The European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) recently published a warning to retail investors about the dangers of investing in contracts for difference (CFDs).
Steven Maijoor, chair of ESMA.
The two supervisory authorities are concerned that during the current period of low investment returns, inexperienced retail investors across Europe are being tempted to invest in complex financial products, such as CFDs and spread bets, which they may not fully understand and which can end up costing them more than their initial investment and more than they can afford to lose.
In a statement, Andrea Enria and Steven Maijoor, chairs of the EBA and ESMA respectively, said: “Retail investors across the EU should be aware of all the risks arising from investing in CFDs. These products appear to promise investors substantial returns at a low cost but may ultimately cost them far more than they may have intended or could afford to lose.”
The warning highlights the benefits of leveraged long and short exchange-traded products (ETPs), which provide an attractive, risk-controlled alternative to CFDs and spread betting.
Short and leveraged ETPs, which typically come in 1x, 2x, and 3x long and short formats, can deliver similar geared investment outcomes to CFDs but boast a number of core advantages. These include: reduced credit risk and enhanced collateral protection; greater liquidity and ability trade in large sizes; no margin calls or position close-outs; and superior transparency.
Among these advantages, the key attractions for retail investors are that they cannot lose more than their initial investment and that their capital is well protected in the event of a credit default (many investors lost money when World Spreads, a popular spread betting firm, went bust in March last year).
Globally, assets under management within short and leveraged ETPs stand at around $45 billion, with roughly just under $10 billion of this residing in Europe. In Europe, the main purveyors of these products are Boost, ETF Securities, db X-trackers and Lyxor, while in the US, Direxion and ProShares are the dominant players.
Unlike CFDs and spread bets, which mainly tend to be available only on equities, currencies and commodities, with ETPs investors can also gain short and leveraged exposure to fixed income, volatility and credit asset classes (in addition to equities, commodities and currencies).
Commenting on the ESMA and EBA warning, Hector McNeil, Co-CEO of Boost, a London-based specialist in three-times short and leveraged ETPs, said: “One of the main reasons that we focused on 3x leverage and 3x short ETPs was because investors were telling us they wanted a robust alternative to CFDs and spread betting. Many investors were concerned that they were often ‘closed out’ during volatile markets and missed the recovery in the markets when they occurred.”
He added: “Investors also told us they were concerned with counterparty risk management following MF Global and World Spreads collapse. As a result, Boost ETPs are over collateralised, adding a layer of comfort missing from CFDs and spread bets. Other features such as multiple market makers, exchange traded and product transparency mean that Boost ETPs are best of breed in the leveraged space.”