The Financial Markets Authority (FMA) has moved to rein-in retail derivative products and ease conduct-licensing concerns for smaller financial firms during a busy week for the regulator.
Retail bets on derivative products such as contracts-for-difference (CFDs) would face tight leverage constraints and tough new suitability rules under the FMA proposals.
Currently, licensed retail derivative operators face no formal leverage caps with the regulator noting some issuers allow clients to lever-up exposures 500-times.
“We have observed that the number of margin calls per investor is significantly higher for DIs [derivative issuers] offering high leverage levels,” the consultation paper says.
The mooted new FMA standard licensing condition for derivative issuers (the regulator counted 25 in the sector during a 2020 review) would put hard leverage caps ranging from about 33:1 to two-times depending on the product class (CFDs, currency, gold, crypto etc) in question.
“While some jurisdictions only set leverage limits for select OTC [over-the-counter] products such as CFDs or foreign currency derivatives, we are proposing limits that apply to all OTC derivatives offered to retail investors,” the regulator says. “Our monitoring of DIs has shown that most retail investors use OTC derivatives to speculate, and when speculation is enabled by high leverage there is a greater chance of losing money.”
And derivative providers will be required to implement stronger measures to ensure retail clients understand the products before placing bets under a proposed update to the ‘suitability’ standard condition.
“We revised the condition to require that DIs must determine whether the retail investor understands the derivative before entering into it,” the FMA paper says. “The DI may not issue a warning and/or enter into the derivative when the product is not suitable or when the DI is unable to assess suitability.”
As per the existing rule, derivative providers can still allow clients to transact even if there is doubt, or insufficient information, about suitability as long as the firm issues a written warning to the investor.
The new derivative standards would come into force six months after formal approval. Submission on the proposals are due by close-of-business on August 7.
Also last week, the FMA published guidance for “smaller firms” set to be licensed under the Conduct of Financial Institutions (COFI) legislation as of next March.
The COFI guide for the littler providers (mostly non-bank deposit-takers and insurers) notes such firms can tailor their ‘fair conduct programs’ (FCP) – a central component of the regime – to suit.
“We recognise that smaller [financial institutions] may find the process of establishing, implementing and maintaining an FCP more challenging than larger [institutions] or firms that already hold other licences issued by the FMA,” the guidance says.
Among other tips, the regulator says smaller COFI-liable firms could turn to third-party specialists for advice.
“If you are considering using an external party to assist with your FCP, we recommend taking the time to ensure you understand what they are going to deliver for you, how it will be tailored and right sized for your business, and how this will help you meet your obligations,” the FMA document says. “You will still need to have personnel in your business who are responsible for the implementation and ongoing operation of your FCP.”
Clare Bolingford, FMA regulatory delivery executive director, said the recently introduced financial advice licensing system delivered some “great examples” of flexible compliance models based on the size and complexity of underlying businesses.
“We expect smaller firms will need a less complex FCP compared to bigger financial institutions,” Bolingford said in a statement. “We also expect firms to review and evolve their FCPs over time. FCPs do not need to be fully implemented until the regime comes into force.”
COFI is slated for further amendments in proposals published by the Ministry of Business, Innovation and Employment last month.
However, any changes to the conduct rules will likely come into force at least a year after the original legislation kicks into gear next March.