In finance, a contract for difference (CFD) is a financial agreement between two parties, commonly referred to as the "buyer" and the "seller."
[1] Developed in Britain in 1974 as a way to leverage gold, modern CFDs have been trading widely since the early 1990s.
The invention of the CFD is widely credited to Brian Keelan and Jon Wood, both of UBS Warburg, on their Trafalgar House deal in the early 1990s.
[4][5][6] CFDs were initially used by hedge funds and institutional traders to cost-effectively gain an exposure to stocks on the London Stock Exchange (LSE), partly because they required only a small margin but also, since no physical shares changed hands, they also avoided stamp duty in the United Kingdom—trades by the prime broker for its own account, for hedging purposes, are exempt from stamp duty.
Several firms began marketing CFDs to retail traders in the late 1990s, stressing their leverage and tax-free status in the UK.
GNI's retail service created the basis for retail stock traders to trade directly onto the Stock Exchange Electronic Trading Service (SETS) central limit order book at the LSE through a process known as direct market access (DMA).
[10] However, unlike CFDs, which have been exported to a number of different countries, spread betting, which relies on a country-specific tax advantage, has remained primarily limited to the UK and Ireland.
[14] CFDs are treated as a gambling product in Hong Kong unless they have been permitted by the Securities and Futures Commission (SFC),[15] which treats CFDs, where the underlying is a security, as futures contracts, that must be exchange-traded, effectively precluding their being offered in Hong Kong.
The advantages and disadvantages of having an exchange traded CFD were similar for most financial products and meant reducing counterparty risk and increasing transparency but costs were higher.
The disadvantages of the ASX exchange traded CFDs and lack of liquidity meant that most Australian traders opted for over-the-counter CFD providers In June 2009 the Financial Services Authority (FSA), the UK regulator, implemented a general disclosure regime for CFDs to avoid them being used in insider information cases.
[19] This was after a number of high-profile cases where positions in CFDs were used instead of physical underlying stock to exempt them from the normal insider information disclosure rules.
[17] This was after they observed an increase in the marketing of these products at the same time as a rise in the number of complaints from retail investors who have suffered significant losses.
[22] This was followed by the UK Financial Conduct Authority (FCA) issuing a proposal for similar restrictions on 6 December 2016.
[24] The German regulator BaFin took a different approach and in response to the ESMA warning prohibited additional payments when a client made losses.
[25] In March the Irish Financial Regulator followed suit and put out a proposal to either ban CFDs or implement limitations on leverage.
In Australia, the Australian Securities and Investments Commission (ASIC) has established leverage limits for retail CFD trading.
A House of Commons Library report explained the scheme as:[29][30] Contracts for Difference (CfD) are a system of reverse auctions intended to give investors the confidence and certainty they need to invest in low carbon electricity generation.
CfDs also reduce costs by fixing the price consumers pay for low carbon electricity.
The costs of the CfD scheme are funded by a statutory levy on all UK-based licensed electricity suppliers (known as the 'Supplier Obligation'), which is passed on to consumers.In some countries, such as Turkey, the price may be fixed by the government rather than an auction.
This means that a CFD trader could potentially incur severe losses, even if the underlying instrument moves in the desired direction.
These range from trading in physical shares either directly or via margin lending, to using derivatives such as futures, options or covered warrants.
The main advantages of CFDs, compared to futures, is that contract sizes are smaller making it more accessible for small traders and pricing is more transparent.
[contradictory] Similar to options, covered warrants have become popular in recent years as a way of speculating cheaply on market movements.
With the advent of discount brokers, this has become easier and cheaper, but can still be challenging for retail traders particularly if trading in overseas markets.
[citation needed] Some financial commentators and regulators have expressed concern about the way that CFDs are marketed at new and inexperienced traders by the CFD providers.
[44] In anticipation and response to this concern most financial regulators that cover CFDs specify that risk warnings must be prominently displayed on all advertising, web sites and when new accounts are opened.
[3] It is impossible to confirm what the average returns are from trading as no reliable statistics are available and CFD providers do not publish such information, however prices of CFDs are based on publicly available underlying instruments and odds are not stacked against traders as the CFD is simply the difference in underlying price.
This topic appears regularly on trading forums, in particular when it comes to rules around executing stops, and liquidating positions in margin call.
Providers of contracts for difference (CFDs) often target potential investors through magazine advertisements, newspaper supplements, prime-time television spots and websites.