Investors will be prevented from using contracts for difference (CFDs) from next month unless they satisfy strict new rules aimed at counteracting mis-selling of the high-risk stock market instruments.
The crackdown will force brokers that offer CFDs – highly-leveraged bets that allow investors to profit from movements in a share price without owning the underlying share – to conduct detailed investigations into individual clients, to find out whether they fully understand the risky nature of the products and the extent of the potential losses to which they are exposed.
A number of CFD investors suffered multi-million euro losses in August, when the share prices of companies to which they were exposed suffered sharp falls of as much as 10 per cent in the space of 24 hours.
Some of the investors who had failed to react to the falls quickly and adjust their trading strategies were forced to liquidate their positions and sell out before prices rebounded.
From next month, however, brokers will be obliged to refuse to carry out client instructions if they fail to satisfy themselves that the client is equipped to deal in CFDs or if they feel the client has insufficient resources to suffer losses.
They will also be obliged to warn investors not to proceed with a transaction if they feel investing in CFDs is not appropriate to their circumstances.
Clients, meanwhile, will be required to provide brokers with information detailing their financial position and evidence of their investment track record before dealing in CFDs.
This contrasts sharply with existing practice in some firms, which only required clients to sign a disclaimer before commencing trading.
CFD trading was widely considered to be a specialised niche activity until recently. Investor interest in the instruments surged on the back of a steady rise in the Iseq index, however, as they allowed investors to make substantial profits without the need to put up large amounts of cash up front.
Confidential briefing documents seen by The Sunday Business Post disclosed that the Irish Stock Exchange estimated that CFD trading accounted for up to 50 per cent of all its share trading activity.