The Financial Markets Authority (FMA) of New Zealand is seeking feedback on potential changes to the standard conditions imposed on Derivative Issuers (DIs) licenses. These changes involve leverage and the suitability of investors engaging in derivative trading.

These proposed changes have been identified in the FMA's 2020 Sector Risk Assessment (SRA) of the derivative issuance sector and subsequent sector monitoring.

Proposed Leverage Standard Conditions

The use of leverage in investments amplifies risks by exposing investors to greater fluctuations in value. Currently, there is no restriction on the amount of leverage provided by licensed DIs to retail investors in New Zealand. For example, while some licensed DIs limit the leverage for Contracts for Difference (CFDs) to 30:1, other companies offer leverage of up to 500:1.

Over-the-counter derivatives may not be offered or issued to retail investors unless the following initial margins are provided by the retail investors:

• 3.33% of the total exposure value generated by the exchange if the underlying asset of the derivative is a major currency pair's exchange rate;
• 5% of the total exposure value generated by the exchange if the underlying asset of the derivative is a minor currency pair's exchange rate, a major stock market index, or gold;
• 10% of the total exposure value generated by the exchange if the underlying asset of the derivative is a commodity other than gold or a minor stock market index;
• 50% of the total exposure value generated by the exchange if the underlying asset of the derivative is a cryptocurrency;
• 20% of the total exposure value generated by the exchange if the underlying asset of the derivative is equity securities or assets not listed in 1(a) to (d).

The proposed standard conditions vary from those in the UK, Europe, and Australia due to differences in the asset classes of derivative underlyings.

Changes to Suitability Standard Conditions

The SRA and subsequent monitoring indicate that some licensed DIs have not always taken sufficient steps to determine the suitability of investors. Monitoring also found that some suitability assessments were poorly designed or ineffective.

Licensed DIs offer a wide range of derivatives with varying levels of risk. Some are straightforward, while derivatives such as binary options or cryptocurrency CFDs may be opaque or highly volatile, thus carrying higher risks.

FMA believes that revising suitability standard conditions to ensure DIs ask retail investors for relevant information needed to assess the appropriateness of derivatives is appropriate and necessary.

FMA has revised suitability conditions requiring DIs to ascertain whether retail investors understand derivatives before investing.

The consultation period ends on August 7.