Spread Betting Shares Plunge As EU Regulator Unveils Trading Crackdown

With two weeks to go before the implementation of the EU’s dreaded new regulatory overhaul, MiFID II has struck again...

This time it’s hit the shares of several derivatives brokers which provide platforms for retail (mainly) investors to speculate on global stocks, currencies, commodities and ETFs. Only a few days ago, we explained how banks were demanding an 11-th hour reprieve due to thousands of investors and corporate issuers lacking the Legal Entity Identifiers (LEI’s) which could see them shut of markets from 3 January 2018. According to Bloomberg.

Shares of stock derivative brokers including IG Group Holdings Plc, Plus500 Ltd. and CMC Markets Plc sank 14 percent or more in London after European regulators laid out harsher-than-expected potential rules on some speculative financial products. The companies operate some of the largest platforms for retail investors to trade contracts for difference, which are derivatives that allow investors to speculate on the price of stocks, currencies, and commodities without owning them. The European Securities and Markets Authority, using powers set out in the overhaul of financial rules known as MiFID II, outlined late Friday how it may curb leverage, limit how much clients can lose on the contracts and ban the sale of binary options.

“ESMA has been concerned about the provision of speculative products such as CFDs, including rolling spot forex, and binary options to retail clients for a considerable period of time and has conducted ongoing monitoring and supervisory convergence work in this area,” the agency said.

Shares in IG Group, which has 40% of the UK spread betting market, fell as much as 14% before finishing 9.3% down on the day. CMC Markets and Plus500 plunged as much as 19 percent before closing 12.5% and 10.8% lower, respectively.

ESMA is an EU-wide regulator, based in Paris, which is tasked with improving the functioning of financial markets across Europe, in particular strengthening investor protection and co-operation between national competent authorities. This is Bloomberg’s take on a “contract for difference”.

It’s a financial product that allows an investor to make a bet on the direction of stocks, currencies and commodities without owning them. There are hundreds of thousands of CFD traders across Europe. For a time, Australia elevated CFDs from an over-the-counter product to listing them on the Australian Securities Exchange. Things are different in the U.S., where regulators have largely banned them for amateur traders.

While they are, in essence, leveraged derivatives, they are also available to retail investors in what is a rapidly growing market. Aite LLC, a Boston-based research firm estimates that daily trading in CFDs amounted to $22 billion in 2007, is currently about $75 billion and is expected to increase to $94 billion by 2019. Scrutiny of CFDs has been increasing due to their complexity and riskiness for retail investors, especially in the wake of the growth in trading of highly volatile cryptocurrencies. However, as Bloomberg notes, the proposed regulations are more stringent than expected.

Many investors were expecting ESMA’s action to be in line with a move made by the U.K.’s Financial Conduct Authority (FCA) in 2016, said Numis Securities Ltd.’s Jonathan Goslin. The agency proposed capping leverage, the amount of borrowed funds investors could use, at 50 to 1 with a 25 to 1 for traders with less than 12 months experience. But ESMA took a harder line, Goslin said: “It’s pan-Europe,” said the analyst, who recommends investors sell CMC shares.

The authority also said it was weighing whether to "restrict the marketing, distribution or sale to retail clients of CFDs." Regulators have criticized CFD advertising for being too aggressive and aimed at retail investors who don’t understand the products’ complexity.

Brokerages such as Plus500 market their offerings to retail investors through sponsorship deals with professional soccer clubs such as Atletico Madrid and Liverpool. Real Madrid forward Cristiano Ronaldo, who has a partnership with Exness Ltd. in London, touts the brokerage to his 66 million Twitter followers.

The FCA estimated that more than 80% of spread betting clients have lost an average of £3,300 ($4,400) on CFD products. A Liberum Capital analyst, Portia Peel, noted that the leverage limits will be a “concern” given that some providers offer leverage on specific products between 250-500:1. Furthermore, a fast-growing part of the CFD business is cryptocurrencies, which may be damaged by tougher regulations. On 14 November 2017, the UK’s FCA issued a statement warning investors that derivatives linked to cryptocurrencies are "extremely high-risk, speculative products”.

In response to the announcement, IG Group complained that the proposals on limiting leverage are “disproportionate”, while estimating that the hit to its revenues would be less than 10%. It also noted that more than half of its UK and EU clients may be “professional” investors not impacted by the rules. It did make one insightful point, however. If the ESMA’s proposals are too tough, investors could choose to trade CFD’s on unregulated exchanges beyond the reach of the EU.