EU watchdogs warns investors of risky derivatives

LONDON Thu Feb 28, 2013 7:37am EST

LONDON (Reuters) - European Union regulators warned investors on Thursday of the dangers of buying contracts for difference (CFDs), a type of derivative that offers potentially high returns.

CFDs are derivatives contracts that bet on price moves of an asset, such as a company's shares, without having to own the underlying asset.

"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," the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) said in a joint statement.

It was ESMA's third warning - it warned on foreign exchange in December 2011 and on using the Internet in September 2012 - a sign of how the EU playing a greater role in consumer protection, an area which has been the preserve of national authorities.

Sellers of CFDs are regulated and required to warn investors about the risk they face but regulators worry such warnings are not being given. They say investors should only consider trading CFDs if they have extensive experience of trading in volatile markets.

CFDs were only suitable for very short term bets or for hedging against an exposure the investor has elsewhere and were not suitable for holding for any length of time.

The regulators also warned about offers of "free start up money", gifts, discounted fees or trading tutorials to attract new clients.

"If investors do not understand what's on offer, they should not trade," the regulators said.

CFDs have become popular across Europe, especially in Britain as they are not subject to the UK stamp duty tax on share trades. Buyers only have to put down a small deposit of the total value of the trade.

"There is no denying that trading leveraged products like CFDs are risky. They can magnify your gains and your losses so it's possible to lose more than your deposit," said Angus Campbell, head of market analysis at Capital Spreads, which offers CFDs.

"As a CFD provider regulated by the Financial Services Authority, we have to make our clients aware of those risks before they trade," Campbell said.

(Reporting by Huw Jones, editing by Elaine Hardcastle)