Windfall profits lure investors
FEW investors living outside Ireland would bother tracking the Irish Stock Exchange’s ISEQ Overall index or worry about the fact that, between May 31 and November 22, it lost about onethird of its value. But there is plenty of worry inside Ireland. This is because about 50 per cent of the business that goes through the exchange is in the form of CFDs — contracts for differences.
The Irish market bounced back in the last week of November but, until that bounce, Irish stocks had hit their lowest point in two years. Irish bank stocks have been trading at around 40 per cent below their 52- week highs, a sign in itself of wavering confidence among investors.
This punting on the market and attraction to CFDs was spurred, in part, by the slowdown in the local property market, so investors looked elsewhere for the prospect of windfall profits, and clearly CFDs looked just the thing.
But the wheel had turned full circle by the end of November when the Irish Independent reported house prices in the better parts of County Dublin were being slashed by up to 25 per cent. The newspaper said the glut of houses on the market reflected the fact that a large number of what it called over- exuberant investors were feeling the pain of CFD margin calls.
CFDs were launched in 1991 by Londonbased GNI, now GNI Touch, still a top CFD broker and which claims to be the world’s largest online futures brokerage.
The initial spark for their creation was to provide a means by which investors — and that meant high net worth investors, not everyday retail traders — could get into the share action without having to pay the high stamp duty attached to each share transaction on the London Stock Exchange.
CFDs are still very much a European tool, although the CFD concept is now spreading to other parts of the world — but not to the US, where trading CFDs is illegal.
However, this does not — in this era of a global financial market — stop CFD trading in US stocks. London- based CMC Markets, which bills itself as the market leader in CFD and financial spread betting, last month handled its 50th million client trade. That trade was on behalf of client Abdul Baki, who has been buying and selling contracts for differences for three years. Baki’s trade was a market order for US stock Patterson Companies, a firm based in St Paul, Minnesota, and which sells dental and veterinary supplies.
Nor does it stop American traders taking advantage of CFDs outside their homeland. For example, the US hedge fund QVT Financial has been reported to have bought a 1.03 per cent exposure to ailing British bank Northern Rock through CFDs. ( Another hedge fund, Monaco- based SRM Global, was reported to have taken a 6.17 per cent stake in Northern Rock through CFD contracts.)
No one is quite sure why the Americans have set their faces against these high- risk instruments, but the two most popular theories are that they either do not want to see leakage of business from their very strong markets in options, or alternatively that it is the not so savvy retail investor that
needs to be protected against the ( high) risks of CFDs. Possibly both considerations played a part.
So while CFDs are outlawed in America, the spread elsewhere continues. CMC, which now operates 22 offices worldwide and has a client base in 70 countries, has in the past 18 months expanded with new offices into Vienna, Singapore, Stockholm and Tokyo.
Windsor Broking, based in London and broker in CFDs, has just opened an office in Cyprus, for example.
At present, about 6 per cent of the business going through the Johannesburg Stock Exchange consists of CFD trades. South African Purple Capital has just bought Global Trader, a company that debuted its CFD and spread betting products on the London Stock Exchange two years ago. Global Trader has offices in Johannesburg, Cape Town, London, Bangkok, Toronto and Moscow with plans to open also in Dubai.
Purple says it aims to lift CFD trading on the JSE to about one- third of that exchange’s business.
The Danes are also moving into the Middle East with these derivative products. Online operator Saxo Bank plans to open an office in Dubai next year, with CFDs among the products offered to the vast pool of private liquidity in the Gulf.
Contracts for differences are also an important tool for the corporate raider. They can leverage a stake without having to declare their position. And these derivatives can be converted into voting shares, usually by means of a separate contract to acquire the underlying shares from an intermediary.
For example, Britain’s biggest casino operator Stanley Leisure — owned by Malaysia’s Genting group — was believed to have built a stake in one of its rival companies, Rank. The suspicion was that Stanley was making an initial move toward a full takeover and Rank was requiring a declaration from Stanley in accordance with London Stock Exchange rules.
But Rank could be frustrated if Stanley has used CFDs and not bought shares directly.
The British are trying to close this loophole. One recent report recalled the 1995 case of one company that, about to bid for another, built up a position in CFDs covering the target company’s shares. This was done in expectation that the underlying shares would shoot up in value due to the takeover bid, delivering a large profit for the CFD contracts.
CFD tactics were also used in the attempt by Nasdaq to gain control of the London Stock Exchange and in the merger of steel giants Arcelor and Mittal.
This has led Britain’s Takeover Panel to push for a 1 per cent threshold for disclosure of CFD holdings.
But even the big players can make big losses. British papers reported that Iranianborn property developer Robert Tchenguiz took massive losses on CFD positions in the supermarket group Sainsbury’s after that company’s shares dropped when the Qatar Investment Authority withdrew its takeover bid.