BaFin considers ban of sale of CFDs

BaFin has raised substantial concerns in relation to the sale of leveraged CFDs to retail investors. Although a possible prohibition is currently still in the public consultation phase, the proposed decree and its reasoning make it clear that the regulator is inclined to enforce a ban in relation to such products. In the eyes of the regulator, leveraged CFDs bear the risk of incalculable losses for investors. In particular, the losses are not limited to the capital committed by the purchaser of such leveraged CFDs but can - at least theoretically - encompass all capital and assets of the investor. The regulator has concluded that it is widely accepted in the “CFD industry” that the risk of such losses cannot be evaluated or calculated at the time the investment is made. This leads BaFin to take the view that such instruments should not be bought by retail investors.

In particular, BaFin substantiates its concerns for the protection of investors with the following arguments:

• Complexity of performance calculation: BaFin finds that the leverage effect inherent to CFDs makes it impossible to pre-calculate possible losses (or the possible upside) for the average retail investor. BaFin is of the view that the leveraged nature of leveraged CFDs makes such instruments particularly risky since the losses to which they can give rise are not limited to the capital invested. 
• Speculation on credit: BaFin applies an economic view on the investment in leveraged CFDs and concludes that, because of the leverage effect inherent to such instruments, investment in them is similar to an investment with borrowed money. Such an investment strategy would normally be considered very risky and would typically trigger various further obligations under German law. BaFin applies these considerations on the investment in leveraged CFDs and believes that these considerations justify additional measures to protect investors from losses that may exceed the original capital amount committed. 
• Lack of transparency due to price gaps: Furthermore, the regulator believes that “price gaps” in turbulent markets adversely affect the interests of the investors. Typically, the CFD provider also acts as counterparty to the retail investor and sets prices. However, past experiences have shown this practice to be unreliable in turbulent markets. Errors in setting the prices are multiplied by the leverage factor and directly affect all of the customer’s assets. The particulars of a leveraged CFD contract are likely to give raise to conflicts of interests that the provider/counterparty could use to the retail investor’s detriment.
• “Margin Call” mechanisms have proven to be unreliable to limit risk of losses: BaFin explains that margin calls cannot effectively be used to limit the risk of losses for retail investors resulting from leveraged CFDs. Spikes in the market price of the underlying securities may lead counterparties to close positions immediately without calling for further margin first. In the case of market turbulence, it may be that a customer is unable to close out his position as his counterparty is not obligated to set prices at all times. This may lead to delays in the closing of positions, thereby significantly increasing the risk of loss. BaFin uses the “CHF/EUR Crash” of 2015 as an example.
• Risk of losses cannot be mitigated by stop/loss orders: Finally, BaFin also concludes that stop/loss orders are not appropriate measures to limit the risk of losses resulting from leveraged CFDs. Executing such orders at the “next available quote” may not occur until the price is significantly different from what the investor envisaged when setting a stop-loss quote

BaFin goes on to elaborate that the intended ban of leveraged CFDs for retail clients is an appropriate measure to mitigate the risks and concerns which it has identified in respect of investor protection. The regulator believes that the proposed ban is both required and proportionate. The German watchdog also gives a glimpse of its mind set: it sets out that retail investors would not be completely prohibited from investing in CFDs - investors wishing to do so would simply have to elect to be treated as professional investors (provided that they fulfil the relevant criteria, including the holding of cash and securities balances of at least €500,000).

Background

Germany has implemented the product intervention rights of MiFID 2/MiFIR prematurely. Since July 2015, BaFin has the right to ban the sale of certain financial instruments where the regulator has reasonably identified material risk for the financial markets or has concerns with regard to investor protection. This marks the second time the German regulator has decided to utilise its product intervention right - BaFin took similar steps earlier this year with regard to the sale of credit-linked notes to retail investors. However, after a first public consultation on the matter in August 2016, the regulator has not publicly announced its findings or final decision. Nevertheless, the public consultations on the ban of the sale of leveraged CFDs and credit-linked notes to retail investors appear to be indicative of a stricter retail regime in Germany.