The European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) have published a warning to retail investors about the dangers of investing in contracts for difference (CFDs).
The two authorities are concerned that during the current period of low investment returns, inexperienced retail investors across the EU are being tempted to invest in complex financial products, which they may not fully understand and which can end up costing them money they cannot afford to lose.
Andrea Enria and Steven Maijoor, the respective chairs of the EBA and ESMA, commented: “Retail investors across the EU should be aware of all the risks arising from investing in CFDs. These products appear to promise investors substantial returns at a low cost but may ultimately cost them far more than they may have intended or could afford to lose.
“CFDs are complex products that are not suitable for all types of investors, therefore you should always make sure that you understand how the product you are buying works, that it does what you want it to do and that you are in a position to take the loss if it fails.”
The two bodies are advising that investors should only consider trading in CFDs if they have extensive experience of trading in volatile markets, if they fully understand how these operate and have sufficient time to manage their investment on an active basis.
Investors should carefully read their agreement or contract with the CFD provider before making a trading decision. They should make sure that they at least understand the following:
- The costs of trading CFDs with the CFD provider.
- Whether the CFD provider will disclose the margins it makes on their trades.
- How the prices of the CFDs are determined by the CFD provider.
- What happens if they hold their position open overnight.
- Whether the CFD provider can change or re-quote the price once an investor places an order.
- Whether the CFD provider will execute investor’s orders even if the underlying market is closed.
- Whether there is an investor or deposit protection scheme in place in the event of counterparty or client asset issues.
If investors do not understand what is on offer, they should not trade, the EBA and ESMA conclude.
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