Should you short the spread betters as profit taking and regulatory changes hit sentiment?
This year has been a difficult one for the spread betting industry so far, with both clients and platforms working hard to adjust to a series of new restrictions finally introduced by European regulators last month. After being hit by the impact of the changes when they were first formally announced in December last year, shares in trading firms like IG Group, Plus500, and CMC market have spent the better part of 2018 in recovery. However, with profit taking and results hitting sentiment over recent weeks, could these businesses now be in for a prolonged period of weakness?
Earlier this month, French regulator AMF warned that ‘certain online trading platforms’ have been attempting to talk investors into opening up accounts outside the EU and classifying themselves as professional clients. In doing so, the watchdog said these businesses were trying to avoid restrictions put in place at the beginning of August around the sale of spread-betting products to retail investors. Specifically, the rules – announced by the EU regulator earlier this year – ban the sale of binary options to retail clients. Binary options allow speculators to bet on whether the price of an asset will rise above, or fall below, a certain level.
The regulator also introduced strict new leverage limits on contracts for differences (CFDs), products that let investors take a position on financial instruments without actually owning them. According to the European Securities and Markets Authority, in March, the percentage of accounts invested in CFDs with a negative balance was 74pc to 89pc for different countries across Europe. On a per client basis, the amount of the loss ranged from EUR 1,600 to EUR 29,000. AMF chairman Robert Ophèle added: ‘The goal of the regulators was not to allow only a select few to trade CFDs and binary options but rather to better protect investors against an identified risk of loss’.
Last week’s warning served as a reminder of the havoc the new restrictions have wreaked across the spread betting industry this year. Although the changes will almost certainly save many new traders from suffering significant losses, they have been called draconian by more professional retail investors who rely on leverage to make a profit.
Things haven’t been looking too good on the other side of the fence either, with the changes making many of the products offered by spread betting companies seem far less attractive to core customers. Indeed, shares in the market’s three big listed players have all suffered at some point as a result of the crackdown, which has been in the works for some time.
IG Group, the industry’s oldest and largest player, fell by nearly 40pc over several sessions in December 2017 when ESMA first announced its planned changes. Its claims that the rules were “disproportionate” and “go beyond what is needed to protect consumers from poor outcomes” were drowned out by the sound of investors heading for the door. It wasn’t alone either, with smaller rival Plus500 falling by a similar degree on the news. Thanks to its geographical diversification beyond Europe and the fact that it had never offered binary options, the impact on third player CMC Markets was less significant.
With the market mainly pricing in the impact of the spread betting changes in December, shares in all three of these firms have advanced considerably over 2018, helped in part by the boom in bitcoin trading. However, that is not too say that risks do not remain, and some cracks have begun to show over recent months.
At the end of July, IG Group lowered its revenue forecast for 2019 and said the regulatory clampdown would make some of its products less attractive. Chief executive Peter Hetherington said: ‘I think our clients are not happy with these new rules. And that is an understatement.’ He added that one in five of IG’s customers had applied to be classified as ‘professional’.
Likewise, in its H1 2018 results last month, Plus500 warned that its strong performance over the period was unlikely to be repeated. It added that the impact of rule changes could affect 30pc of group revenues in the short-term.
Finally, in its results for the year ended 31 March 2018, CMC Markets said higher minimum margin requirements for retail clients is likely to impact its revenue. However, it added that this loss would be partially mitigated by clients opting to be treated as elective professional clients, exempting them from retail restrictions.
Another important red flag in the sector has been a raft of profit taking over the last few months. Most notably, the founders of Plus500 announced plans to sell 8pc of the company’s issued share capital earlier this month for a whopping £145m. Days later, Playtech slashed its 10pc stake in the business to below the threshold level.
After a strong start to the year, all three of the major spread betting businesses have suffered a decline in recent weeks. If you believe the tighter regulations in the sector could continue to hit revenues as more markets around the world follow Europe’s lead, then more weakness could be in the way. With that in mind, the firms may turn out to be a good candidate for a short position.