London's spread betting sees murky future after regulatory blow

The proposals by the UK markets watchdog, the Financial Conduct Authority, to restrict the amount that customers, especially inexperienced ones, could borrow to back their trading positions was a bolt few were expecting.

The plans also set out to curb trading of binary bets, which allow traders to bet whether the price of a financial instrument will be higher or lower than a fixed threshold at a future point in time.

For an industry trying to rebuild confidence after the Swiss franc shock of 2015 burnt its customers, this was an unwelcome St Nicholas day gift.

“This is negative — period,” says Peter Lenardos, an analyst at RBC Capital Markets in London. “When the companies say they can’t quantify the impact, that’s negative.”

“

“

The reaction was severe. The share prices of the three most high profile companies, CMC Markets, IG Group and Plus500 dropped 35 per cent, 40 per cent and 28 per cent respectively

”

In one regard, the FCA’s plans bring the UK into line with European counterparts, where authorities are growing concerned at a proliferation of speculative products such as contracts-for-difference (CFD), binary options and rolling spot forex, as well as a surge in complaints from investors who have lost thousands of pounds.

Products are not standardised, the features of the product can be different from one provider to the next and watchdogs are concerned that many products are being offered by unauthorised and unregulated entities.

Several EU countries, including Belgium, France, Cyprus and the Netherlands, have announced plans to ban promotions of CFDs, a product that allows customers to gamble on price movements without owning a particular share, which is subject to stamp duty.

But the regulator’s proposals hit London especially hard. In the past 15 years the UK capital has been the European home of CFD trading, burnishing the fortunes of millionaires such as Peter Cruddas and Stuart Wheeler, pioneers of spread betting, and drawing in businesses from other countries such as Cyprus.

Further reading on the FCA move

● Lex: IG’s experience in Japan means caps could hurt
● Case study: One trader’s pain on the Swissie
● News: Watchdog clamps down on spread betting groups

In the past six years alone the number of retail CFD providers has doubled and there are now 97 authorised companies, the FCA estimates. Most of that has been down to improvements in technology, which have lowered the cost for new companies to set up.

UK-based companies have about 125,000 active clients in retail CFDs in Britain and — the regulator conservatively estimates — some 400,000 active traders outside the country. They collectively hold about £3.5bn in client money.

“

“

The UK’s proposals highlighted that there were about 130 companies registered to provide cross-border services into the UK under European rules, with the majority based in Cyprus

”

Jake Green, regulation partner at law firm Ashurst, said the clampdown was a shock because the regulators had not indicated it was coming during detailed industry briefings earlier this year. “This is less an example of ‘conduct regulation’, rather, ‘product intervention’,” he said.

The FCA acknowledged that the largest UK provider had about 40 per cent of the market and another half dozen made up a further 30 per cent share, with a long tail of smaller companies making up the remaining 30 per cent.

“CMC Markets and IG Group — the two that operate to the highest standards in the industry in our opinion — are collateral damage,” says Mr Lenardos.

When the companies say they can’t quantify the impact, that’s negative
Peter Lenardos, analyst at RBC Capital Markets
For investors such as Mr Cruddas, who owns 57 per cent of CMC, and Goldman Sachs, a 5 per cent shareholder, the reaction may last for several years after the rules come into effect.

Many drew a comparison to a crackdown by Japanese regulators six years ago, which steadily reduced the amount of leverage available to customers from 100 times to 25 times. Revenues from IG’s Japanese business halved over four years, say analysts at Liberum.

CMC, which as of September 30 2016, derived 93 per cent of its net operating income from CFD and spread betting revenue, argues it focused on “higher value experienced premium clients who understand the markets and products they are trading”. IG said the FCA’s proposals “do not appear to directly apply to firms operating from outside the UK” that passported their services under European rules.

“

“

Some lawyers said they had already been contacted by their CFD providers about moving overseas but others warned the rules were being applied across Europe

”

And others doubted it would deal a fatal blow to the CFD market London has painstakingly built.

Sam Tyfield, a partner at London-based law group Vedder Price, said market reaction had been “a bit hyperbolic”, as CFDs offered retail investors access to markets that would not otherwise be within their budget, and allowed for a tax-efficient way of trading.

“Everyone’s gone into a bit of a tailspin,” he said. “It’s an established product that is not necessarily traded by inexperienced retail clients.”

In the short term there would be a negative impact, said Justin Bates, an analyst at Liberum, “Over the medium to long-term we expect this to result in a positive outcome, ie driving out some of the private and more unscrupulous operators.”

But that is likely to be a significant shift. Mr Green said consolidation or diversification was likely as providers focused on retaining customers. “You’ve got two options. You either go into more of a conservative, share-trading robo-type product or you pull out of UK financial services regulation and go into more of a gambling company,” he said.