The UK Financial Services Authority (FCA) has announced that it intends to ban the offering of crypto derivatives and exchange-traded notes (ETNs) starting 2021 due to the high risk for retail investors.
In the press release the Financial Conduct Authority (FCA) announced that it will prohibit the sale, marketing and distribution of derivatives on cryptoassets (i.e. contracts for difference – CFDs, options, futures and ETNs) to all end-users starting in 2021. The ban will take effect on 6 January 2021 and is aimed at companies operating in or from the UK. This announcement comes less than a week after the crypto derivatives exchange BitMEX was indicted in the US.
Reasons for the ban
According to the FCA, these products are not suitable for retail investors as they can cause potential losses. Retail investors would not be able to properly value these products for the following reasons:
- Inherent nature of the underlying assets, which means that they do not have a reliable basis for valuation
- Incidence of market abuse and financial crime in the secondary market (e.g. cyber theft)
- High volatility in the price movements of crypto assets
- Inadequate understanding of crypto assets by retail investors
- Lack of a legitimate investment need for retail investors to invest in these products
The high price volatility combined with the difficulty of reliably valuing crypto assets poses a major risk for retail investors. Although 97% of the 527 respondents in the FCA survey were against a ban, this is an appropriate measure.
“Significant price volatility […] exposes the retail investor to a high risk of suffering losses from trading in crypto-derivatives. We have evidence that this happens on a significant scale. The ban provides an adequate level of protection and consumer protection is paramount.” – Sheldon Mills, interim Executive Director of Strategy & Competition for the FCA
The decision was criticized by some people. On the one hand, the clear result of the FCA survey, with 97% of respondents opposing further regulation of the sector, led to a lack of understanding for the latest FCA announcement. Coinshares, according to its own statements the largest asset manager of digital assets in Europe with headquarters in London, had already reacted to the FCA’s advance in an earlier public statement last year. The criticism is directed, among other things, at the fact that different types of structured financial products are lumped together by the FCA. For example, “Delta 1 certificates”, which replicate the price of an asset, are not comparable with leveraged instruments such as derivatives.
We argue that it is inappropriate to treat derivatives and CFDs as risky as ETNs when they have historically performed much better than others, especially given the context of differing structural transparency, disclosure requirements and fees. – Statement Coinshares September 2019
The criticism is understandable if these instruments actually have different risk profiles and investment intentions.
Investor protection or paternalism of retail investors?
In the present case, the question should generally be asked as to when an authority should classify certain asset classes as too volatile for private investors, or whether this is objectively possible and sensible at all. According to which objective criteria does an asset show too high price fluctuations and is therefore not / no longer suitable for retail investors? As far as volatility is concerned, this year’s corona-induced financial market shock, stock and commodity markets, for example, exposed extreme price fluctuations and led to several losses. Also, individual stocks often show similarly high volatility patterns as crypto currencies. These markets have been offering leveraged derivatives for retail investors for years.
The definition of “speculation with financial instruments” is naturally associated with risk. Whether authorities should now decide which speculation and investment instruments are suitable for private investors is another matter. The points listed by the FCA, even if they were possibly well-intentioned in principle, could just as well be interpreted as paternalism or exclusion of an investor group for certain asset classes. At least the argument put forward by the FCA “lack of a legitimate investment need for retail investors to invest in these products” is highly questionable. The free market determines whether there is an investment need. Should financial market supervisory authorities in the future decide which asset classes are suitable for retail investors, or should their focus be more on a regulated environment for all investors?