Those who closely followed the recent trial of Patrick Quirke, who was convicted last month of the murder of part-time DJ Bobby Ryan in a love-rival case that gripped the nation, may recall evidence of the Tipperary dairy farmer's apparent successful foray into exotic financial derivatives.
Quirke told gardaí during the investigation that Mary Lowry, the object of both men's affections, had given him €80,000 at one stage to invest in contracts for difference (CFDs). The punt delivered a €40,000 return for each of them over 18 months as part of a profit-share agreement, the trial heard.
They would have been rare cases.
Assets
CFDs are financial instruments that allow investors to bet on the price of assets, including shares, currencies and commodities moving up or down – without owning the assets – by putting up a small initial deposit, or margin. An initial outlay on a share-based CFD would typically have been in the region of 5 per cent to 10 per cent of the stock’s value, with the rest effectively borrowed from the brokerage offering the product.
Like buying a house with a 10 per cent deposit, a 10 per cent move in the value of the asset would result in a 100 per cent profit for the investor.
However, the power of leverage can be a destructive force when a bet goes awry. Investors face calls from their broker to deposit more cash in the CFD accounts to cover any losses if a wager starts to go against them, in what are known in the business as margin calls.
The Central Bank moved this week to invoke new powers it secured last year to restrict the sale of CFDs
The Central Bank published research in 2015 which found that three-quarters of small, or retail, investors who made CFD investments over the previous two years had lost money – averaging almost €7,000. A follow-up survey covering 2015 and 2016 showed a similar loss rate, though the average amount was lower, at €2,700.
The Central Bank moved this week to invoke new powers it secured last year to restrict the sale of CFDs and their close relatives, spread bets, to retail investors as soon as temporary limits imposed last year by European regulators run out. That’s currently scheduled for next month.
The bank ordered an outright ban on the marketing of another instrument, called binary options, which it considers a “fundamentally flawed product” that allows people to speculate on short-term price movements of an asset.
"They are no more an investment than betting on a horse," said Derville Rowland, director-general of financial conduct at the Central Bank, in the announcement on Wednesday.
Leverage
On CFDs, Rowland said that based on the work “at a domestic and EU level, we have concluded that retail investors must be protected from excessive levels of leverage, which can result in unexpected high levels of losses”.
The restrictions include leverage limits and a requirement that retail investors cannot lose more money than they put into their CFD account. They also ban the use of incentives to lure small investors to get involved in CFDs, and place an obligation on brokers to warn clients on the risk of these instruments.
The leverage limits will be along the lines of temporary pan-European caps introduced last year, according to a spokesman for the Central Bank. This means, for example, that investors have to put down at least a 20 per cent deposit on a stock bet and a 10 per cent against most commodities.
While speculators can get away with as little as a 3.3 per cent initial margin on most major foreign exchange pairs, such as euro versus sterling, they must put 50 per cent upfront to wager on cryptocurrencies. The Central Bank had seen cases where small investors with minimal experience of trading CFDs were being offered a 400:1 leverage ratio before the European restrictions were introduced. That’s the equivalent of a €50,000 bet funded with an initial margin payment of €125.
The Quinns lost €3.2 billion investing in Anglo Irish Bank between 2007 and 2008, almost entirely through CFDs
The restrictions, however, have come more than a decade too late – and, arguably, do not go far enough.
The Central Bank of Ireland, more than any other financial supervisor, knows first-hand how dangerous CFDs are in the wrong hands, having being caught up in a saga surrounding the family of businessman Seán Quinn's ill-fated bet on Anglo Irish Bank before the financial crash.
Loans
The Quinns lost €3.2 billion investing in Anglo Irish Bank between 2007 and 2008, almost entirely through CFDs. Regulators knew in 2008, as Anglo’s shares were plummeting, that the bank, rattled by the size of the Quinn shareholding, was planning to provide loans to the Quinns to convert most of the derivatives into shares.
The Central Bank also effectively gave Anglo the green light to lend €450 million to a group of 10 clients – known as the Maple 10 – to soak up the remainder of the shares underlying the CFDs. The transactions resulted in the convictions of three of the lender's then top managers, including chief executive David Drumm.
The regulator only started a consultation in 2017 on the protection of small CFD investors. It held off on taking action as the European Securities and Markets Authority (Esma) slapped down its own temporary restrictions 12 months ago. It should have acted much sooner – and gone further.
CFDs have their place. They offer market players such as hedge funds a chance to bet that a stock or other asset will fall in price – a mechanism known as short selling. This improves market efficiency, allows for alternative views, and can even play a valuable role in preventing price bubbles forming.
But they’re best left to professional investors.
