Britain's financial watchdog has 'serious concern' about a 'high-risk, complex' corner of the market

FCA says it has "serious concern" about the "contract for difference" (CFD) industry after a year-long review.
Watchdog says firms are not doing enough to safeguard customers in an industry where 78% of people lose money.
FCA tells firms to improve their practices or face action in a letter the CEOs.
The stock of CFD providers Plus500, IG Group, and CMC Markets all down on the news.

LONDON — Britain's top financial regulator has put the "contract for difference" (CFD) industry on notice, warning CEOs to improve their practices or risk action from the watchdog.

The Financial Conduct Authority (FCA) on Wednesday published the results of its year-long review of the CFD industry, which targets ordinary investors with "high-risk, complex" products, the FCA said.

CFDs explained

Both CFDs and spread bets are short-term wagers on whether a stock, currency, index, or commodity will rise or fall in price over a certain period. They allow investors to make money from stock markets and asset classes without paying the fees associated with actually buying the underlying asset.

But the stakes are high — CFD providers let people buy on leverage, meaning they can bet with a higher amount of cash than they put down. If the trade goes right, it means the customer will net outsized returns relative to how much they bet. But if the price moves against them, they can lose far more than they put down — an initial bet of £100 could leave them will losses of £200. The FCA said on Wednesday that it found during its review that 78% of people lost money on CFDs.

Serious concern

Megan Butler, the FCA's Executive Director of Supervision for Investment, Wholesale and Specialist Division, said in a statement on Wednesday that the FCA has "serious concern" about parts of the industry.

Concerns centre around how much companies are doing to protect customers and what is being done to manage conflicts of interest.

Butler said the FCA's review of 19 CFD providers found that companies weren't properly defining who their customers were and, as a result, were pitching CFDs to people who should not be using them.

CFD-provider Plus500 is a sponsor of Atletico Madrid. BusinessInsider

CFD providers sit on the other side of trades with clients and the FCA's review found "conflict of interest management arrangements that were either ineffective or needed improvement" at all firms it looked at.

"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," Butler wrote. In one instance, the CEO was also the head of compliance.

Other concerns include a lack of oversight of third-party brokers and affiliate marketers who funnel customers to CFD brokers, a lack of appropriate due diligence on these partners, and issues around how employees in the industry are paid.

"Some firms paid their employees on a 100% variable basis," Butler wrote. "This arrangement significantly increases the risk of mis-selling since staff may feel pressured to achieve minimum sales targets, regardless of whether this delivers good outcomes for customers."

Significant weaknesses

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

The FCA said several firms are pulling out of the CFD market altogether following the watchdog's revenue and one is facing further action from the FCA because its processes were so bad.

Butler warned CEOs in her letter: "You should consider the issues we raise in this letter against the conduct of your firm as a CFD provider or distributor. If, when reviewing your arrangements, you identify any areas of concern, we expect you to have regard to the applicable rules and guidance in this letter and take action to ensure compliance."

The FCA has already proposed stricter rules on leverage and risk warnings for the industry. Regulators in Germany and the EU are also leading a crackdown on the industry.