ESMA should ban CFD passporting

Speak to Centroid Solutions about your bridge and risk management technology.

We have a new podcast out.

This time we speak to Norayr Djerrahian – Chief Strategy Officer at Hantec Markets.

Listen via the links below.

ATFX is on a hiring spree – read about it here.

There are two things that you may or may not agree are true.

One is that people have always wanted to speculate on financial markets. You can find examples of this happening in Ancient Rome, 14th century Venice, and 17th century Netherlands. In the UK in 1734, legislation was introduced to try and stop people from speculating on financial markets without them owning the relevant underlying assets. It failed. If you follow the ‘Lindy effect’ way of thinking, then financial speculation is going to be with us for a long time to come.

The other thing is that governments the world over need more tax revenues. If you look at the US, for example, you will have noticed that they are increasingly opening up to gambling. This is because states need more tax revenue.

What does this have to do with anything?

Last week we asked if the CFD industry was ‘done’ and part of the reason for that is regulatory pressure in Europe. Over the last couple of months some providers have basically stopped doing business in Spain, where you are now effectively banned from promoting CFDs at all.

The problem is that this doesn’t deal with the fact that people still want to speculate on markets – as they always have. We already saw that clients just go offshore in many instances for higher leverage. Another consequence of this could be that people shift to options and futures trading, although in Spain’s case it looks like they’ll restrict these as well.

The latter point is interesting because it basically means the large majority of revenues will shift to market makers and exchanges in the US. But if you look at research by Spain’s regulator, other research in India, or in the US, the win-loss ratio of clients trading ETDs is basically exactly the same as it is for CFDs. In fact, Spain’s regulator says 75% of CFD traders lose money, which is lower than the equivalent figures for options traders in India and the US that I have seen.

The point here is that, if you accept the premise that people want to speculate on markets, then you may as well let them do it in such a way that it is (1) regulated / done properly and (2) you get tax revenues from it. US companies already take so much potential tax revenue from European countries, usually via Ireland, so why let this happen in another industry?

Part of the problem for EU countries is the passporting mechanism. How much of the revenue that CFD trading generated in Spain actually remained in the country and how much was siphoned back to Cyprus or other countries?

I would estimate that the large majority went out of the country. Clearly from the Spanish regulator’s point of view, this is a product they don’t like and there is no monetary benefit for them to counterbalance this view.

Contrast this to Poland where (1) XTB is now one of the largest listed firms on the Warsaw Stock Exchange and (2) they have paid upwards of $100m in tax revenue over the last three years and you understand why the Polish regulator has been happier to ‘play ball’ with the industry. This is also true in the UK where, among other things, spread bet losses can’t be claimed back as a capital loss from the taxman as they are technically a gambling product.

So what could actually work? No one is going to listen to me but from my point of view there are a few policies that regulators could make which would help things work properly.

1. Ban CFD passporting in Europe. All companies must have a small local presence / entity and any revenues generated in country are subject to local corporation tax. Any company that creates fake expenses to send revenues back to another corporate entity is banned permanently from operating in that country.
   
2. End binary choice of retail or professional classification. There is a huge chasm between someone with no financial experience and someone who has the cash and experience to be professional. Current restrictions are appropriate for someone who is a beginner / doesn’t know much. Some kind of middle ground should exist that gives you access to higher leverage – nothing else – and which is means tested by the regulator, not a company, with any associated costs paid for by the industry. Poland’s regime is a good start. Note that in the UK this would also benefit investment platforms, who have been needlessly hit by Consumer Duty overreach.
   
3. Actually punish people and companies who break serious rules. One of the differences between the US and Europe is that the US is much more laissez-faire / buyer beware culturally. But if you deal with retail and break their rules then you are toast. Too often companies in the UK / EU get away with a slap on the wrist but their poor corporate governance ends up causing the regulator(s) to hate the industry even more, leading to more restrictions on it. Actually punishing these people / companies should be a priority and act as a warning against further bad behaviour.

Note that this logic applies to pretty much any country. The key benefit of CFDs for the taxman is the fact it internalises revenues and keeps them in country.

Would it work? I think so but would need to be fleshed out more. Will it happen? Probably not.