Wind­fall prof­its lure in­vestors

The Weekend Australian - Review - - Wealth -

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.

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