In a recent 'Dear CEO' letter to the distributors of contracts for differences, the FCA states that most firms are not yet able to identify their target markets among retail customers or to align the products to their interests. It is keen to warn intermediaries who distribute such products to retail consumers on either an advisory or discretionary basis.

Investopedia defines a contract for differences as an arrangement made in a futures contract whereby differences in settlement are made through cash payments, rather than by the delivery of physical goods or securities. Contracts for differences and spread bets are taxed differently and incur charges in different ways, with CFDs attracting commission costs whereas spread bets do not (source: Financial Spread Betting). Somewhat confusingly, the FCA's rulebook lumps contracts for difference, spread bets and certain ‘rolling spot’ FX contracts together as types of 'CFD.'

This notwithstanding, the FCA wants to make firms deliver CFD products to their intended target markets and pay due regard to the interests of customers and treat them fairly. In the last two years it has gathered information about:

• firms' identification of a target market and ability to explain how the CFD product is aligned to this group’s needs;
• providers' processes for taking on new distributors (this need not concern us here);
• the effectiveness with which providers monitor the ways in which distributors sell the products;
• the use of management information (MI) and key performance indicators (KPIs);
• whether distributors identify, manage and mitigate potential conflicts of interest;
• distributors' client categorisation processes;
• end-consumer gain/loss data between July 2015 and June 2016; and
• distributors' remuneration arrangements and controls.

In doing so, it analysed 19 firms on the 'sell' side (producing CFDs and distributing them to intermediaries) and 15 on the 'buy' side (distributing them to retail investors). In doing so it looked at the competence of firms that offer CFDs to retail customers on "either an advisory or discretionary (including limited power of attorney) portfolio management basis." Most distributors were unable to give the regulators a satisfactory definition of their target markets or to explain how they align the needs of this group to the CFD products in question. Three-quarters of retail customers who bought CFD products (on either an advisory or discretionary basis) lost money over the 12-month period.

The FCA noticed that providers were exercising a wide range of "communication, monitoring and challenge practices" (whatever those might be) over their distributors, many of which were ineffective. Most of them had flawed 'due diligence' processes for taking on new distributors. Conflicts of interests abounded everywhere. Most (but by no means all) firms had MI and monitoring structures in place, but these were hopelessly flawed and did not enable them to deal well with bad conduct or failures of control. The quality of remuneration arrangements at CFD distributor-firms was decidedly mixed.

The FCA is warning firms to redouble their efforts in this area, lest they fall foul of its purposefully vague, catch-all 'principles for business.' The chief of these are principle 2, which states that a firm must conduct its business with due skill, care and diligence, and principle 5, which states that a firm must observe proper standards of market conduct.

In the 'Dear CEO' letter the FCA also expresses a desire (which, however, it does not back up by reference to any rule) that product providers should identify their target markets, i.e they should determine which types of customer the products or services are likely to benefit. It complains that providers and distributors in the survey "had a poor target market definition" and looks forward to a rectification of this shortcoming.