CFDs under focus: Central Bank probe finds 75% suffered loss

Seven years after the market instruments known as Contracts for difference — or CFDs — helped destablise Anglo Irish Bank and added to the country’s huge losses from the fallout of the banking collapse, they are again causing the regulators here some concern.

The Central Bank yesterday warned ordinary investors to be aware of the “high risk” nature of CFDs, saying they are not suitable for people who cannot sustain big losses.

In a themed investigation of CFD transactions in the last two years, the Central Bank found three quarters of retail clients of Irish investment and broking firm selling CFDs made a loss. It found most of the nine brokers who sell CFDs in Ireland were warning their clients about the potential risks, and ordered those who were not complying to do so.

CFDs are notorious here because of the €2.4bn in losses Seán Quinn generated as he used CFDs to gamble that Anglo Irish shares would continue to soar in 2007 and 2008 — just as the spectacular collapse of the Irish banking industry was drawing ever closer.

But despite their notoriety and their billing as complex instruments, CFDs are relatively straight forward. They allow stock market investors to acquire exposure to a large chunk of the underlying share with a relatively small outlay. This creates big problems.

They are leveraged products and when a stock price rises this can lead to substantial profits for the investor. But when things go wrong, they expose investors to huge margin calls and significant losses.

As in the Quinn case — though Mr Quinn was not the only high-profile investor to lose badly — CFDs become extremely dangerous when the investor borrows huge amounts to maintain and fund CFD positions as the underlying stock continues to slide.

Not surprisingly, the Central Bank and the new regulatory regime after the disastrous failings of the former regime are sensitive to any whiff CFDs would again lead to substantial losses. Its inspection of transactionx in 2013 and 2014 found:

* There were over 39,000 retail clients, of which 5,000 were Irish residents, investing in CFDs with Irish-based brokers.

* 75% of clients made a loss, of which the average loss was €6,900.

* Some brokers over-estimated the client’s knowledge and experience and failed to maintain up-to-date records.

* Some marketing material was not presented in a sufficiently-balanced way. “It is our view that CFDs are unsuitable for investors with a low-risk appetite,” said Bernard Sheridan, the bank’s director of consumer protection.