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Is Overregulation Killing the CFD Markets?

- By Jacob Maslow

Contract for difference trading is in trouble. Volumes are down and regulation is hitting markets around the world. Since its inception in the 1990s, CFD trading has evolved into a trillion-dollar industry. The advancement of the internet opened CFD trading to retail traders and, as such, an ever-increasing number of online brokerages sprang up very quickly.

The sometimes quite intense competition between brokers and a rapid rise in online CFD trading among the "make money online" targeted audience saw leverages of up to 500:1 being offered along with dreams of instant trading success. This often resulted in highly leveraged retail accounts going bust, with some even owing the broker money from losing positions held for too long.

Some less than savory practices were exposed in the binary options industry, which by 2018 saw all but a handful of platforms close up shop. As of Aug. 1, the European Securities and Markets Authority restricted CFD trading leverage to 30:1 and 2:1 dependent on the underlying asset's volatility. The restrictions were reviewed on Feb. 19 and extended for another three months. Currently, the rules must be renewed by the pan-European regulator every three months.

The ESMA intervention measures had a sizable impact on CFD brokers. CNC Markets PLC (CMCX.L) posted a trading update in April, reporting CFD trading and spread betting revenues were 37% lower from the same time last year. The decline from 131 million pounds ($170.7 million) to 110 million pounds was attributed by CMC Markets to reduced client trading activity following the implementation of ESMA's restrictions. Profit before tax fell 76%, from 29.8 million pouds to just 7.2 million pounds for one of the first and largest CFD trading platforms.

Polish broker X-Trade Brokers (WAR:XTB) also felt the pinch from the ESMA restrictions. The retail brokerage posted a 4.4% decline in revenues for the first quarter of 2019. The Polish company cited product intervention measures from ESMA contributing to lower volatility and reduced customer engagement.

Some regulators have taken it upon themselves to make the restrictions a permeant regulation. On April 19, the Dutch Financial Markets Authority joined the U.K.'s Financial Conduct Authority, Germany's BaFin and the French Autorite des Marches Financiers to either pass as law or committing to making the ESMA restrictions permanent. The FCA did, however, recently announce that due to ongoing Brexit negotiations, the publication of the final rules that will govern the retail trading industry will be pushed back to "Summer 2019."

So are the latest ESMA regulations, set to come into effect July 30, the final nail in the CFD trading coffin? Probably not.

The online trading world needed to clean up its act after a period of almost wild, wild west behavior for much of the early years. Abuse from brokers and the targeting of uneducated and inexperienced traders meant leverage of 500:1 was nothing more than financial suicide. The latest regulations reduce leverage even further, down to 20:1, and even less for indexes and commodities. This emphasis on risk management is something that protects the everyday trader. It removes some of the key risks from the leveraged investment market within the European Union, creating a safer trading environment for anyone dealing with a broker regulated by the organization.

Regulation isn't killing the CFD trading markets. A lot of the damage was done by brokers offering dangerously high leverage and bonuses. Regulation was needed, but it will be interesting to see how many more online platforms pull out of the CFD trading markets once the new regulations kick in.

Disclosure: The author does not have any stakes in the listed equities.

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This article first appeared on GuruFocus.