What the FSA’s regulations mean for you
The new rules might be heavy handed, but they could be to your advantage, writes Katie Hope
Hot on the heels of the decision by the FSA, the City’s watchdog, to clamp down on investors using contracts for difference (CFDs) to short shares during a rights issue period, it’s now taken another stab at improving transparency. Last week, the FSA announced that from next year CFD investors will be required to disclose net long positions of 3 per cent of outstanding stock, based on a mix of share and CFD holdings.
The new regulation is the result of a consultation last November, initiated due to fears that institutions could be using CFDs on an undisclosed basis to influence corporate governance and build up stakes in companies. Some kind of change has therefore long been expected. In fact the question of how to treat hidden stakes has been around for more than five years and under discussion for at least two.
Hedge funds, however, are predictably up in arms about the changes, with Andrew Baker, deputy chief executive of hedge fund trade body AIMA, warning they could drive investors away from the UK.
“We have strongly argued in favour of lighter regulation of CFDs to achieve the correct balance between an appropriate level of transparency in the market and a competitive environment for the hedge fund industry in the UK,” he said. “The FSA’s intention to further regulate CFDs is not the most effective way to achieve this.”
No applause
Nobody expected applause for the new changes from the direction of Mayfair, where many hedge funds are based. But what does it mean for the retail CFD investor?
The substantial size of the holding which prompts disclosure, putting CFD investors on a par with the disclosure level for share traders, means very few, if any, will be directly affected.“ We’re pretty relaxed about it. It wouldn’t have any impact on our typical client,” says Yusef Heusen, senior sales trader at CFD and spread bet provider IG Index.
He points out that even if a client did have a long position of 3 per cent via a CFD provider, it would be the clearing party’s name which appeared on the share register (so in this case IG Index) rather than the account holder’s.
But what does impact the retail trader, he points out, is the FSA’s implied criticism of CFDs, which will affect their reputation.
“This would never have come up in the middle of a bull market. CFDs help to improve the liquidity in the market, but are blamed for creating greater volatility. The image of CFDs is based on a misunderstanding of what they are and what they do and this doesn’t help,” he says.
Excessive Disclosure
The FSA’s response bears this out. It admits that it has found “no compelling evidence” of market failure in respect of inefficient price formation caused by a lack of transparency, and says it is aware that “excessive disclosure” can cause market inefficiencies. In spite of this it is still opting for what many in the market view as an overly tough approach.
CFD holders will have to declare interests – comprising CFDs and shares – of 3 per cent, the threshold set for shares in the Companies Act of 1985. The only exemption will be CFD writers who hold long CFD positions as a result of writing short positions for clients.
But the FSA’s consultation paper had indicated that other CFD holders could be exempt. Under its initial plans, holders that stated their intention not to pursue voting rights, or that agreed not to exert pressure on CFD writers to vote, would not have been expected to disclose their interests unless specifically requested by the company whose shares underlay the contract.
And only CFD holders with a 5 per cent stake or more that is entirely held in CFDs would have been required to disclose their interest. The FSA now says its consultation suggests these sorts of exemptions would have been “unenforceable”.
“Our goal is to provide an effective and proportionate disclosure regime that works for all involved, and sustains market confidence and efficiency. We recognise that views differ widely across the market,” says Alexander Justham, FSA Director of Markets.
Curbing Positions
But Dave Norman, an ex-trader who now risk-manages professional equity traders, believes the FSA has taken advantage of market turmoil to exert stronger changes.
“This directive is actually a thinly veiled attempt to curb excessive long position taking by hedge funds. There may be more to come. Watch out for a sudden change to the stamp duty exemption on CFDs,” he says.
The FSA’s zest to appease the government by clamping down on speculative activity could eventually have a much greater impact on retail investors. Increasingly, there are fears that the FSA will impose restrictions across the whole of the derivatives market, and damage it by over-regulation.
But every cloud has a silver lining. In the short term, the new changes could prove advantageous to the retail investor, by helping to narrow the gap between them and institutional investors.
“Institutions use market inefficiency to make money and the retail investor is the one getting abused,” says Clem Chambers, chief executive of financial information website ADVFN.
“If someone manipulates the market it’s not a victimless crime. These changes will make it more efficient and help to ensure a level playing field.”