The Small Print in CFD/Spread Betting Accounts

Q:How safe are client funds?

A: In the UK CFD providers are authorised and regulated by the Financial Conduct Authority (FCA). Under the rules, clients are classified as either private or intermediate customers. This decision is made by the compliance department of the CFD provider and will take into account the applicants’ knowledge of CFDs together with their experience of trading on margin. A number of CFD providers will only take on intermediate customers.

The key from the providers’ perspective is to accurately assess the client’s understanding of the risks, since those sufficiently familiar with these areas will be categorised as intermediate customers and consequently will not benefit from the same level of protection afforded to private customers.

Intermediate customers do not enjoy the protection of rules relating to the issuing of direct-offer financial promotions, the obligation to disclose charges, remuneration and commission in writing, restrictions on the ability to lend money or grant credit to private customers, the notification of the circumstances in which a customer may be required to provide any margin requirements and ensuring that customers are able to obtain a reasonable price for non-exchange traded securities.

There are also other key differences for intermediate customers. In particular, money held on behalf of these clients will not be subject to the protections conferred by the FCA’s client money rules. In other words these funds will not be segregated in a ring-fenced account.

The one advantage of this is that pooling together the intermediate customers’ funds enables them to enjoy a higher rate of interest than private customers. On the downside though, in the unlikely event of the company becoming insolvent, intermediate customers would only rank as general creditors, making it less likely that they would get all their money back. In addition, intermediate customers do not have the automatic right to receive ‘best execution’ in all markets and lose their rights of access to the financial ombudsman scheme.

Client Money Risk

Please note however that although CFD providers are required to separate client monies from their own monies, they are not however obliged to separate your money from the monies of other clients and a number of CFD brokers ‘pool’ all their clients’ money into one or more pooled client accounts. Because most CFD brokers pool the monies of different clients together into one or more client accounts, your access to the monies held by the CFD provider could be impacted if other clients fail to pay the CFD provider the money they owe. For instance, if the CFD company’s bulk of the business is focused on a few clients and one or more of those investors suffer trading losses which the client can’t cover (for example, on a losing trade), this may cause serious financial problems for the CFD broker, which may then affect whether or not they can meet their obligations to clients.

CFD provider may also decide to ‘hedge’ some or all client trades with one or more other companies. This means that if you place a CFD trade over a particular security, commodity or index market, the CFD broker may take out matching arrangements with another company to acquire exposure to that security, commodity or index for internal risk management purposes. If the other company doesn’t deliver what they promised under the hedging arrangement, there can again be problems. If the CFD provider hedges with multiple companies of strong financial standing, this can reduce the risk of something going wrong.

This is why it is essential for you to use a regulated CFD provider that is listed on the stock exchange and that is well capitalised. The fact that they are listed on the stock exchange means that they have to issue a circular if anything material is going to impact their business which ultimately means a better level of accountability and transparency. The customer agreements used by some OTC CFD providers permits them to make withdrawals from client monies for a number of other purposes. You should check the details carefully as these clauses mean that your money is much less protected. Read the terms of the client agreement and personal disclosure statement carefully to find out where you stand. Check the financial statements of your CFD provider, if they are available (and they will be available if the broker is listed on an exchange; both IG Markets and Capital CFDs for instance are listed on the London Stock Exchange), to get some idea of whether they have sufficient financial resources and cash available to run their business.

If you open an account with a CFD broker based in the United Kingdom you are also protected by the Financial Conduct Authority under the Financial Services Compensation scheme. In the event the provider was to go into liquidation individual clients of the CFD provider are covered by the Financial Services Compensation Scheme (FSCS). Clients get the first £30,000 in full + 90% of the next £20,000. Maximum payout per client if the firm goes bankrupt is £48,000. Note that this protection applies even to international clients – all you need is to make sure that you have a UK account, say with Capital CFDs [some providers will direct you to their international sites (so if you are in Germany they might prompt you to sign up at IGMarkets.de) which may not carry this additional protection].

Q:The small print on CFD/spread betting accounts worries me…

It seems to be standard practice for you to have to sign away your FCA regulated rights, and that your cash and securities can be held in the “broker’s” general accounts offering no segregation in case of their insolvency.

A: To my understanding, during the lead up to MiFID when everyone was freaking out about it the FCA’s view was essentially, “you’d better not non-segregated ‘widows & orphans'”. Indeed, MiFID threw a big spanner into all of this. I queried a professional acquaintance from an industry leading firm and the acquaintance said that the FCA told that person that they liked the “old” way of pre-MIFID separating “private” (seg) from “intermediate” (non-segregated) customers.

The damn difficult thing about MiFID is that almost everyone is going to be defined as a “retail” customer, but then, at the same time, you have this Title Transfer Collateral thing which as I’ve read in the FCA regulations, can theoretically enable anyone to get non segregated treatment from the CFD provider.

Bottom line is that it’s your choice – not the firm’s – to be non-segregated. You tell them you don’t want to be subject to a Title Transfer Collateral arrangement and to confirm same to you in writing. They can say no, but they can’t take your business. Hit up the next shop and you’ll get it to work out for you eventually.

Now, under MiFID any classification of client can enter into the Title Transfer Collateral arrangement and that effectively gets them out of segregated funds status. Also, MiFID requires a best execution policy across the board…no more “spread bet waiver”. This means that at most providers anyone can get a CFD account. When you sign up now, you’ll be handed this “trade and execution policy” or something similarly titled. There is your best execution…so in the end a paper job and its business as usual even with MiFID but you, the client, have to be shepherded to that result via different legal gymnast cities that existed pre-MiFID.