Financial Mail - Investors Monthly
Special mention: CFD providers
For the past three years Top Stockbrokers has provided a ranking of the best providers of contracts for difference (CFDs), a type of derivative that allows for low-cost, short-term leveraged trading. Determining the best providers is a fraught conceptual problem; there are many issues that are important. Ideally we would determine three things: client satisfaction, costs and credit risk. This last measure, though, is very difficult.
CFDs can now be traded on the JSE or “over the counter” between the broker and client. The latter type have been going for longer and probably still make up the majority of CFD trades. CFDs imply credit risk because brokers can end up owing traders money if it moves into a profit position. That should be no problem for brokers who are managing their risk correctly, but can become a big problem if they are not. Dealstream, a broker that collapsed in 2008 owing clients money, is the oft-cited example. This year we attempted to assess this risk more comprehensively than before, but without conducting a full systems audit it remains very difficult to do.
Brokers also write CFDs in various ways, sometimes using their own balance sheets as the counterparty, other times using the balance sheet of big banks or prime brokers.
We asked brokers to identify just which balance sheet was the counterparty to the CFD contracts they wrote, but knowing the answers doesn’t shed much light on just how creditworthy those balance sheets are. Given these difficulties, our assessment considered credit risk for only 20% of our weightings in determining the firms worthy of special mention.
It is also important to clients that CFD trading facilities are easy to use and costs are low. Costs can be assessed directly but have two sources: the charges for
CFD transactions and the implied leverage in transactions. Often low fees are paid for by charging high interest rates for leverage, or paying low interest rates for short exposures. We measured the difference between these, which is known as the spread. These cost issues had a 20% influence in our assessment.
Client satisfaction can be assessed from CFD-trading clients’ opinions on the quality of their brokers’ interaction with them and the support they offer. Our assessment gave 60% weighting to client views, particularly on support available for CFD trading and their views on overall quality.
This led to our list in the table opposite of those firms which get a “special mention” as excellent CFD providers.