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FMA Opens Consultation On Proposed Standard Conditions For Derivatives Issuers

The Financial Markets Authority (FMA) – Te Mana Tātai Hokohoko – is seeking feedback on potential changes to the standard conditions imposed on Derivative Issuer (DI) licences. The changes relate to leverage and the suitability of investors for derivative trading.

The proposed changes have been identified in the FMA’s 2020 Derivatives Issuer Sector Risk Assessment (SRA) and subsequent monitoring of the sector.

Proposed leverage standard condition

Investing with leverage amplifies the risk by enabling an investor to have much greater exposure to an increase and decrease in value. Currently, there is no limit to the amount of leverage a licensed DI can offer to retail investors in New Zealand. For example, while some licensed DIs limit contracts for difference (CFDs) leverage to 30:1, others offer up to 500:1.

The higher the level of leverage, the greater the financial impact felt from price volatility. For example, if a trade is leveraged 10:1, an investor with $1,000 in their account can control a position in an underlying asset valued at $10,000. When a position is leveraged 500:1, that same investor with $1,000 can control a $500,000 position. Leverage can enable efficient asset allocation, but highly leveraged derivatives mean retail investors may experience much higher losses.

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The proposed standard condition is similar to those in the UK, Europe and Australia and varies depending on the underlying asset class of the derivative.

Changes to suitability standard condition

The SRA and subsequent monitoring indicated some licensed DIs were not always taking sufficient steps to determine suitability for the investor. Monitoring also found that some of the suitability assessments were poorly designed or ineffective.

Licensed DIs offer a wide range of derivatives with varying degrees of risk. While some are straightforward, others, like binary options or cryptocurrency CFDs, can be opaque or volatile and are therefore riskier.

The FMA considers it both appropriate and necessary to revise the suitability standard condition to ensure that DIs ask retail investors for relevant information needed to assess whether the derivative is suitable.

The FMA has revised the suitability condition to require that DIs must determine whether the retail investor understands the derivative before investing.

Director of Markets, Investors and Reporting, John Horner said: “The proposed changes are about ensuring retail investors fully understand the nature and extent of the risk around derivatives and to align protection measures with international norms.”

The consultation period runs until 7 August.

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