Sector Risk Assessment for derivatives issuers

Last week, the FMA published their Sector Risk Assessment (SRA) for derivatives issuers. The SRA summarises the key risks posed by the licenced derivatives issuers to the FMA’s objective to promote a fair, efficient and transparent financial market.

The FMA’s SRA report is available here.

Who needs to read it?  Why?

Derivatives issuers should note the main regulatory concerns the FMA has highlighted in their SRA report. Where the FMA has labelled a risk level as high, derivatives issuers should expect increased monitoring and attention by the FMA.

What does it cover?

The FMA asked derivatives issuers to assess their governance, culture, systems and controls. The FMA found high-risk areas of concern:

  • Compliance with regulations for handling client money: The FMA found that client money and property is frequently held offshore, and issuers rely on overseas entities to manage client money. The FMA expects all issuers to have adequate and effective arrangements to receive, hold, use and disburse client money. The FMA intends to examine further how issuer’s money controls and procedures work in practice.
  • Assessments of whether derivatives are suitable for retail investors: The FMA found that issuers often do not take into consideration prior trading experience and understanding of risk and leverage when assessing whether a derivative is suitable for a retail investor. In addition, some issuers did not keep written records of this assessment. The FMA intends to increase monitoring of issuers who offer cryptocurrency CFDs, high leverage and binary options, which the FMA considers are not suitable for retail investors.
  • Review of governance and compliance: The FMA found that reviews of governance framework were often informal, and not done in an adequate or timely manner. Some issuers had not completed a review since licensing. The FMA was highly concerned that this could result in a breach of minimum standards, as governance arrangements would not be effective in overseeing risk and compliance.
  • Treatment of vulnerable customers: The FMA found that over half of issuers surveyed did not have a vulnerable customer policy in respect of their derivatives issuer services. With the impacts of COVID-19, the FMA considers that there is an increased need for consideration in this space. Derivatives issuers, and all financial firms, are encouraged to have vulnerable customer policies in place.

Our view

The SRA highlights the significant areas of concern for the FMA. Derivatives issuers can expect increased regulator interest and monitoring from the FMA in these areas. Derivatives issuers should ensure they have the necessary controls and policies in place to address the FMA’s concerns. Issuers should also ensure that they keep written records of assessments. Any review of a policy or governance framework should be formal and clearly documented.

What next?

If you have any questions in relation to the areas of concern highlighted in the SRA or regulatory requirements imposed on derivatives issuers, please contact one of our experts.

Who can help