From CFDs to the future: Expert insights on Europe’s brokerage industry evolution

The European financial market is on the cusp of a significant transformation, influenced by regulatory pressures and a growing demand for more diversified and transparent trading options. 

Industry thought leaders have weighed in on this shift, particularly from Contracts for Difference (CFDs) to listed derivatives, underscoring a critical pivot in how the brokerage industry operates and how investors are safeguarded.

European regulatory pressure driving a move from CFDs to listed derivatives

There is evidence of European regulatory pressure influencing the brokerage industry’s move from Contract for Differences (CFD) products towards listed derivatives. This shift is largely in response to new regulatory restrictions aimed at the CFD market, which have become increasingly stringent, particularly with countries like Spain leading a new round of controls on retail-focused financial instruments last year. These controls include banning the promotion of CFDs and restricting leverage on other instruments. The restrictions have led to a lack of support among retail brokers for these regulatory moves, with a significant portion of them disagreeing with the regulators’ intentions.

A study by Acuiti, in partnership with ION, has highlighted that European retail brokers are now looking towards growth in institutional markets and expansion into listed derivatives as a strategic shift to mitigate the impact of these regulations. The report suggests that this move could potentially increase competition in the institutional brokerage landscape, as retail brokers expand their offerings to include institutional investors. It also anticipates a boost in listed derivatives markets due to greater engagement from retail investors, leading to improved liquidity and revenue opportunities for institutional firms.

However, this transition also presents challenges, including increased market volatility and competition for existing institutional sell-side firms. Despite these challenges, the report remains optimistic about the opportunities for reinvention and innovation within the European institutional markets prompted by these regulatory pressures.

Meanwhile, the European Union has taken significant steps towards reducing its reliance on London for clearing euro derivatives, aiming to enhance its capital market’s depth. This provisional deal focuses on supervising EU clearers more directly, marking a move towards shifting euro derivatives clearing from London to mainland Europe. Such a transition could potentially influence the brokerage industry, including those dealing with Contracts for Differences (CFDs), as it underscores a broader regulatory push for increased oversight and localization of financial activities post-Brexit. The emphasis on direct oversight by EU regulators and the requirement for banks and asset managers in the EU to engage with EU-based clearing houses for euro interest rate swaps and other derivatives signify a strategic shift that may affect market dynamics and the distribution of financial products like CFDs​​.

A different Acuiti survey found that a relative lack of retail trading and the fragmentation of market structure were stifling the growth of the European listed derivatives market when compared to the US, but this hasn’t stopped several firms from expanding further into the European Union.

Cboe Europe Derivatives recently expanded into single stock options and secured commitments from major brokers like Interactive Brokers to trade these products. Cboe Europe Derivatives’ focus is to grow volumes in European options by building a comprehensive ecosystem that simplifies access to trading, clearing, and market data​, for both retail and institutional investors.

Nasdaq Europe is also making significant moves by planning to expand derivatives clearing to include euro interest rate swaps (IRS) in the coming months. This is part of a broader strategy by European Union market operators to attract business from London following Brexit. Nasdaq Europe’s expansion is specifically aimed at users of euro IRS in the Nordics, complementing their existing clearing services in Swedish crowns and introducing multi-currency clearing to attract more Nordic clients​​.

Euronext has confirmed the expansion of Euronext Clearing to derivatives markets for Q3 2024. This move is part of Euronext’s strategy to connect European economies to global capital markets and accelerate innovation and sustainable growth. By expanding its clearing services, Euronext aims to provide a more comprehensive offering for its clients across Europe​​.

These developments reflect a growing trend in the European financial markets, where firms are actively working to expand their derivatives trading and clearing capabilities.

What experts say about it

FinanceFeeds spoke with Andrew Saks of trading technology provider TraderEvolution Global, Iouri Saroukhanov, Head of European Derivatives at Cboe Europe, Remonda Kirketerp-Møller of onboarding platform Muinmos, and Quinn Perrott of regulatory reporting firm TRAction Fintech, to ascertain their perspectives on the evolving regulatory environment in Europe, specifically how it’s shaping the transition from CFDs to listed derivatives and what it means for the future of trading and brokerage services in the region.

Andrew Saks and Quinn Perrott underscored the regulatory scrutiny over CFDs, noting that the high percentage of losses among retail investors has drawn the attention of regulatory bodies like the FCA and ESMA. Saks also highlighted the evolution of firms like Swissquote, which successfully transitioned to exchange-traded products, implying a smoother path for similar transitions.

Quinn Perrott suggested that a complete shift from CFDs to listed derivatives is unlikely unless CFDs face outright bans. Additionally, brokers operating outside Europe will continue to prefer CFD products due to lower execution costs, higher leverage, smaller deposits, a larger range of products, and simplified products. 

Iouri Saroukhanov offered a unique perspective on the fragmentation of European retail activity and its impact on market liquidity and volumes. By advocating for a consolidated move towards listed derivatives, Saroukhanov emphasized the role of regulatory frameworks in guiding retail investment toward more transparent and efficient exchange-traded products. 

Remonda Kirketerp-Møller provided a regulatory-focused insight, discussing the challenges posed by the EU’s passporting regime and its exploitation of high-risk products like CFDs. Kirketerp-Møller’s emphasis on the need for regulatory reform to address cross-border investment challenges presents a nuanced understanding of the regulatory landscape’s complexity and its impact on the brokerage industry.

Below, we present the complete, unaltered quotes provided by each expert, offering direct insights into their perspectives on the matter at hand.

Andrew Saks, TraderEvolution Global 

The recent survey which showed many CFD brokers across Europe being concerned about their future as a single-asset OTC provider is telling. Most regulators require CFD firms to publish the average percentage of their client base that loses money trading CFDs. How long will regulators, who are supposed to act in the best interests of retail customers of financial institutions, allow a product range that results in up to 80% of clients losing their investment?

The natural course of progress for more mature participants within the electronic trading business has been to develop their trading infrastructure and product ranges toward a multi-asset environment. For example, Swissquote was originally established as a CFD brokerage which moved toward listed products later, however by 2016 most of its business was exchange traded products. Other firms have more recently added specific asset classes. For example, WeBull added listed futures, and Public.com added fixed income products to its range.

The only way to continue to offer a retail product range that is sustainable is to be able to provide access to all global markets, including those with a central counterparty and have listed products such as futures, options, fixed income and the adaptability of infrastructure to add others as demand arises. If exchange-traded products across a variety of global executing venues are offered by brokerages alongside CFDs, it is likely that regulators may accept that there is enough diversity of product to allow client success, and to understand that if a broker is allowing access to venues with a central counterparty, it is not party to any market making practices that can create a zero-sum situation for retail clients.  

Iouri Saroukhanov, Cboe Europe

 “Our view is that the fragmentation of European retail activity across shares, ETFs, CFDs, exchange-traded derivatives and structured products is one reason why the region’s capital markets have trailed other developed markets in terms of liquidity and volumes over the past decade. Policymakers are looking to enhance retail participation in listed markets by strengthening investor protection measures, including restrictions on CFDs. As the number of European retail investors that make their own investing decisions continues to grow, we believe it’s important that retail is encouraged to access exchange-traded products, which are more transparent, are quoted more competitively and limit counterparty credit risk due to central clearing. There is more that regulators can do, such as ensuring exchange-traded products are not disadvantaged through excessive disclosure requirements, and Cboe will always do what it can to bring greater efficiencies to Europe’s trading and post-trade architecture and drive retail investment, including the recent launch of single stock options trading on Cboe Europe Derivatives (CEDX), our pan-European equity derivatives exchange.”

Remonda Kirketerp-Møller, Muinmos

In recent years, the EU’s financial scene has faced the challenge of regulating cross-border investments. The European Securities and Markets Authority (ESMA) and national regulators see the need for better oversight of investment firms operating across borders. The issue canters on the passporting regime, which allows firms licensed in one EU country to work throughout the bloc. This system, though designed to unify the market, has been misused, especially with high-risk products like Contracts for Difference (CFDs), leading to regulatory gaps and increased investor risk. French and Dutch regulators, AMF and AFM, have suggested shifting enforcement to the jurisdiction where a firm’s main client base is, sparking debate on EU market principles and indicating a significant need for reform, the Spanish regulator, CNMV, went further by restricting marketing, distribution and sale of CFDs aimed at retail investors in its jurisdiction. The UK’s Financial Conduct Authority (FCA) published a “Dear CEO” letter highlighting its continued concerns regarding the retail CFDs industry’s problems and ‘poor practices’. It pointed out the EU brokers operating in the UK under the temporary passporting regime and said its actions have stopped 24 firms from marketing CFDs in the UK.

The rise in online financial trading highlights these regulatory challenges, with many regulators critiquing the passporting regime’s exploitation for regulatory arbitrage. Calls for reform aim at a market that balances growth and investor protection. Amidst these changes, brokers and trading platforms face pressures, especially regarding CFDs, prompting a shift towards listed derivatives to diversify and comply with tighter regulations. However, this transition requires hefty investment in technology and expertise due to its complexity and compliance demands.

The move towards listed derivatives isn’t just about compliance; it’s a strategic shift towards a diversified, transparent, and sustainable model. Despite the challenges, it offers growth opportunities and a chance to enhance reputation by aligning with regulatory expectations and expanding into institutional markets. Strategic investments and partnerships are key for navigating this transition successfully, positioning brokers as leaders in a transforming financial services era. 

Quinn Perrott, TRAction

It is beyond contention that both the FCA and ESMA are placing significant pressure on the contracts for difference (CFD) and margin foreign exchange products, which are primarily operated as over-the-counter (OTC) derivatives rather than listed derivatives. This is pressure which is also coming from the IOSCO forum which has taken a very conservative view of the OTC products.

Offering OTC derivative products rather than listed derivative products is always going to have the potential to be far more lucrative. Further, the derivative component is appealing to clients because of the opportunity for leverage along with the ability to trade fractional shares (in the form of OTC derivatives) and thereby access shares that would otherwise be unavailable due to their price point and further diversify their portfolio.

What regulatory obligations could be avoided if firms switched to listed derivatives?

(EMIR and MiFIR would both be required still, but maybe it would be easier to report because they’re standardised products? No requirement to report UTIs, or the UTI would be more easily available). 

Trading on listed derivatives does offer an enhanced level of transparency and trust in execution, however in Europe this is mostly not an issue because the risk is mitigated with highly regulated CFD brokers who have to comply with MiFID II Best Execution rules.

I think existing brokers making a large scale move from CFD to listed derivatives would only happen if CFDs were banned or effectively banned. This may happen at some stage in the future (although we are not aware of any regulators giving it serious consideration), however until then the current CFD model offers some advantages for both the broker and retail traders.

Clients outside Europe (or regions with similar potential tightening of access to CFDs) will still prefer to trade OTC CFDs over listed futures because; 

• The cost of execution is generally lower
• Leverage can be higher (outside the G20)
• A larger range of potential products
• Simplified products for retail trading (automatically Rolling futures based CFDs for example)
• Ability to open an account with a smaller deposit