New rules for contracts for differences (CFDs) are prompting traders and brokers to explore other options, like futures and options contracts. A survey by Acuiti found that more than half of European retail brokers are considering offering futures and options instead of retail over the counter (OTC) instruments like CFDs. This shift comes alongside changes in the prop trading industry, where new platforms are being launched specifically for futures trading.
The survey also revealed that European retail brokers are looking to expand their reach, with 77% of those surveyed interested in offering their services in other regions as a result of restrictions due to come into force Europe-wide. Additionally, 69% see potential in expanding to institutional markets.
Regulations on CFDs Impacting the Industry
Europe, traditionally a hub for retail OTC instruments like CFDs, has seen a regulatory crackdown. Since 2018, the European Securities and Markets Authority has imposed stricter rules, limiting the leverage offered to retail investors.
Many European countries already have their own regulations for retail OTC instruments. France, for example, has tight restrictions on promoting CFDs and forex. Spain followed suit last year, banning CFD promotion and distribution entirely, and limiting leverage on other retail investment options.
Despite the regulations, some experts suggest the shift away from CFDs hasn’t been dramatic. Mahesh Sethuraman, Asia Pacific Head of Trading and Investing at Saxo, told Finance Magnates that “In terms of number of clients, there’s no sign at the moment that Saxo clients around the world are leaving CFD trading to futures trading. But these are still early days, and we expect futures exchanges to create more micro futures contracts without a compromise on liquidity, which will facilitate a greater adoption of futures by retail investors.”
However, CFD brokers haven’t had much success entering the US market.
Prop Trading: a loophole to trade CFDs in the US
CFDs are banned in the US, and while retail forex is permitted, it’s subject to heavy regulations, limiting the number of players in the field. Some US traders therefore turn to prop trading firms to get their fill of CFD trading. While prop firm offerings differ from retail brokers, they do provide a simulated environment where traders can access CFD-like instruments. Successful traders who pass evaluations and receive a funded account (generally using simulated funds) receive a share of profits from their trades.
This workaround for US traders recently encountered a difficulty: MetaQuotes, the developer of the MetaTrader platfor, reportedly clamped down on the industry. Brokers suspected of “grey-labeling” their MetaTrader licenses for prop firms now face the risk of losing access to the platform entirely. As a result, prop firms are looking for alternative platforms to MetaTrader.
A Shift to Futures Prop Trading
Industry experts are pointing to a shift from CFDs to futures. This is likely to apply particularly to the US market, though European traders keen on CFDs may also consider futures.
The recent disruption in the American prop trading industry has led to many futures prop firms actively promoting their services.
A key difference is the structure of the market. Futures trading is highly centralised, and futures prop firms get price feeds from exchanges, offering more transparency and potentially less manipulation than MT4 or MT5 price feeds. This can lead to fairer spreads for traders.
While futures trading offers several advantages over FX and CFDs, there are also drawbacks to consider for all parties involved (traders, brokers, and prop firms). These challenges include drawdown structures (rules for managing losses), limited flexibility in position sizing, data fees, and stricter risk management regulations.
Potential Drivers for a Shift:
- Regulatory landscape: Tighter CFD regulations, especially leverage restrictions, might nudge some traders towards futures. This is because futures have a different risk profile from CFDs.
- Clearer picture: Unlike CFDs, which are OTC instruments, futures contracts are standardised and exchange-traded. This provides more transparency in pricing.
- Making futures more appealing: If futures exchanges develop user-friendly micro contracts with lower margin requirements, they could become more attractive to retail investors who are used to the flexibility of CFDs.
Challenges and Considerations:
- More complicated: Compared to CFDs, futures trading demands a more thorough understanding of derivatives markets and margin requirements.
- Higher costs: The benefits of futures trading for some retail investors might be offset by additional costs. These include exchange fees and subscriptions for data feeds, which can add up compared to CFDs.
- Liquidity: While futures offer greater transparency, the liquidity of micro contracts, particularly for less popular assets, may be lower compared to CFDs.
Overall:
Here’s why the transition from CFDs to futures will likely be gradual, rather than a sudden departure:
- Familiar territory: Many traders are comfortable with the mechanics of CFDs and may be hesitant to switch to a new instrument like futures.
- Unique features: CFDs offer specific advantages that futures might not readily match. For example, shorting an asset with CFDs doesn’t require borrowing.
- Regional differences: Regulations and product offerings differ substantially from region to region. The impact of CFD restrictions, like those in Europe, may be less significant in other parts of the world.
The Future:
- Both CFD and futures markets will need to be innovative to thrive.
- CFD brokers can be expected to adjust their offerings in order to adhere to regulations and also to tailor their products to meet the specific requirements of their clients.
- Futures exchanges will probably continue to develop user-friendly products and provide a range of educational materials in order to attract a larger set of traders.
In Conclusion
Even with stricter regulations pushing some traders towards futures prop firms, CFDs aren’t likely to disappear completely. Themarket will probably see both instruments coexisting, each appealing to different needs and risk tolerances.
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