23 September 2020

Leveraged Trading, Margin Calls And The Retail Client: Katherine Harper writes for Law 360

Dispute Resolution Senior Associate, Katherine Harper's article entitled 'Leveraged Trading, Margin Calls And The Retail Client' was published in Law 360.

In this article, Katherine discusses the increase in margin calls in the spring as a result of the turbulence in the financial markets triggered by the Covid-19 pandemic and considers the disputes which may follow with particular focus on “retail clients”.

This article was first published in Law 360 and can be accessed here.


The recent turbulence experienced in the financial markets as a result of the COVID-19 pandemic has been well documented. One of the effects of the commotion in the financial markets was that there was a significant increase in margin calls last spring.

Leveraged trading involves a party putting up a deposit — or margin — and, in effect, borrowing the rest of what it needs to trade on positions which are much larger than what they could access otherwise.

There are various leveraged trading products but a common one is spread betting. Spread betting involves betting on whether the price of an underlying commodity, asset or index will move up or down beyond a specified range.

The ability to access a much larger exposure can result in large profits from a small initial outlay and this is one of the reasons why leveraged trading is so attractive to some. However, the other side of the coin is that the losses are also amplified and can well exceed the initial investment.

Further, where the ratio of margin to investment exceeds the ratio set by the counterparty bank or broker as a result of the market moving away from the trader's position, a margin call — essentially a demand for more funds — will be made by the counterparty to maintain the position.

In volatile markets, the changes can be sudden and significant, with the result that margin calls may exceed the levels that some traders can meet. Where the margin calls cannot be met, positions will usually be closed out.

As early as April, the Financial Times reported that private investors who had lost money through disputed margin calls on their margin loans — loans acquired on the basis of a margin which are then used to make investments in, for example, shares — had started preparing possible legal action against banks and wealth managers in an attempt to recover losses.

While that article refers to margin loans rather than leveraged trading products, it is not difficult to see that there is plenty of scope for disputes where margin is concerned in the context of leveraged trading products also.

Such disputes might concern, for example, disputes concerning the calculation of the additional margin demanded, the communications of (and surrounding) margin calls and the closing out of positions.

Disputes brought by individuals concerning leveraged trading products have made their way through the English courts on many occasions before and many of these have featured spread betting as the particular product involved.

At the heart of these cases tends to be the allegation that the counterparty firms in question have breached rules set down by the Financial Conduct Authority, thereby providing a basis to bring a statutory claim under Section 138(D)(2) of the Financial Services and Markets Act, which essentially permits claims for damages to be brought by individuals who suffer loss as a result of breaches of the rules.

The rules alleged to have been broken are typically the conduct of business sourcebook, or COBS, rules, which are found in the Financial Conduct Authority Handbook.

Complaints from individuals will naturally depend on the facts in the case but have often featured allegations of rule breaches based on inappropriate client classification — "retail clients" are afforded far greater regulatory protection than "professional clients" — and/or that the particular product was not suitable because the individual didn't have sufficient knowledge or experience to understand the risks involved.

There may also be other claims that can be advanced based in contract and/or negligence against the counterparty firm. For example, the facts may allow for a claim to be brought on the basis that the counterparty firm breached its own terms and conditions or that, notwithstanding that the service provided by the firm was formally expressed to be execution-only — i.e., opening and closing positions on instructions — the reality of the relationship was that advice was in fact given and that such advice was negligent.

However, alongside the above, retail clients involved in leveraged trading products with disputes concerning margin calls should be paying particular attention to the provisions found in COBS 22.5, which came into force relatively recently — in August and September 2019 depending on the product involved.

These rules concern the retail marketing, distribution and sale of contracts for differences and similar speculative investments, which includes leveraged spread bets, and specific provisions regarding, among other things, margin.

The COBS rules include provisions regarding the levels of margin required and the obligations to provide a clear description of how the margin closeout level will be calculated in good time, before the first position is opened and before any changes to applicable terms and conditions take effect.

Also included are provisions regarding obligations to close open positions as soon as market conditions allow where a retail client's net equity falls below 50% of the margin requirement.

In addition, counterparty firms are expected to comply with the client's best-interests rule in COBS 2.1.1R and the obligation to execute orders on terms most favorable to the client in COBS 11.2A.2R when making a margin call to a retail client, exercising a discretionary right to close a retail client's position or closing a retail client's position.

Accordingly, for retail clients whose trading activities are within the scope of COBS 22.5 and who have complaints arising out of margin calls made in spring 2020, the new rules and guidance may prove to be a fertile ground for pursuing a claim for damages.

Katherine Harper is a Senior Associate in the Dispute Resolution team.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

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