Financial Mail - Investors Monthly
Special mention: CFD providers
Determining a winner in this sector is hard, especially as assessing credit risk is tricky
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.