In a matter of two days, the Financial Conduct Authority (FCA), the UK’s regulatory watchdog, has published two press releases, back to back, which lower the boom on Contracts for Difference (CFDs) and seek to produce evidence for applying future directives to restrict or ban the sale of derivatives and exchange traded notes (ETNs) referencing certain types of cryptoassets. The regulator appears determined to protect consumers not only from fraud, but also from losing small fortunes from the promoters of these complex and overly risky trading instruments.
Christopher Woolard, Executive Director of Strategy & Competition at the FCA, stated that: “As with our work on the wider CFD and binary options markets, we will act when we see poor products being sold to retail consumers. These are complex contracts built on top of complex assets. Most consumers cannot reliably value derivatives based on unregulated cryptoassets. Prices are extremely volatile and, as we have seen globally, financial crime in cryptoasset markets can lead to sudden and unexpected losses. It is therefore clear to us that these derivatives and exchange traded notes are unsuitable investments for retail consumers.”
The FCA has stepped up its game in the past year, first by following the lead of the European Securities and Markets Authority (ESMA) in 2018 when it issued a temporary ban on binary options and restrictions on CFD trading. As we reported: “When it comes to regulatory oversight of binary options, the FCA is the “new kid on the block.” Responsibility transferred from the Gambling Commission in January of this year (2018), and the folks at the FCA have made it known to all in the City and the UK that compliance with new ESMA rules is priority Number One. It has delayed banning binary options outright, choosing rather to police heavily in the space, warn consumers of illegal solicitations from offshore, and produce a blacklist of 94 firms that have been accused of committing fraud.”
What actions has the FCA taken in 2019 related to these topics?
March was an active month for the regulator and for news having to do with fraud in the investment arena. Early in the month, a report from a separate group revealed that: “UK citizens had lost £50.1 million due to investment scams in 2018”. The FCA soon released the results of two of its findings, as well, which detailed that consumers were not as educated as they should be to put money at risk in the cryptocurrency market:
- “73% of UK consumers surveyed do not know what a ‘cryptocurrency’ is or are unable to define it”, and
- “Cryptoasset owners interviewed were often looking for ways to ‘get rich quick’, citing friends, acquaintances and social media influencers as key motivations for buying cryptoassets.”
Independent of these actions, it also made permanent on the 29th of the month its ban on any types of trading or investing having to do with binary options. ESMA had continued to extend its 90-day ban on binary options and its restrictions on the sale and issuance of CFDs. On the 2nd of July, however, the FCA made permanent its restrictions on the sale, marketing, and distribution of CFDs and “CFD-like” products to retail customers. The exception for “Professional Clients” still stands, but the FCA will pay particular attention during audits, as to how the exception is applied.
The FCA also added a “twist” to its rules, a response to its market considerations and the feedback received during its consultation period. ESMA was quick to respond to these differences, which had to do with minor changes in the area of leverage and various wordings in passages, like “CFD-like” products. The FCA responded that maintaining these minor differences would be necessary in its market and would not pose a problem going forward. Neither agency was that bothered that rules might vary a bit by market. The permanent restrictions are:
- Limit leverage to between 30:1 and 2:1 depending on the volatility of the underlying asset (i.e., cryptocurrencies).
- Close out a customer’s position when their funds fall to 50% of the margin needed to maintain their open positions on their CFD account.
- Provide protections that guarantee a client cannot lose more than the total funds in their trading account.
- Stop offering current and potential customers cash or other inducements to encourage retail consumers to trade.
- Provide a standardised risk warning, telling potential customers the percentage of the firm’s retail client accounts that make losses.
- Clarify the scope of products, activities, and firms caught by our rules.
- Clarify the methodology for the standardised risk warning, and the ban on monetary and non-monetary benefits.
- Exclude certain sales activities for CFD-like options.
These new rules apply to all domestic firms, any MiFID investment firms operating in or from the UK, and any UK branches of third-country investment firms who are “marketing, distributing or selling CFDs and CFD-like options to retail clients”. The implementation dates were staggered, i.e., 1 August for CFDs and 1 September for “CFD-like” products.
What did the FCA announce concerning cryptocurrencies?
On the following day, the 3rd of July, the FCA issued a press release that stated: “The Financial Conduct Authority (FCA) is proposing rules to address harm to retail consumers from the sale of derivatives and exchange traded notes (ETNs) referencing certain types of cryptoassets. The FCA considers that these products are ill-suited to retail consumers who cannot reliably assess the value and risks of derivatives or ETNs that reference certain cryptoassets (crypto-derivatives).”
The FCA appears to be very suspicious of any type of instrument that involves a cryptocurrency, and despite recent crypto-related guidelines that were adopted at the G20 meeting in Japan at the end of June, the regulator seems determined to follow its own path when addressing what it perceives as an unacceptable risk.
At this juncture, it is proposing that it produce a “Consultation Paper” (CP), based on responses received from participants in the investment industry. The regulator seeks guidance regarding a “potential ban on the sale to retail clients of derivatives and certain transferable securities that reference cryptoassets.”
The FCA has already concluded that these crypto-related investments are “ill-suited” for retail investors due to the following reasons:
- Inherent nature of the underlying assets, which have no reliable basis for valuation;
- The prevalence of market abuse and financial crime in the secondary market for cryptoassets (eg cyber theft);
- Extreme volatility in cryptoasset prices movements, and
- Inadequate understanding by retail consumers of cryptoassets and the lack of a clear investment need for investment products referencing them.
The FCA invites anyone and everyone having anything to do with the sale, marketing, and distribution of cryptocurrencies, along with any other stakeholders in regulated or unregulated firms, to respond to this CP request. Responses must be received by 3 October 2019. No other timeframes were offered. The agency could always extend the receipt and review period, but if history provides a good guide, final rules would more than likely be forthcoming in early 2020.
Industry reaction was swift and generally fell in line with this narrative provided by the Financial Times: “Timo Schlaefer, chief executive of UK-based Kraken Futures, warned that an outright ban would drive the retail market to unregulated venues that did not follow client protection rules. ‘The most effective way to protect retail investors is to take decisive action against opaque, unregulated cryptocurrency derivative platforms that have been operating unhindered for years out of Europe and offshore’.”
The FCA appears to be on a mission to protect consumers from outright fraud, as well as from themselves, when it comes to losing money in the financial markets. The agency had always stated publicly that binary options were nothing more than “gambling”. As soon as it obtained responsibility over these digital options from the domestic Gambling Commission in January of 2018, it moved swiftly to ban the items.
It has also claimed that trading in “cryptocurrencies” is nothing more than “gambling”, as well. Perhaps, its intentions are well known, but the crypto-sphere is already a global phenomenon, not run by shady characters out of Bulgaria or some other seamy locale, as was with binary options. Yes, crypto-related entities are in need of more regulation, and more regulation will come in time, despite the effort of the FCA to shut down by its own accord a decade-long industry with a market capitalization, including all token programs, exchanges, miners, and supporting companies, in excess of $500 billion.