Trading in contracts for difference (CFDs) remains restricted
The Czech National Bank has decided to restrict trading in contracts for difference (CFDs) for retail clients. This step is a follow-up to the temporary measure which was issued with EU-wide effect by the European Securities and Markets Authority (ESMA) in May 2018 and which restricted the marketing, distribution and sale of this investment instrument.
A provision of a general nature (pdf, 13 MB, in Czech only) was published on the CNB’s official board and takes effect on 9th August 2019.
A contract for difference (CFD) is a speculative derivative that began to develop on financial markets with the advent of the internet mainly at the start of the millennium. It is a contract between the buyer and the seller about the payment of the difference between the prices of an underlying asset at the time of opening the position and at the time of closing it. If the client estimates correctly the price movement of the asset and the difference is positive, the provider pays it to the client. But if the difference is negative, the client pays instead to the provider. Thus, only the price difference is the subject of the transaction. Underlying assets include exchange rates, shares, precious metals or stock indices and the price of the asset is usually determined with reference to an agreed reference market.
The main risk of investing in contracts for difference is the extremely high probability of loss – up to 89% of accounts of retail clients in Europe recorded a loss at the start of last year. But even if the client is successful, his profits are reduced by fees.
The problematic nature of CFDs is amplified by leverage, which may increase the client’s profit but also exacerbate the client’s loss significantly if the price movement estimate is wrong. Some clients were not aware that their loss may exceed several times the deposit due to leverage.
The CNB has repeatedly drawn attention to the unsuitability of CFDs for retail (non-professional) clients. Professional clients are defined in the Capital Market Undertakings Act. Generally, they are entities assumed to have sufficient experience in financial market trading. The CNB’s notices about the risks relating to CFD trading and the CNB’s Financial Market Supervision Reports are available at www.cnb.cz.
Before the ESMA restricted CFD trading, the CNB had received dozens of complaints by aggrieved clients of foreign traders. According to ESMA data, the situation improved markedly after the restriction on these trades was introduced in August 2018 (for example, the number of client accounts with a negative balance dropped almost sevenfold).
Although the provision of a general nature does not entirely prohibit investment in CFDs, it protects retail clients with a number of measures, such as a limit on leverage, protection against a loss exceeding the initial deposit and the prohibition of some related practices. Nevertheless, it still holds true for those CFDs which remain allowed that they are unsuitable for inexperienced clients who do not have sufficient knowledge, financial reserves or time to monitor developments in positions. Investment firms should carefully define a suitable target market as part of the rules for the creation of products and clients should be very cautious when dealing with such risky instruments.
Markéta Fišerová
Director of the Communications Division and CNB Spokesperson