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Something you often read about the UK is that it’s in a state of ‘managed decline’. Basically the country faces insurmountable problems and so the best the government can do is let it gradually get worse, without the shock of a ‘hard’ landing.
I don’t know if that’s true but as I walk around London I often think of that quote from the first Pirates of the Caribbean film, except instead of a skeleton man yelling at Keira Knightley, it’s a barber in a Hoodrich puffer jacket walking out of a vape shop, shouting it at me – ‘you best start believing in emerging markets Mr Kimberley – you’re in one!’
Anyway, one component of managed decline is the regulator slowly killing off businesses. And last month the Financial Conduct Authority put out a ‘Dear CEO’ letter for companies in the CFD industry. A couple of people I spoke to had the usual gloomy retorts – ‘writing is on the wall’, ‘industry is done’ etc etc. Is that true? Is this managed decline?
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The letter makes a few points that are worth considering. First up, 100 companies used the post-Brexit ‘temporary permissions’ regime to keep doing business in the UK. Zero companies got full authorisation after that regime ended (lol).
No more license for branding
Another key point was what the FCA calls ‘Halo firms’. These are basically inactive entities that companies use for branding / marketing, to show that they are a higher quality business because of the respectability that an FCA license (in theory) confers. They then onboard clients offshore. We’ve looked at this before when working out if it’s better to get an FCA license or sponsor a Premier League team.
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The FCA has said they don’t like this and will force companies doing it to either start using the license in a normal way or shut shop. Incidentally, this seems to be something CySEC has done as well, which is why you are seeing some firms say they are ‘B2B only’ or giving up their license entirely.
The other interesting part of the FCA’s discussion here was that they said they treat takeover efforts as equivalent to an application for a new firm. In other words, buying an existing entity is not really a backdoor to getting a license.
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Is this a disaster? I don’t think so. This apparently affects 20% of the companies in the UK industry. But if you aren’t doing business with the entity, it’s hard to argue that your business is being killed because there is nothing there to kill. You weren’t using the license anyway!
Not using pro money for hedging
Perhaps the most significant change that the FCA has hinted at is changes to how client money is held.
The main ‘problem’ here relates to clients that have pro status entering into Title Transfer Collateral Arrangements (‘TTCAs’) with brokers. These allow the broker to use the client’s deposit to post margin with whoever they are hedging with. This could include one of their own entities.
I get the impression that for a lot of companies, if this is banned, then it’s ‘GG – see you later’. Two executives told me that this would be the death knell or close to it for smaller firms if they have to do this.
But then the FCA didn’t say that they would ban it. They just said don’t do it in a way that breaches regulations.
It is hard to say if that will change but I think it ultimately won’t. Working in this industry means you can often operate in a silo and forget there is a much larger financial services industry operating outside of your purview (I am saying this for me too, so don’t feel offended!)
Pro client status impacts many, many other things too. For example, if you want to invest in a lot of hedge funds in the UK as an individual, you cannot do it unless you have pro status. I don’t think you could chisel out a weird, unique ban on TTCAs purely for pros trading CFDs because it could have unintended, knock on effects elsewhere.
No surprises
The other points the FCA makes in the letter were, to my mind, just not that surprising or unexpected.
One of the themes could be summed up as ‘if you offer different products and grow, make sure you have systems to handle the large number of new clients.’ Another was more Consumer Duty stuff about appropriateness.
None of this looked that new to me. To my mind, the main takeaway is that the regulatory burden will continue to grow and if you are not big, you will not be able to handle it, because of both the cost and the human resources needed to do so.
I don’t like that and it makes me annoyed that a regulator is basically killing competition – particularly as their remit is to increase it.
However, if I contrast this with some European countries, which I think could ban CFDs, I don’t think it will happen in the UK. You have to keep in mind the fact that there are three large firms listed on the London Stock Exchange who continue to have CFDs as their primary product. XTB’s size also means Poland will not ban them and is why the regulator there gave allowances for higher leverage.
A better analogy is the US. Over in the Land of the Free, exchange lobbies and a clear disdain on the part of the regulator, made it so capital intensive to offer leveraged FX for retail that there are now only a handful of companies that do so. The goal seems to have been, not to kill the industry entirely, but make it far more concentrated, so that it was less of a headache and easier for the regulator to manage.
The FCA is probably hoping to achieve something similar. They are slowly adding incremental pressure to reach a point where only a small number of players are active in the industry. It’s less about managed decline and more about them not wanting the ‘headache’ of having to deal with loads of small firms. If you look at the UK retail stockbroking sector, there are really only three companies of any significant size and then 10 – 20 smaller firms. That is probably what the FCA is hoping for with CFDs.
