The Financial Markets Authority (FMA)—Te Mana Tātai Hokohoko—is following in the footsteps of its Australian counterpart and is seeking consultation on restricting leverage for derivatives, including contracts for differences (CFDs), offered to retail investors. The consultation paper released today (Tuesday) also focuses on assessing the suitability of retail investors for derivatives trading.

Another Regulator Cutting CFDs Leverages

The proposed changes regarding the offered leverages are similar to those introduced by other top regulators: 30:1 for major currency pairs, 20:1 for minor currency pairs, gold, and major stock market indices, 10:1 for commodities (excluding gold) and minor stock market indices, 2:1 for cryptocurrencies , and 5:1 for equity securities and other underlying assets.

Currently, with no leverage restriction in place, many brokers offer leverage up to 500:1 to Kiwi investors. Such high leverage levels put the capital of retail investors at significant risk. The regulator revealed that it has observed that the number of margin calls per investor is significantly higher for brokers offering high leverage levels.

The Kiwi regulator pointed out that while some jurisdictions only set leverage limits for selected over-the-counter (OTC) products, like CFDs or forex, it proposes limits that will apply to all OTC derivatives offered to retail investors. Australia brought similar leverage restrictions in 2021 after the regulations in the UK and EU.

“Our monitoring of DIs has shown that most retail investors use OTC derivatives to speculate, and when speculation is enabled by high leverage, there is a greater chance of losing money,” the FMA stated.

“We acknowledge that retail investors who use OTC derivatives to hedge their exposure to the underlying securities will also be impacted by the introduction of this leverage condition. However, we consider that they represent a small percentage of total derivatives investors.”

Mandatory Suitability Checks

Regarding the suitability of retail investors to invest in derivative instruments, the FMA seeks more checks. The Kiwi regulator wants to mandate brokers to determine whether the retail investor understands the derivative before entering into it.

There are already licensing conditions in place that require brokers, that is brokers, to assess the suitability of a derivative for a retail investor before the investor enters into the derivative.

“The requirements are not complex, but our monitoring has identified instances of non-compliance and ineffective procedures since the condition was introduced in 2015,” the regulator noted. “Our monitoring also found that where suitability is being assessed, the suitability assessments are poorly designed and sometimes ineffective.”

Although New Zealand-licensed brokers offer a wide range of derivatives, a risk assessment report published in 2020 deemed cryptocurrency CFDs, high leverage, and binary options unsuitable for most retail investors.