The Financial Conduct Authority (FCA) has slammed the contracts for difference (CFD) market after uncovering ‘areas of serious concern’.
In a review of the CFD market, the FCA looked at the conduct of firms which provide the CFD service and the organisations that distribute the product and deal with the end customer.
The review found that most providers and distributors 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 of all sizes that provide CFDs to intermediaries, which in turn distribute this product to retail consumers on either an advisory or discretionary basis.
It also evaluated 15 firms that distribute CFDs on these bases to retail investors.
The FCA’s review found that 76% of retail customers who bought CFD products on either an advisory or discretionary basis between July 2015 and June 2016 lost money.
The regulator said most sample 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 (MI) 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 MI or KPIs.
Megan Butler, executive director of supervision at the FCA, has sent a letter to the bosses of all providers and distributors of CFDs to retail customers to remind them of their obligations and to address ‘failings which may cause significant consumer harm’.
She said: ‘Across the sample, we found the majority of CFD providers and distributors had a poor target market definition.
‘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 prove the FCA 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.’
She added: ‘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.’
The FCA review comes as the European Securities and Markets Authority is considering a major market intervention into the rules covering contracts for difference and other binary options.
In the middle of last year, stockbroker Saxo Capital Markets quit the UK CFD and FX Association amid growing regulatory pressure, while shares in spreadbetting firms tumbled in December 2016 after the FCA first announced plans to impose stricter rules on the CFD market.
But in the same month, IG Group said it found loopholes in the FCA's crackdown, as the FCA's proposals did not appear to directly apply to firms operating from outside the UK offering CFDs to clients in the UK from another EU member state.