The FCA has announced proposals to tighten regulation on an industry that liberally markets a sophisticated financial product to the uninitiated, attracting criticism that it has got rich on the back of misery.
The UK’s financial services regulator the FCA (Financial Conduct Authority), is proposing stricter rules for firms selling ‘contracts for difference’ or CFDs, to retail customers, after their own research revealed almost all lose money.
Spread betting firms advertise widely, you will probably have seen their adverts across the mainstream and financial press, and given that so many of their customers lose money, it is unsurprising that they can afford to spend so liberally on marketing.
They often proffer enticing introductory offers of free bets to attract new customers. But the problem with spread betting begins with the name, because unlike a flutter on the horses down the bookies, this is a lot riskier form of gambling, it is a highly-leveraged bet on a sophisticated financial instrument, that takes considerable effort to understand, and requires a high degree of knowledge of the underlying financial instrument being traded.
Horror stories
Horror stories about of investors losing serious amounts of money abound across internet bulletin boards. Last March, the Swiss Central bank, the SNB, suddenly scrapped their currency ceiling, only days after describing it as a cornerstone policy. A number of investors had speculated the Swiss franc falling against the Euro, when in fact, upon the SNBs announcement of change in policy the opposite happened.
Synopsis of the FCA proposals
The FCA is therefore proposing a package of measures intended to enhance consumer protection by limiting the risks of CFD products and ensuring that customers are better informed. The new measures include:
Introducing standardised risk warnings and mandatory disclosure of profit-loss ratios on client accounts by all providers to better illustrate the risks and historical performance of products.
Setting lower leverage limits for inexperienced retail clients who do not have 12 months or more experience of active trading in CFDs, with a maximum of 25:1.
Capping leverage at a maximum level of 50:1 for all retail clients and introducing lower leverage caps across different assets according to their risks. Some levels of leverage currently offered to retail customers exceed 200:1.
Preventing providers from using any form of trading or account opening bonuses or benefits to promote CFD products.
The FCA is also setting out its vision on a range of policy measures for binary bets that would complement existing conduct of business rules, once these products are brought into the FCA’s regulatory scope.
The Independent newspaper reported at the time about a customer in Ireland, who worked as a supply teacher on an £18,000 salary. He was taking a class when his phone bleeped with a text saying the SNB had scrapped the cap. He had taken a hefty position in the anticipation that the Swiss currency would fall agin the Euro, but he suddenly faced a loss of nearly £280,000. He told the Independent: “I got a text message. I was talking at the front of class, gave the children some work to do. Then I got the text, and went to look at one of the computers at the back of the classroom. My first reaction was that there had been some kind of computer glitch. The children were working away, my heart rate was going at 200 beats a minute.” He doesn’t own a house and he has no hope of paying.
The crucial risk in spread betting is that losses – and gains – are magnified by leverage. In the case of the Irish customer, he bet the euro would gain against the Swiss franc and stood to make £100 for every one-hundreth of a cent it moved in his favour. But instead the currency soared and by the time IG’s clients were closed out, the euro had fallen to €0.925 against the franc. That left him with 2,770 pips of losses – each costing £100 – and a bill of nearly £280,000.
You can read The Independent article here (opens in another page/window).
What is Spread betting and how does it differ from CFDs?
Spread Betting and CFDs are actually two different products, with strong similarities. They both allow customers to speculate on the price moments of shares, foreign exchange, commodities, and indices. The company issuing them profits regardless of how the customer performs. CFDs are actually a physical contract between two parties, based upon the underlying financial instrument, and because of this they are subject to capita gain tax, unlike spread betting which because it is considered gambling (by HMRC) invokes no CGT.
What makes them both highly dangerous however, is that they are highly leveraged, sometimes astronomically so, which could mean a £50 wager is leveraged so that it is a £2,500 punt on the per price move of for example the price of BP shares. If the shares of BP went up 25 pence, in this instance, the customer would see their £2,500 wager that only cost them £50 (on a 50 to 1 leverage), turn in to £62,500 (32,500 x 25). However, if the BP share went down 25 pence, the customer would see a loss of £62,500.
Trading CFDs or spread betting, certainly involves skill, and a skilled practitioner is much more likely to do well than an unskilled one. But there is a real danger that the gambling element of it, which as we all know, too many humans fall victim to, can mean that punters over estimate their own skill level, which can cost them dearly.
The FCA is restricting its investigations to CFDs and something called Binary Trades. These, as the name implies, allow customers to bet on a price increasing or decreasing over a given time period in return for a fixed profit or fixed loss.
Spread Betting and CFDs Compared
Spread betting
No capital gains tax
Issuing firm charges a spread rather than commission
Deal on rising and falling markets
Leveraged access to the markets
No stamp duty
Use prices based on the underlying market
Inherent leverage means you could lose much more than your initial outlay. You could end up owing additional monies in excess of your deposited funds.
CFDs
Direct market access or DMA on forex and shares
Trade at the market price on shares
Profits are subject to capital gains tax
Losses can be offset against profits for tax purposes
Deal on rising and falling markets
Leveraged access to the markets
No stamp duty
Use prices based on the underlying market
Inherent leverage means you could lose much more than your initial outlay. You could end up owing additional monies in excess of your deposited funds.
Spread betting firms at risk
The share prices of listed spread betting firms such as CMC Markets, IG Group and Plus 500 tanked following this announcement. This is because the measures are likely to result in fewer of the types of punters these firms depend up doing business with them – the ones who lose money – which threatens the profitability of their business, to an extent which the market can’t, at this early stage be certain.
Ironically, if you are of the opinion the share prices of these businesses is under further threat, I know of a way you can trade upon that, but beware of the risks.
You can listen to our editor discuss Spread Betting on Share Radio below: