FCA expresses “Serious Concerns” over Complex and Highly Risky Contracts For Difference (CFD) Products Mis-sold to Retail Investors

The FCA, following a year-long review, have published a “Dear CEO” letter addressed to firms providing and distributing products in the CFD market to amateur investors. The FCA used strong language to criticise firms for employing “poor practices” in promoting and selling speculative products leaving unsophisticated consumers at a “serious risk of harm” with over three-quarters of users losing money. Industry-wide failings were identified as firms were unable to properly define their target market leading to mis-selling to unsuitable customers; widespread due diligence problems and the inability to manage conflicts of interest.

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The FCA’s intervention represents an overdue crackdown on the spread betting market by toughening the application of regulations and is another damning indictment for the majority of CFD firms and banks who have been largely ignoring the rulebook at the expense of their customers.

What are CFDs (Contracts for Differences)?

CFDs are a type of derivative trading allowing the investor to speculate on the value of an asset (such as shares or currency prices) without ever owning the commodity. CFDs are highly risky, complex financial products and are in essence a gamble on the entry and exit prices of a market asset within a set time period. This risk is exacerbated by the fact that CFDs are often highly leveraged, resulting in many consumers losing significantly more than their original investment as losses are greatly magnified. The massive leverage underpinning the spread betting market means that CFD providers are meant to strictly adhere to FCA guidelines and should only sell to sophisticated investors who are in a position to risk capital and who understand the high levels of risk involved.

However, sellers of CFDs regularly target inexperienced consumers, which is evidenced by the fact that the FCA review found that the majority (76%) of retail customers lost money and in an earlier review found the average losses totalled £2,200 per person. Worryingly in several instances, pension funds have been invested in CFDs based on the bad advice of marketing companies or financial advisers through Self-Invested Personal Pensions (SIPP). Mis-sold SIPPs gamble entire retirement savings in volatile and risky markets instead of investing in regulated and secure asset classes.

Increased Offering of Bitcoin CFD Trading

The FCA have noted a steady growth in the volume of CFDs gambling on the ever-changing value of cryptocurrencies such as bitcoin or ethereum. The biggest story in finance recently has been the surge in value and price volatility of bitcoin- akin to the tulip mania of the 17th century- with the FCA in November 2017 describing digital currencies “extremely high risk, speculative products”. The risks of the cryptocurrency market have been amplified by trading platforms offering large leverages up to 50:1 to consumers, which means that CFD speculators trading on margin stand to lose huge sums if (or when) the bitcoin bubble bursts. Moreover, unsophisticated consumers are at risk because cyptocurrency CFD brokers typically only hedge in the market when they perceive volatility increasing and most bitcoin brokers remain anonymous, leaving unsuspecting customers with huge losses.

FCA Highlights Areas of Concern in the CFD Market Causing Significant Consumer Harm

The scope of the FCA’s review was to examine 19 firms providing CFDs on an advisory/discretionary basis and 15 firms distributing CFDs to the end consumer. This is the FCA’s second “Dear CEO” letter in just two years to the spread betting market (in addition to other warnings), demonstrating that previous concerns have yet to be adequately addressed by CFD firms.  The Executive Director of Supervision at the FCA, Megan Butler, said:

“Given the significant weaknesses we found…there is a high risk that firms across the sector are not meeting our rules and expectations when providing and distributing CFDs. As a result, consumers may be at serious risk of harm from poor practices in this sector.”    

The FCA’s intervention represents a welcome crackdown on the CFD market with one unnamed firm now being subject to “further action” by the FCA and several firms intending to stop distributing to retail consumers.

The FCA highlighted its serious concerns about several breaches of the FCA Handbook that led to the mis-selling of CFDs:

(1) Poor target market identification

The FCA found that firms used “excessively broad definitions of target markets” such as “experienced”, “sophisticated” and “financially literate”. Undefined investor descriptions led them to target the majority of potential customers for selling CFDs when these were highly unsuitable for most customers and did not align to their needs (breaching Principles 2 & 5 and RPPD 1.17(1)). As CFDs are high-risk complex products, it is very important for firms to ensure their target market (of sophisticated investors willing to make risky bets) is properly identified to ensure that unsophisticated, risk-averse customers were not sold complex and risky CFDs.

(2) Lack of communication, oversight and challenge by providers over how distributors sell the product

All providers reviewed were in breach of the FCA’s RPPD guidance. Information was not provided to distributors on key characteristics of specific CFDs such as the inherent risk, the intended target market and whether such information was available to the end consumer. The lack of due skill, care and diligence (breaching Principles 2 & 6 and RPPD 1.18(2)) in the dissemination of crucial information has led to distributors blindly selling CFDs without understanding enough to give suitable advice to consumers. Moreover, 18 out of 19 firms were unable to demonstrate that they had used robust due diligence in assessing whether an intermediary even had the necessary knowledge and experience to sell CFDs, thereby increasing the risk of poor consumer outcomes. Unfortunately, it is clear that many CFD firms failed to take proper care towards their unsophisticated customers.

(3) Ineffective conflict of interest management arrangements and weak use of management information

The FCA found a widespread culture of failing to identify, manage and mitigate potential conflicts of interest affecting the consumer’s best interests (breaching Principles 3 & 8 and SYSC 10.1.3R)).  All firms identified had ineffective conflict of interest management systems and, unbelievably in several cases, some firms failed to record even one potential conflict of interest over a period of one year. Moreover, firms failed to effectively use management information to assess the performance of their distributed products, challenge bad practice and analyse poor customer outcomes.

(4) Inadequate client categorisation processes

Firms are duty bound to undertake an adequate assessment of a consumer’s “expertise, experience and knowledge” to ensure the product is suitable for the consumer and that they properly understand the risks (COBS 3.5.3R). Much like Mr Justice Andrew Baker’s reasoning in Abdullah v Credit Suisse [2017] (discussed in our article), the FCA found that firms asked poor qualitative questions to assess an investor’s knowledge and accepted weak answers. As a result of an inadequate threshold test, unsophisticated customers were categorised as “elective professional”, which allowed firms to sell unsuitable products to unsuspecting clients.

(5) Unsuitable remuneration structures

Many firms paid employees and portfolio managers on a 100% variable basis which “significantly increase(s) the risk of mis-selling” since staff working on commission feel pressured to achieve minimum sales targets regardless of the harm done to consumers.

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Click to Download the FCA Review Letter into the CFD Market

What Next for the CFD Market?

The FCA’s letter and continuing review of the spread betting industry is encouraging for consumers because it demonstrates that the financial watchdog intends to hold firms to account for breaching the regulatory framework. Nevertheless, in a rapidly growing industry where 76% of consumers are losing money, “Dear CEO” letters are not enough: the FCA must do more. If CFD market behaviour does not improve, supervisory intervention may be taken by the FCA through a skilled person review or restrictions may be applied to certain wrongdoing firms. However, the FCA has not always championed transparency when investigating misconduct by banks, having refused, for example to publish their commissioned review into RBS’s treatment of SME customers referred to its rogue GRG division; a decision which has been roundly criticised and suggests that the FCA are abdicating their regulatory responsibilities.

The FCA’s warning is also unlikely to effect revolutionary change in the way CFDs are sold by large established providers in the market. However, it may ensure that smaller, low-quality operators who are relatively new arrivals to the CFD market will not be able to operate whilst disregarding the FCA guidelines and dangerously mis-selling highly leveraged inappropriate products to ignorant consumers.

The best hope of meaningful reform for unsophisticated purchasers of mis-sold CFDs is from Europe. The European Securities and Market Authority (ESMA) announced in December 2017 that it will consider utilising product intervention powers under the new Markets in Financial Instruments Directive (MIFID II) to minimise risks to investors of CFDs by restricting their marketing, distribution and/or sale. A public consultation will commence in January 2018 and it is hoped that ESMA maintains its tough stance and considers significant interventions in the CFD market to protect consumers.

Consumer Rights: Claiming for Financial Loss Suffered Following a Mis-sold CFD or SIPP

A purchaser of a mis-sold CFD or SIPP would have to prove that their loss was caused by bad advice provided by the financial advisor showing:

  • The investment was unsuitable to the client’s needs; or
  • The level of risk was inadequately explained; or
  • The consumer did not have sufficient knowledge of CFD trading.

If a consumer has suffered loss of capital due to CFD mis-selling there are a number of solutions available that we can assist with:

(1) Request a copy of the bank or financial company’s internal complaints process and lodge a formal complaint for compensation.
(2) Complain to the independent Financial Ombudsman Service or Pensions Ombudsman.
(3) Issue legal proceedings against the bank or financial broker.

Financial Mis-selling Dispute Lawyers

Our market-leading Financial Services Litigation team of Solicitors and Barristers in London are highly experienced in banking litigation and other financial mis-selling claims. Our high profile and high value cases regularly appear in the national and international media. Our banking litigators advise on the protection of borrower legal rights in the face of predatory bank practices. We have successfully managed and settled court litigation against all major UK banks. Call us on ☎ 02071830529 or complete our online contact form.

Financial Services Litigation Team, LEXLAW