The British Financial Conduct Authority (FCA) speaks about its observations and discoveries from its recent study into firms that provide CFD and spread bets.
The FCA has pointed out that CFDs and spread bets are particularly prone to insider trading, as they are highly leveraged and risky. These investments generate a lot of Suspicious Transaction and Order Reports (STORs).
The regulator is also aware of a potential rise in a manipulative activity where spread bets and CFDs are being employed to gain profits through manipulative practices on the underlying market made by other companies.
The FCA looked at nine companies and asked for details about how they work, the risks of market abuse, and measures to identify and report market abuse. They reviewed documents such as policies and plans, risk assessments, and management reports. The FCA then visited seven of the firms to take a closer look at the risks and controls.
- Peer review results were mostly favorable
- Regulator noted some areas of improvement
- All firms noted insider trading in individual stocks as the main risk of market manipulation.
Assessing Market Abuse Risks in Non-Equity CFDs and Spread Bets
All the firms provided CFDs and/or spread bets in non-equity asset categories, but not all could show that they had taken into account all the risks of market abuse applicable to their operations.
Those who could have an assessment of the risks of market abuse indicated that different market abuse risks had been taken into account. Two companies had a paper outlining the policies and processes for market abuse, rather than an analysis of the market abuse risks that apply to their business.
All these businesses offer CFDs and/or spread bets in non-equity asset classes, but there was little thought given to these in their market abuse risk assessments and only limited information about manipulation in all asset classes.
Two firms divided up different types of manipulation in their risk assessments thought about how the risks varied depending on the trading platform and trading technique and wrote down why certain risks were not relevant for their business.
FCA Examinations of ‘Reducing the Gap’ Trading Practices
FCA examined a type of cheating called ‘reducing the gap’, which they think may be growing. This approach is used to control the costs of wagering or CFDs related to thinly traded stocks. It involves decreasing the gap in the fundamental market.
Orders are submitted to the order book by a DMA broker (using CFDs or regular stocks) to buy (or sell) a security at more expensive (or cheaper) rates than the current best bid (or offer). This reduces the price gap of the security, leading to a change in the execution cost of the CFD or spread bet. Which is based on the underlying asset.
Then, the same (or related) trader will trade in the reverse direction, in larger quantities, in a related derivative such as a CFD, generally at a different broker, taking advantage of the better price. The DMA order is usually canceled prior to its trading.
Many firms were informed of this activity, and some of them even submitted STORs. However, none of the firms had mentioned this kind of behavior in their risk assessments.
Trading/hedging desks that monitor profits were sometimes informed to bring it to the attention of Compliance. One business’s trading desk used reports to make warnings when clients kept making profits by quickly opening and closing positions.
The FCA is asking CFD brokers to make sure that their processes for spotting and reporting any potential market manipulation are suitable and in line with their business operations. They must also have good plans and processes in place to reduce the chance of their services being employed for financial crime associated with market abuse, in accordance with SYSC 6.1.1R.
