Shares in spread betting firms have taken a fresh tumble after the City regulator wrote to bosses warning it had uncovered 'areas of serious concern' in the contracts for difference (CFD) market.
The Financial Conduct Authority's (FCA) warning, in a 'Dear CEO' letter, has sparked a fresh sell-off in the shares of CFD providers, which came under pressure last month from EU plans to ban the sale of binary options to retail clients.
In a review of CFD providers and distributors, the FCA found most were ‘unable to offer a satisfactory definition of their target market’ or ‘explain how they align the needs of this group to the CFD product they offered’.
It assessed 19 firms that provided CFDs to intermediaries, which in turn distributed them to retail consumers, and 15 distributors.
The FCA’s review found that 76% of retail customers who bought CFD products between July 2015 and June 2016 lost money.
The regulator said most providers had ‘flawed due diligence processes for taking on new distributors’ and identified ‘weaknesses in the conflict of interest management arrangements at all the distributors’ it assessed.
Most firms had management information and monitoring structures in place, the FCA said, but ‘flaws in these tools meant firms did not have the effective oversight they needed to robustly challenge poor conduct or control failings’, while some firms were unable to offer any evidence of management information.
Megan Butler, executive director of supervision at the FCA, said firms needed to address ‘failings which may cause significant consumer harm’.
‘Across the sample, we found the majority of CFD providers and distributors had a poor target market definition,' she said.
‘Many relied on broad investor descriptions such as "experienced", "sophisticated" and "financially literate", without setting out what these terms actually mean in practice.
‘Most firms were also unable to adequately explain how the nature and risks of the CFD product was aligned to their target market.’
Butler added that none of the providers in the review were acting in line with the FCA’s guidance, and ‘could not demonstrate that they were acting with due skill, care and diligence’.
Only one of the 19 providers in the review could provide the FCA with evidence of due diligence when taking on new distributors.
In addition, Butler said all distributors in the review ‘had conflict of interest management arrangements that were either ineffective or needed improvement.’
‘Several firms failed to record a single instance of a conflict of interest affecting their business and a number of others claimed there were no potential conflicts of interest,' she said.
IG Group said in a statement to the market that it believed the FCA review had 'no new financial implications' for its business.
'IG does not offer advisory or discretionary services for CFD products and has terminated its very small number of relationships with distributors who offer our CFD product on a discretionary or advisory basis to retail clients within the UK and European Union,' it said.
'We have taken steps to address the observations made by the FCA in their individual letter to IG on this apsect of the industry in October 2017.'
Numis analyst James Hamilton said that while the FCA's letter could prove 'very damaging' to many in the CFD sector, IG was likely to emerge unscathed.
'We believe that the more rigorous process, a focus on the most professional clients, endeavouring to keep the business model in line with the FCA thinking and ahead of its regulatory changes leaves IG as the stand-out leader in the sector,' he said.
He added that the FCA's intervention presented more issues for Plus500 given that it sold 'complex financial products to less experienced, lower net worth individuals who may not realise that they are buying an over-the-counter derivative,' he said.
'It also has very many distributors which it could find hard to monitor,' he said.