Hearing on contracts for difference
Article from the Annual Report 2016 of the BaFin
In December 2016, BaFin initiated another hearing1, this time on contracts for difference (CFDs). BaFin wants to restrict the marketing, distribution and sale of CFDs in order to protect retail investors. The sale to retail investors of contracts entailing an obligation to make additional payments should then no longer be permitted.
In contracts for difference entailing an obligation to make additional payments, retail investors are unable to calculate the risk of loss, and BaFin finds that unacceptable. If the difference the retail client has to settle exceeds their invested capital, they have to settle the difference from their other assets (see info box "Speculating with contracts for difference").
Losses cannot be limited effectively
In BaFin's opinion, the risk of loss cannot be limited effectively, even if the margin call process is used. This is because price movements of an underlying can be so high within a very short timespan that the CFD issuer does not have the time to make a margin call on the investor to request additional collateral. In such a case, the investor's position would have to be closed out – compulsorily and, in some circumstances, at a loss. Likewise, stop-loss orders do not give investors protection against high losses. The reason is that the next available price at which such an order can normally be executed may vary significantly from the originally targeted price. In some circumstances, the investor will then have to settle a difference that is many times higher than the total amount invested.
Speculating with contracts for difference
When entering into contracts for difference (CFDs), investors speculate on changes in the price of underlying instruments, such as indices, shares, commodities, currency pairs or interest rates. The capital invested is lower than in the case of direct investments. Positive or negative changes in the price of an underlying instrument are tracked by the CFD. If the difference is positive, the investor receives the difference; if it is negative, they have to pay the difference.
The European Securities and Markets Authority had previously warned against CFDs on two occasions, most recently in July 2016. The products caught the public's attention primarily as a result of the Swiss franc shock at the beginning of 2015. At the time, the Swiss National Bank abandoned the minimum exchange rate for the euro, causing many CFD investors to incur heavy losses because they were obliged to make additional payments. Several studies conducted by national supervisory authorities in the EU have confirmed that clients have often lost money with CFD investments.2 In addition to findings made in the course of ongoing supervision, BaFin had also received a number of customer complaints about CFDs.
Comments on the draft general administrative act could be submitted until 20 January 2017. No decision had been taken on this issue by the time of going to press.
Footnotes:
- 1 See hearing on credit-linked notes.
- 2 See, among other publications, press release by the Central Bank of Ireland of 23 November 2015 and press release by the Autorité des Marchés Financiers of 13 October 2014.
