Spe­cial men­tion: CFD providers

De­ter­min­ing a win­ner in this sec­tor is hard, es­pe­cially as as­sess­ing credit risk is tricky

Financial Mail - Investors Monthly - - Cover Story -

For the past six 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.

CFDs are a con­tract between two par­ties in terms of which one pays the other prof­its that de­pend on the move­ment of a ref­er­ence as­set. So, for ex­am­ple, two par­ties can write a CFD on MTN and then pay each other the profit im­plied by the move­ment of the ref­er­ence share.

When we in­tro­duced this award in 2012, CFDs were ex­tremely pop­u­lar: they were the sec­ond-most traded in­stru­ment af­ter eq­ui­ties. Their pop­u­lar­ity ap­peared to wane for a while as ex­change traded funds over­took CFDs in trad­ing ac­tiv­ity. This is a world­wide trend.

But we no­tice that CFDs are mak­ing a bit of a come­back, with more and more bro­kers start­ing to fo­cus on them.

CFDs are use­ful for short­ert­erm traders, be­ing gen­er­ally cheaper to trade in and out of than nor­mal shares; but the longer the hold­ing pe­riod, the more ex­pen­sive they be­come.

De­ter­min­ing who the best CFD providers are is a fraught con­cep­tual prob­lem — there are many is­sues that are im­por­tant. Ide­ally we would as­sess three things: client sat­is­fac­tion, costs and credit risk. This last-named mea­sure, though, is very dif­fi­cult. Many firms write CFDs off the bal­ance sheet of big­ger prime bro­kers and they are there­fore much less of a credit risk than it ap­pears from the size of the bro­ker it­self.

CFDs can now be traded on the JSE, which elim­i­nates the credit risk, as it guar­an­tees set­tle­ment, or “over the counter”, between the bro­ker and client. The lat­ter type have been go­ing for longer and still make up the ma­jor­ity of CFD trades. CFDs im­ply credit risk, be­cause bro­kers can end up ow­ing traders money if the un­der­ly­ing as­set prices change. That should be no prob­lem for bro­kers who are man­ag­ing their risk cor­rectly, but can be­come a big is­sue if they are not. While we as­sess this risk as com­pre­hen­sively as pos­si­ble, with­out con­duct­ing a full sys­tems au­dit it re­mains dif­fi­cult to do.

We asked bro­kers to iden­tify just which bal­ance sheet was the coun­ter­party to the CFD con­tracts they wrote and to ex­plain how they seg­re­gate client money from that of the firms. We score bro­kers highly if there is a clear and sub­stan­tial bal­ance sheet stand­ing be­hind the con­tracts and mark them down if the bal­ance sheet is small or hard to as­sess.

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.

Client sat­is­fac­tion can be as­sessed from CFD-trad­ing clients’ opin­ions on the range of CFD prod­ucts of­fered, the qual­ity of their bro­kers’ in­ter­ac­tion with them and the sup­port they of­fer. We used those rank­ings, costs and our own in­ves­ti­ga­tions to de­ter­mine scores.

Unum Cap­i­tal is the topranked CFD provider for 2018 with Sharenet sec­ond and IG South Africa third. All firms scored well across all cat­e­gories but Unum takes top spot with re­sound­ingly stronger scores from clients.

Pic­ture: 123RF — WIROJSID

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