This article was written by Meir Velenski, Director of Fibonatix.
The announcement that the Financial Conduct Authority (FCA) in the UK is planning to reduce the leverage and gearing on CFD products for retail clients means that the FCA is looking to focus on professional clients.
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The UK CFD, FX and spread bet market is one of the biggest retail trading markets in the world. The financial centre has built its reputation up over many decades as a safe and secure place to do business, based on etiquette and good business practice.
The UK financial markets have been groomed over the years in a strict regulatory regime that allows the retail trading client to access markets and leverage that was only available to professionals at one time.
The FCA has decided that the exposure that a general retail client has should be monitored more closely and limited. The reason it states is that it wants to protect the retail client.
The firms over the years have been expanding and spending significant amounts in marketing to keep pace and to attract the retail trader and this is an essential part of their strategy and profits. The reason being that the small retail trader who has little financial experience and understanding will tend to overtrade and therefore lose his deposit.
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On the other hand, the experienced professional trader who engages in trading long term rarely trades more than 50 times multiple and therefore is likely to be a winner and this model does not suit the firms that are running a B book model.
For this reason the shares of the leading firms like IG, Plus500 and CMC that run A book and B book models and many others were hammered as their business model incorporates this high leverage approach and could see a downturn in their profits.
However, the good news going forward is that these leading firms are very well placed to absorb the fallout from the smaller less secure firms that will struggle on a pure B book basis.
What happens now?
Firms that have been comfortable for years attracting retail clients on high advertised leverage will have to rethink their global strategy and quickly adapt to the new arena. The large firms will continue to do well as they have the financial strength to absorb the change. There will be probably be several firms now looking as potential takeover targets and good quality client banks to be looked at.
The next few months will give the CFD market a chance to redraw the lines. The market place will consolidate which is not a bad thing as there are too many players in the UK as it is.
I believe that the share price of these firms will slowly retract and probably move higher as the new more strict regime comes into play.