Whilst specific guidance on the Duty is welcome, this latest letter is fairly generic and offers little new insight. Any insight provided would have been useful at the start of the implementation timeline but less so now when most firms should have already made significant progress. We are now at a stage where more substantive and direct guidance would have been helpful.
The Dear CEO letter reminds CFD firms of their future obligations under the Duty, which must be implemented by 31 July 2023.
We have provided an overview of the letter, what we consider to be the most useful insights and our recommended actions for firms in the CFD space.
Overview of the Letter
The letter opens by reiterating the now familiar tone set by the FCA in relation to the Duty:
"We expect the Duty to be a top priority for you personally. We want good outcomes for customers to be at the heart of firms’ strategies and business objectives, and leaders have a key role to play"
Firms will be aware that senior management may face regulatory action for failures to implement the Duty. The bulk of the letter repeats high level obligations regarding the Duty with which firms should be familiar. Whilst the letter goes on to discuss CFD-specific considerations, the majority of them relate to issues identified under the current rules such as:
- Poor client categorisation: Firms must ensure clients are correctly classified and are not simply 'electing' or (worse) wrongly encouraging clients to elect to be a professional client to circumvent consumer protections. The letter confirms the categorisation process is subject to the Duty.
- Insufficient principal oversight: Principals must be able to demonstrate oversight of their ARs' products and services including ensuring they are marketing their products to the appropriate target market. This has been a significant issue in recent years for the investment industry as a whole.
- Failure to provide clear consumer communications: With the potential for losses, it is very important that communications are clear to allow investors to fully understand the risk they are taking. Additionally, there have been concerns around 'gamification' of adverts and marketing.
Whilst a generally if only vaguely useful reminder, ensuring current issues are remediated is hardly insightful guidance as to how the Duty will apply to the CFD market. The letter has two annexes, which purport to offer new information:
- Annex 1: How the Duty applies to firms in the CFD provider portfolio: This annex provides insight into the far reaching scope of the Consumer Duty rules.
- Annex 2: Key things for CFD firms to consider: This annex provides some insight into what may constitute good customer outcomes for CFD firms. Examples include providing clear and fair pricing, providing clients with appropriate information and support and ensuring clients have adequate risk management tools.
Again, we note that a lot of what is covered in the annexes is either generic or relates to issues previously identified under the current regulatory regime.
Useful takeaways (mainly reminders)
We consider the most useful takeaways to relate to:
- The scope of the Duty
- Target market
- Distribution chain
- Customer communications
It has been clear for some time that the Duty does not apply exclusively to firms which have a direct client relationship with retail clients, however the exact breadth of the Duty still remains uncertain. The letter reiterates that where firms have a material influence over customer outcomes, the Duty will likely apply. Firms need to ensure they have understood the broad reach of the Duty and know which parts of their business must comply with the Duty. This can be more challenging light of some of the more complex CFD distribution chains and the proliferation of 'professional client only' firms.
One of the points of friction arising from the Duty in the CFD market is the notion of acting in good faith and preventing foreseeable harm when a majority of retail customers lose money with CFDs. The letter states that firms should consider clients' losses and profits when assessing whether good outcomes are being achieved:
"…You should also consider the amounts of money made or lost by retail consumers, when assessing whether good customer outcomes are being achieved. Clearly, we would not consider it a good outcome if no customers make money."
With the exception of saying that it is not acceptable for all clients to fail to make money, the FCA does not address the real question as to how firms should approach the Duty, and the need for firms to deliver good outcomes, in light of the fact that 70 to 80% of retail clients may lose money. This focus on loss may appear intimidating for firms operating in the context of investments where most retail clients lose money. In other words, it could be said that it is foreseeable retail clients will lose money which would appear to go against the requirement of the Duty.
However, it is vital to provide context on how firms may want to approach this topic. For example, it is necessary to consider some of the general guidance provided by the FCA. For example the FCA has stated in its Final Guidance FG22/5:
Paragraph 4.11: "The Consumer Principle does not mean that individual customers will always get good outcomes or will always be protected from poor outcomes. It also does not impose an open-ended duty that goes beyond the scope of the firm’s role and its ability to determine or influence customer outcomes, or protect customers from all potential harms"
Additionally, PRIN 2A.2.5 R states that if a firm identifies that retail customers have suffered foreseeable harm as a result of acts or omissions of the firm it: "must act in good faith and take appropriate action to rectify the situation, including providing redress where appropriate".
Again, while intimidating, remember that this is not a duty to protect consumers from all foreseeable harm. PRIN 2A.2.6 R provides that firms need not redress harm "caused by risks inherent in a product, provided the firm reasonably believed that retail customers or the relevant retail customer (as the context requires) understood and accepted those risks".
What is clear is that just because losses occur, this does not mean that a firm has failed to comply with the Duty. A holistic view needs to be taken when determining what the Duty requires. For example, we would say it is reasonably foreseeable that retail clients who invest in CFDs are likely to lose money as this is an inherent risk of the product. In light of the above, it is all the more critical to ensure other Duty requirements are complied with, such as ensuring:
- appropriate product governance arrangements are in place;
- target markets are understood;
- oversight and monitoring of distributors is implemented (if applicable); and
- that consumer communications are clear,
These will be determinative of whether the firm has complied with Principle 12.
This is an important obligation for all firms but will be all the more important for CFD firms owing to the nature of the products distributed:"Under the rules, manufacturer firms will also need to have an intended distribution strategy that is appropriate for their target market. They will also need to take all reasonable steps to ensure distribution to the target market and regularly review that the distribution strategy remains appropriate"
At the product design stage, firms will need to ensure that the products they provide are appropriate for the target market. For the CFD market, this means limiting the types of individuals who can access these products. This may include, for example, setting minimum eligibility criteria and ensuring that clients have sufficient knowledge and understanding of the products before allowing them to trade. The letter reminds us that this is an ongoing duty, stating:
"If they [firms] find the product is reaching customers outside the target market or the distribution strategy is no longer appropriate and harm is foreseeable, they must take appropriate action"
Firms will need means to ensure that they have a way to identify where customers outside the target market are captured in the distribution of the CFD products.
Distribution Chain (and Arrangements)
The FCA has already identified under current rules problems with how CFDs are sold by third parties. Manufacturers will need to take a number of steps to review their distribution chain:
"[The FCA has] previously identified problems with the way CFDs are sold by third-party distributors and, under the Duty, [the FCA] will expect you to review your distribution strategy… This may include reviewing the communications of third parties that market or distribute your products, particularly affiliate marketers, introducers, financial influencers, and agents."
One of the key challenges will be ensuring there is sufficient data flowing within the distribution chain. Firms need to be ready to demonstrate that they are actively working together and sharing information with other firms in their distribution chain, not least to ensure sufficient and correct information reaches customers and that products are distributed only within its target market.
The FCA expects manufacturers to have completed their assessment against the Duty outcomes by the end of this month (April 2023) so they can provide their results to their distributors for them to complete their own assessments by the end of July 2023.
Customers' information needs and Gamification
Whilst points raised in the letter about gamification and the failure to prevent vulnerable customers purchasing inappropriate products are already well publicised, the below provides a useful reminder and clarification on certain key considerations:
"CFD firms… should review how they advertise and market products to consumers, including the negative impacts of gamification highlighted in [the FCA's] recent work on behaviours around high-risk investing. Communications to consumers should be reviewed to ensure they adequately reflect the high-risk nature of CFDs and that they are appropriate for the target audience."
"Firms should consider if they are causing foreseeable harm if they encourage consumers to put money at risk they cannot afford to lose, including where they are pressured to top up margin to avoid the crystallisation of losses on open positions."
This guidance raises crucial points around how a firm designs the distribution of its products/service and whether any active friction or limits should be incorporated. The example used about customers being pressured to top up accounts to avoid crystallising a loss is interesting but nuanced. On one hand, customers may lose money by failing to top up, equally customers may lose more money than they can afford to by topping up, particularly when they feel under pressure to do so. The pressure may come from the risk of loss rather than anything a firm says or does. This leaves firms with a tricky balance of ensuring customers are provided the information required to allow them to make their own decisions whilst not unduly pressuring them.
In our view, this guidance leaves many unanswered questions and provides limited help for CFD firms implementing the Duty. It is still not clear, for example, how a CFD firm should determine what a good outcome is (in the context of the CFD market). That said, one of the things firms will want to do is ensure their implementation plans addresses each of the points raised in the letter, even if the points raised focused on generic or pre-existing issues.
In readiness for the approaching implementation deadline, firms should have already made good progress. Firms cannot sit back and hope for further guidance and instead must continue to develop their own approach to complying with the Duty. The starting point in our view is for a firm to answer the following:
How does the firm define good outcomes (over the short, medium and long term) for customers using its products and services?
Building on from this, unless and until the FCA provides further guidance, some of the key points to address will include:
- Being clear on what part(s) of your business model are caught by the Duty.Defining what fair value is in the context of investments where many clients lose money.
- Ensuring that the target market and distribution strategy are well defined.
- Taking account of vulnerable clients and explaining how the firm ensures people outside the target market are excluded from investing.
- Ensuring client categorisation processes are thorough and are under ongoing review.
- Reviewing consumer communications and ensuring that clients are provided sufficient detail to satisfy their information needs.
- Where applicable, putting in place oversight over third parties where they play a role in the provision or distribution of products/services, in particular appointed representatives and unregulated parties.
- Developing MI and KPIs to allow senior managers and the governing body ongoing oversight of the firm's compliance.
- Ensure comprehensive documentation as to how the firm will implement / has implemented the Duty.
This is not an exhaustive list (far from it) and we would expect most firms to have progressed beyond considering these preliminary points. If not, please (urgently) get in touch.
Despite its intentions, in our view, the letter does not provide Firms with much aid in navigating the requirements arising from the Duty in the CFD space. This ambiguity serves only to undermine the FCA's aim of increasing consumer protection, by making it harder for firms to ensure they are doing the 'right' things.
Whilst more substantive guidance is required from the FCA, to enable firms to drive real compliance and meet the FCA's expectation, we expect this to follow in the months and years after the implementation date, rather than before. This may take the form of supervisory alerts and enforcement actions, from which firms will need to extrapolate principles for their own business models.
Firms must continue to take a proactive approach towards the Duty, to prevent themselves being made an example by the FCA, post-implementation.