C.F.D.s, or contract for difference, was the cause of the hastened demise of one Irish bank. They also triggered a supposed Chilean Ponzi scheme. C.F.D.s also featured in a U.S.A. inside-trading dissonance worth $100 million. What’s more, their echoes have been heard in the Archegos Capital Management implosion.
Moreover, C.F.D.s have spooked regulators owing to the risks they pose when it comes to retail investors. These risks are what spiked tighter rules in the E.U. and U.K. Even with the new regulations, amateur traders continued flocking towards C.F.D.s in the previous year. This was majorly caused by volatility during the Corona Virus pandemic. This year, it was caused by a retail interest surge in the global markets.
What is C.F.D.?
This financial product is a derivative that enables investors to bet on commodities, currencies, and stock directions without necessarily owning them. C.D.F.s value is derived from or reliant on different assets. They are directly traded between counter-parties instead of through public exchange.
While instruments like these are commonplace, especially among asset managers and bank traders, C.F.D.s are unusual as they can be accessed by retail traders from all over the world, with the exemption of traders from the U.S.A. as they’re banned.
Are C.F.D.s high-risk for retail traders?
All retail traders have the ability to borrow money, thereby magnifying their trade sizes. Until recently, traders residing in Australia, Europe, and the U.K. have the ability to increase bets by a large margin. For example, a $500 can be turned into a $250,000 notional gamble.
The downside of this is, a small market change in a way you didn’t anticipate would see you wipe clean your deposit. Amateurs tend to lose money, and this sees them owing C.F.D. firms money.
What else are regulators worried about?
C.F.D.s have been in existence for decades. However, regulators started having concerns years ago regarding rising leverage. They also had concerns about the manner in which complex derivatives were marketed and pitched to naif amateurs.
C.F.D. firms have also increased their reach and now even sponsor soccer clubs like Liverpool FC and Real Madrid and even players like Andres Iniesta and Cristiano Ronaldo. The arrival of cryptocurrencies added to their concerns as they got linked to C.F.D.s.
What steps are taken by regulators?
Sweeping rules were introduced for all C.F.D. firms and have been there since 2017. These rules aim to mitigate product risks for amateurs and also reduce the trading volumes of C.F.D.s. Restrictions were ushered in by the Australian Securities & Investments, the U.K. Financial Conduct Authority and the European Securities & Markets Authority. These restrictions affected retail traders from all over the world. They include restrictions on distribution, sale, and marketing of C.F.D.s and are also curbed on leverage.
All brokerages are also required to take appropriate measures to protect their customers from going into debt when a trade doesn’t go their way. Cryptocurrency C.F.D.s were also banned outright.
Impact of the rules Imposed.
The introduction of the rules means retail traders have less access to leverage as compared to before. They are also more protected than before against losses. Even so, the rules still make it possible for retail traders to borrow 30-times the deposits they have for their C.F.D. Trades.
Why are C.D.F.s liked so much?
C.F.D.s don’t get charged stamp duty even in highly taxed jurisdictions like the U.K. Products also come with secrecy, and many large investors like this. As a result, it has been used to accumulate clandestine stakes in companies that are publicly traded. Other reasons include:
- Easy access to the global market from a single platform
- No borrowing stock or shorting rules
- No fees required for professional execution
- Day trading doesn’t have requirements
- Different trading opportunities to choose from
The downside
- Traders get tp pay Spread
- Industry regulations aren’t strong enough
- There are risks always involved
Conclusion
C.F.D.s are advanced strategies that are mainly used by well-versed traders in matters C.F.D.
While they may be illegal in the U.S. by virtue of being O.T.C. (over the counter), they are still legal in many other countries. It is a risky affair if you are new to trading, but once you get the gist of it, you stand to make profitable trading decisions with them.