UK Watchdog Fires Back: Regulator Responds to ESMA’s Critique on CFD and CFD-Like Options Regulations

UK Watchdog Fires Back: Regulator Responds to ESMA’s Critique on CFD and CFD-Like Options Regulations

November 2, 2024 Catherine Williams - Chief Editor News

Following the release of ESMA’s opinion on UK regulations restricting the provision of CFDs and CFD-like options to retail investors, the UK Financial Conduct Authority (FCA) has made a decision statement Points of divergence with pan-EU regulators.

On 1 September 2019, the FCA published Policy Statement (PS) 18/18 and final rules restricting the sale, marketing and distribution of CFDs and CFD-like options to retail customers in or from the UK.

Today, ESMA published an opinion concluding that, overall, the national measures proposed by the FCA are reasonable and appropriate, with the exception of the following decisions:

  • We do not apply our sales and distribution restrictions to CFD-type options providers authorized in other EEA member states other than UK branches or exclusive agents.
  • Sets the leverage limit for CFDs referencing certain government bonds to 30:1 (5:1 under ESMA measures).

The FCA explains that CFD-type options carry the same risk of harm as CFDs because their payout structures are similar to CFDs and they share common product characteristics (i.e. they allow retail consumers to invest in a variety of assets at a fraction of the asset’s value ). By regulating CFD-type options, the FCA rules aim to ensure that UK companies do not circumvent the FCA’s CFD measures by offering highly substitutable products.

Under the FCA’s final rules, UK retail clients will continue to be able to open accounts and trade unrestricted CFD-type options with product providers in other EEA member countries (other than through UK branches or agents), provided these providers are not already trading in The UK markets its products aggressively. The FCA considers that it would be inappropriate, impractical or ineffective to seek to apply its rules to overseas companies that are not regulated by the FCA and are subject to different rules in its own jurisdiction.

Therefore, if a UK customer proactively contacts a company overseas, the company can still sell the products, provided they are licensed in their jurisdiction. UK retail consumers generally do not trade CFD-type options, and UK companies generally do not sell such options.

The FCA noted that EEA firms outside the UK are not permitted to sell CFDs to UK retail clients if UK retail clients proactively contact the firm, as this carries greater risks. This is because these CFDs are more commonly sold across borders and are used by UK retail consumers to speculate on financial markets.

The FCA considers it reasonable and appropriate to limit its scope in this way.

Regarding leverage limits, the FCA noted that under its regulations, UK firms must limit leverage on CFDs and CFD-like options referencing certain government bonds to 30:1 (compared to 5:1 under ESMA’s measure). To ensure that its leverage limits are appropriate and proportionate, the FCA has adopted ESMA’s approach to setting its leverage limits. The regulator used historical price data to conclude that the 30:1 leverage limit was consistent with leverage limits set for other asset classes, given the historical volatility of certain government bonds.

The FCA also considered whether its proposed leverage limits would lead to regulatory arbitrage and have a significant impact on markets in other member states, or cause harm to retail consumers located in other EEA jurisdictions. However, UK firms are required to limit the leverage of CFDs referencing certain government bonds to 5:1 when selling CFDs to retail clients in other EEA jurisdictions that adopt the same rules as ESMA.

As ESMA points out, 30:1 does not exceed the maximum leverage limits for other asset classes in ESMA measures. The FCA agrees that this eases competition among providers who are subject to tighter leverage restrictions.

As retail consumers are protected by the rules of other national competent authorities (NCAs), the UK regulator concluded that its rules would not affect other member states’ markets or cause harm to their consumers.

Having considered this feedback, the FCA considers that a leverage limit of 30x is reasonable and appropriate for CFDs referencing certain government bonds.