The U.K. Financial Conduct Authority (FCA) issued a so-called "Dear CEO" letter Wednesday to firms that manufacture and trade contracts for difference (CFDs) with retail investors. The letter highlights the results of a review, which found "significant weaknesses" in firms' practices.
Among other things, the review found flawed due diligence processes, weaknesses in managing conflicts of interest, weak governance and flawed compensation structures.
"Overall, we consider that distributors need to significantly improve their remuneration structures and how they identify and manage associated conflicts," the FCA says in the letter.
The review also found that 76% of the retail clients who traded CFDs lost money during the period reviewed by the FCA (July 2015 to June 2016).
As a result of the review, "we believe there is a high risk that firms across the sector are not meeting our rules and expectations when providing and distributing CFDs. As a result, consumers may be at serious risk of harm from poor practices in this sector," the FCA warns.
Following the review, some firms have stopped dealing in CFDs, the FCA says, and others have indicated that they intend to drop the business. One firm's practices were so poor that the regulator says it intends to "take further action" against it.
Overall, firms that remain in the business need to improve their oversight and controls. "We are concerned that if firms do not address these poor practices, there is a greater risk that consumers will experience poor outcomes through the provision and distribution of CFDs," the FCA says.
The European Securities and Markets Authority is planning a consultation later this month to consider measures to prohibit or restrict trading in CFDs for retail clients, amid its own investor protection concerns, the FCA notes.
"The provision and distribution of CFD products and delivering good customer outcomes in this sector will remain areas of focus for us," it says.