It has been a month and a half since the FCA delivered its December broadside against the UK brokerage community. The shot heard round the world may have been directed at Contracts for Difference (CFDs) and Spread-betting in general, but the message was clear that further directives addressing other concerns will soon be in the offing.
At this stage, the proposed rules were delivered via a “Consultation Paper” (“CP16/40”), in which all industry participants are requested to express their respective comments. The FCA “welcomes feedback on the policy measures we have proposed by 7 March 2017.” The regulator would then update its Handbook of rules “by late spring 2017.”
The proposed rules, published on the first of December, sent shockwaves through the London Stock Exchange, where many of the larger brokerage firms have publicly traded shares in the market. The reaction was swift and severe. As we previously reported, “When the news spread that revenue projections could easily be impaired in 2017 and forward, a fire sale was on. Shares for once popular gambling entities plummeted by 30% or more. The most notable victims were the IG Group Holdings, CMC Markets, and Plus500. Each firm reacted with hastily prepared press releases to, hopefully, stem the carnage.” There has been little recovery. Shares for IG, the largest loser in the group, have lost nearly 37% in value, basically flat-lining since the initial FCA announcement.
Sufficient time has now passed for the dust to settle and for industry experts to express what their next moves will be. A few brokers have already gone public with their recommended responses and have issued entreaties for traders to take action, as well. The 7th of March is not that far away, even if many in the brokerage community believe the new rules are already cut in stone. When a similar situation presented itself in the U.S. marketplace a few years back, the CFTC and the NFA did soften their stances, so there may be still hope that the new regulations will not be as draconian as perceived.
What were the specifics of the FCA’s rationale and of its proposals?
Despite the surprise nature of its holiday missive, the FCA had been investigating complaints in the CFD sector for the past six years. After much internal deliberation, it has proposed a set of new rules that it thinks will clean up many of the current abuses from its perspective. As for its rationale for its far-reaching recommendations, you only need to look at the statement provided by its spokesman.
Christopher Woolard, Executive Director of Strategy and Competition for the FCA, said quite clearly and succinctly, “We have serious concerns that an increasing number of retail clients are trading in CFD products without an adequate understanding of the risks involved, and as a result can incur rapid, large and unexpected losses. We are introducing stricter rules for CFD products to ensure the sector addresses the shortcomings identified, and that firms make sure that retail clients are aware of the high risks involved in trading these complex products.”
How heavy is the loss rate? By its own determination after reviewing a representative selection of client accounts for CFD providers, “82% of clients lost money on these products”. This figure may even be low, since guesstimates of casualty rates for global CFD providers have run as high as in the nineties. Any supposition that only CFDs, including such items as spread bets and rolling spot foreign exchange products, were the only targets was dispelled by Woolard’s additional comment: “The FCA also has concerns that binary bets pose investor protection risks and question whether binary bets meet a genuine investment need.” We must wait for other shoes to drop.
You may peruse Consultation Paper 16/40, all 47 pages of it plus appendices, at your leisure on the FCA’s website, but it summarized its proposed actions in a subsequent press release, as follows:
“The FCA is therefore proposing a package of measures intended to enhance consumer protection by limiting the risks of CFD products and ensuring that customers are better informed. The new measures include:
- Introducing standardised risk warnings and mandatory disclosure of profit-loss ratios on client accounts by all providers to better illustrate the risks and historical performance of these products.
- Setting lower leverage limits for inexperienced retail clients who do not have 12 months or more experience of active trading in CFDs, with a maximum of 25:1.
- Capping leverage at a maximum level of 50:1 for all retail clients and introducing lower leverage caps across different assets according to their risks. Some levels of leverage currently offered to retail customers exceed 200:1.
- Preventing providers from using any form of trading or account opening bonuses or benefits to promote CFD products.”
As for binary options, oversight responsibility for those items presently rests with the Gambling Commission, but a transfer has been anticipated for months. The FCA is committed to tightening the rules in that sector, as well, since it has observed that, “Binary bets are not transparent enough for investors to adequately value them, and have product features which are more akin to gambling products than investments.”
After the initial blast, what have more sober reactions been to the FCA’s plans?
Although the FCA’s actions were reviewed harshly in the press as a bold over-reach of power, it must be remembered that fair warning was given to CFD providers earlier in 2016. A “Dear CEO” letter was distributed as early as February, outlining the agency’s expectations related to client appropriateness assessment standards, AML controls and compliance, and client categorizations. In other words, the CFD industry was on warning and had time to prepare, clean up its act, and anticipate changes down the road.
Here is a selection from various corridors of later reactions to the FCA’s plans:
- Do I stay or do I go now? – The first notion taken up by the press was to insinuate that major employers would leave London to escape the wrath of the FCA. IG was quick to deny any rumors to that effect, but for some reason, CMC Markets was said to be in discussion with German officials, as if a move of 300 employees was imminent. The rumor began when CMC put out a statement that, “The board of CMC will consider all options open to the business to ensure that shareholder value is delivered whilst continuing to offer the highest levels of customer protection. Until CMC has finished discussions with the UK and German regulators as part of the consultation process the board is not in a position to make any comment on the outcome of its review.” As it turned out after further review, German officials were considering similar rule changes, and CMC staff was assisting, since they already had a client base in the country.
- A change in scenery is not advised – While rumors were flying, saner heads did prevail with logical arguments do disprove any benefit for relocating to another jurisdiction. As one pundit noted, “I don’t see much point in CMC relocating to Germany. Currently, it appears more likely than not that these FCA rules and regulation changes will soon apply throughout Europe anyway. So what are they going to achieve? I suspect not a lot. Okay, there is a temporary gain to be had but of course it does not make sense long term.” CySEC has already issued new rules, quite similar to those of the FCA, and the European Securities and Markets Authority (ESMA) is reviewing possible changes to impact all of the EU. As a result investigative reporters have refrained from putting forward any more relocation rumors.
- We are not the enemy – The chief of IG, Peter Hetheringon, has been quite vocal in his criticisms of the overt actions of the UK regulator, claiming that more notice should have been given to prevent the carnage on the London Stock Exchange and the FCA has many other tools at its discretion that could have been used to address its concerns. An overly public crackdown was not necessary, but in the long run, IG does support ensuring “fair outcomes for all UK clients”, and approves of curtailing prevailing bonus practices. Hetherington also argued that the real source of problems in the CFD industry originated with smaller CFD firms that “don’t get supervised to the same degree, and I’m putting that as tactfully as I possibly can. You’ve then got [hundreds of] firms from an island in the Mediterranean which might or might not follow the rules”, a sideways jab at Cyprus and other foreign jurisdictions. In a statement to its customers, he invited “clients to share their opinion with the UK Financial Conduct Authority.” Will this “Call to arms” actually influence the FCA?
- What took so long? – There are other industry participants, like Saxo Bank, that wonder why the FCA and other European regulators have been dragging their collective feet. The new rules may cause some contraction in the CFD industry across the UK and the EU, but the FCA should be applauded for finally taking action. “Analysts and bankers say the shake-up was overdue. The UK has lagged behind the US and Asia in tightening consumer protection regulation, despite the number of CFD providers in the UK doubling since 2010. Cyprus, the only other European country with a meaningful number of CFD providers, is also cracking down.”
The regulatory establishment has risen in 2017 from a long hibernation and come out snarling. As noted, these actions may be long overdue to address the level of consumer complaints and losses that have escalated on a geometric basis for the past few years. As for next steps, “Clients and potential clients in retail CFDs, providers and distributors of retail CFD products and binary bets and associated trade bodies should submit comments to the FCA by 7 March 2017.”
The FCA will more than likely publish the feedback it receives and ask for further comments, before it finalizes the new rules in its Handbook. While a number of regulatory agencies across the EU are at different stages in the process, CySEC has already published the rules it expects to enforce, effective 31 January 2017.
Revenue streams for brokers just got smaller, and competition for new and existing customers just heated up to a fever pitch. Consolidation and contraction will be the order of the day this year, as well as for 2018. Keep close tabs on your broker to determine its worthiness, and look for any signs of financial distress. He, who hesitates, is lost.