Despite what you may have read elsewhere, contracts-for-difference (CFDs) are not banned in the US, nor are they illegal.
There is no regulation or law issued by any US financial regulator that explicitly names CFDs and says they are either ‘banned’ or ‘illegal’.
The only slightly plausible argument you can make is that most CFD products are implicitly banned, but not explicitly. Even this is not a convincing argument to make.
Why is that?
In very simple terms, CFDs in the US are considered to be security-based swaps or swaps.
An important exception to this are rolling spot FX contracts.
These are considered to be CFDs by most other major global regulators, including the UK’s Financial Conduct Authority (FCA) the European Securities and Markets Authority (ESMA), and the Monetary Authority of Singapore (MAS). In the US they are not.
Both of these points matter. Let’s look at why.
CFDs or swaps?
To start with, let’s look at what the actual regulation of CFDs in the US is.
We think the International Organization of Securities Commissions (IOSCO) – a global association which counts over 200 financial regulators as members – has a great, simple overview of this, so we’ll quote them in full from their report on retail OTC leveraged products:
In the United States…Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, CFDs and binary options may be classified as swaps or security-based swaps. In those instances, they may only be offered to retail investors if the transaction takes place on a registered exchange.
The most important part here is the last one – that CFDs must be exchange-traded.
This is the reason some people say that CFDs are banned in the US.
They believe that because CFDs are usually traded over-the-counter (OTC) and off exchange, this means they are banned or illegal in the US.
But that’s not the case. Exchange-traded CFDs exist. They used to trade on the Australian Securities Exchange and still trade today on the JSE in South Africa. There have also been exchange-traded CFDs in Romania and Japan.
And guess where else exchange-traded CFDs have been traded before? The US.
As the IOSCO report notes:
In the United States some binary options and some CFDs are (or have in the past been) listed and traded on registered exchanges or designated contract markets such as the Chicago Board of Options Exchange, Nadex (North American Derivatives Exchange) and the New York Stock Exchange.
As the quote correctly states, there are lots of companies offering binaries to US customers on exchanges. In most other countries, these products are traded off exchange and on an OTC basis. No one would say that they are banned in the US because of this.
Although they have proven less successful, exactly the same dynamic applies to CFDs in the US. Saying that they’re banned because they have to be exchange-traded makes no sense because there have been CFDs that traded on-exchange in the US before!
So why don’t companies offer CFDs in the US?
Given that you can, in theory, offer CFDs in the US, you may ask why more exchanges don’t do it.
There are a few reasons for this.
- There is little incentive
CFDs are similar to futures contracts. Indeed, the prices of many popular CFDs are derived from underlying futures contracts.
The US already has lots of opportunities to trade futures.
For individual investors, this is only becoming more pronounced with the rise of smaller contract sizes and spot futures contracts.
To top that off, US investors can also trade in options, binaries, and crypto derivatives.
The result is there is little incentive to offer CFDs in the US because exchange-traded products already exist that offer many of the same features as CFDs.
- Experience
Compounding this first point is the fact that many of the benefits a trader accrues from CFDs traded on an OTC basis are hard to replicate on exchange. Moreover, an on-exchange CFD ends up looking a lot like a futures contract anyway.
To give one example, an OTC CFD contract can be customised in size to the trader’s needs. On exchange instruments have standardised contract sizes and margin requirements, meaning this is not possible to do.
This again goes back to the futures contracts. Many of the features that you would get from an exchange-traded CFD are very similar to what you get from a futures contract. Consequently, it would make more sense for US traders to just trade in futures, rather than exchange-traded CFDs.
- Worse pricing and poorer liquidity
Exchange-traded CFDs have tended to have poorer liquidity and worse pricing than assets traded on an OTC basis.
If you were in the US specifically, this would probably end up happening again because of the fact you have existing products with very similar features to CFDs already.
Rolling spot forex in the US, CFDs elsewhere
Another very important fact to keep in mind when you hear about CFDs being ‘banned’ in the US is that Americans can trade rolling spot FX contracts without the same caveats as above.
US retail traders can trade rolling spot forex contracts easily on an OTC basis, with no requirement for them to be exchange-traded.
The reason we believe this is worth highlighting is that almost every other major jurisdiction considers rolling spot FX contracts to be CFDs. This is true in the UK, Singapore, Australia, and the European Union, for example.
So to say that CFDs are prohibited in the US is somewhat misleading. The US does not regulate rolling spot FX contracts as CFDs, even though most other jurisdictions do.
The situation here is very similar to Hong Kong. It’s common to hear that CFDs are ‘banned’ in Hong Kong. In theory this is true.
In practice, Hong Kong does not regulate leveraged OTC contracts on FX and precious metals as CFDs. The result is that Hong Kong companies can offer FX and precious metals products that would be regulated as CFDs in the UK, EU, Australia and several other jurisdictions.
The same is true of forex trading in the US. In almost every other major jurisdiction, the forex contracts that US traders can access would be regulated as CFDs. In the US they aren’t.
Guilty by association
Ultimately the claim that CFDs are banned or illegal in the US is damaging to the reputation of the product and the wider industry that lets users trade in them.
If someone tells you a product or service is illegal in a given country, your inference is almost certain to be that this product or service is bad. That feeling is only going to be felt more acutely if you don’t understand what the product or service is.
When people say CFDs are banned in the US, this is what they are doing – unintentionally or not.
Saying that the largest economy in the world, with perhaps the most respected and influential set of financial regulators globally, have made CFDs illegal, automatically makes people assume that the product must be bad in some way.
What makes this even worse is that many of the people claiming that CFDs are banned have clearly done no research into the topic and often don’t understand the product or the different jurisdictional regulatory regimes which govern it globally.
The result of this is they end up inventing random reasons that the US has banned CFDs. Even more ridiculous is that many articles cite other articles doing the same thing as evidence of their claims!
Some common claims we see about the US ‘banning’ CFDs, include the following:
- US regulators banned CFDs because leverage is high
This is an asinine claim. The US allows futures trades for retail clients which provide leverage that is higher than you get with CFDs in many other jurisdictions – why don’t they ban these products if they don’t like leverage?
More importantly, there is no rule or regulation anywhere that says CFDs are prohibited because they have high leverage. This is something the authors of these articles have invented.
- The product is toxic, evil, not sophisticated, or some other negative trope
There is no doubt that the large majority of marketing and public awareness of CFDs is for their use among retail traders. But the reality is hedge funds and large asset managers use them too.
For example, today there are funds run by a large number of asset managers, including JP Morgan, Blackrock, and Invesco, that make use of CFDs. The biggest asset managers in the world would not make use of a product that was inherently bad or evil.
- That the US is more ‘ethical’ and its regulators are against complex, speculative products
Another vague claim that is made is that the US banned CFDs because they have lofty moral standards and don’t like speculative products.
The first point to note here is how obviously reverse engineered this argument is. You clearly have people who ‘discovered’…
- CFDs are ‘banned’ in the US
- Concluded CFDs are bad
- Made up the argument that US regulators are more ethical because they banned a bad thing
As with the above, there is no factual basis to this argument.
And that is something you can clearly see from the fact that the US allows options, futures, perpetual futures, forex, and binary options. It is hard to see how anyone could argue US regulators are against speculation when they allow these products to exist and for retail traders to access them.
Ending the myth
Ultimately we think a mix of incuriousness, laziness, and a lack of understanding of the product have all contributed to the myth that CFDs are banned in the US.
That has been compounded by a kind of circular information flow. People assume the product is banned, then quote other people who say it has been banned, and the cycle continues.
To top that off, there are lots of people who seem to want there to be a US CFD ban, even if it doesn’t actually exist in writing.
These are nearly always individuals who have some pre-existing dislike of the product, typically because they see it as ‘unethical’, and others who are motivated to dislike a product that trades OTC and have a financial interest for financial products to trade on exchange.
That’s all well and fine but it doesn’t change the fact that there is no CFD ban in the US. It’s a myth and one that should finally be put to bed.
