant off-boarding or deregistering of distributors by CFD providers, ARs by principal firms.
Since then FCA has focused on inappropriate use of ARs, and intervention resulted in deregistration of most of those remaining, continues to focus on distributors.
Is concerned that some of remaining distributor firms may either be halo firms or not sufficiently adding value to justify consumers' additional costs when accessing CFDs.
FCA will conduct deep-dive business model analysis on all remaining distributors to identify those not meaningfully using their permissions, delivering good outcomes.
Operational Resilience and Outsourcing
FCA reminds firms of their obligations to ensure operational resilience, some firms rely heavily on outsourcing arrangements with 3rd-party providers or group affiliates.
Are reminded of responsibilities to conduct adequate due diligence and oversight of all outsourced operations, assess adequacy of financial resources to mitigate risks and to ensure wind-down plans sufficiently address outsourcing complications.
Next Steps
FCA expects CEOs and their boards to discuss the contents of the letter, consider how the risks highlighted apply to their business and ensure they manage them effectively.
Expects all CEOs to have discussed the letter, agreed next steps by Jan. 13, 2025.
Firms, and where applicable their wider groups, which fail to appropriately address these key risks can expect the regulator to take swift and assertive action.
