Spread-betting and binary trading, two controversial methods of financial trading that have become more popular recently, have come under the glare of the regulator.
The Financial Conduct Authority (FCA), has this week proposed a package of measures to “limit the risks” of these products, which it hopes will “enhance consumer protection”.
In response to the announcement, shares in some of the most popular firms offering these services, including IG Group and CMC Markets, fell dramatically. In total, almost £1.5 billion was lost in share prices across the sector as a whole.
What is spread-betting and binary trading?
Spread-betting allows somebody to gamble on the movement of shares without owning them. The bettor can go long (buy shares) or short (sell shares after borrowing them). If the shares move up or down, you will win or lose money according to which direction you bet on.
It sounds harmless enough, but the danger with spread-betting if you don’t know exactly what you’re doing comes through ‘gearing’. This is where you can make large bets using small amounts of money. But this essentially means you’re leveraging the full value of the bet – so if you win, you could make the full amount of the bet, but if you lose then you owe that amount. For example, a ratio of 100:1 enables you to make a £10,000 bet with only £100.
Binary trading is a little different. If you’ve spent any time on the internet, you’ve probably been bombarded with adverts for this fast-growing take on investing, with people selling their success stories and strategies.
You are offered the opportunity to buy an asset for a fixed price for a fixed amount of time – generally ranging from five minutes to 24 hours. At the same time you bet on whether you think the share price will rise or fall in that time period.
Once the time is up, you can either win a pay out of around +85% of the amount you paid in, or lose 100%. Sometimes a broker will offer a compensatory amount of 10% of your deposit in this event.
However, because the timespan is so short, and asset price movements are so random at this scale, binary trading has been compared to gambling on a coin flip.
What exactly does the FCA want?
The FCA wants companies that offer these services to better inform customers of the risks involved, which includes a mandatory full disclosure of profit/loss ratios and historic performance.
It also wants the gearing ratios, which we’ve explained above, to be lowered, with a cap of 25:1for those who are inexperienced – defined as 12 months or less experience in the sector – with a cap of 50:1 for everyone else.
Additionally, it wants providers to ditch bonuses or payouts for opening customer accounts.
The plans are under consultation until 3 March 2017, after which the FCA will confirm its new rules.
Christopher Woolard, executive director of strategy and competition at the FCA says: “We have serious concerns that an increasing number of retail clients are trading in CFD products without an adequate understanding of the risks involved, and as a result can incur rapid, large and unexpected losses.
“The FCA also has concerns that binary bets pose investor protection risks and question whether binary bets meet a genuine investment need.”