Warning to investors over buying derivative contract

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EUROPEAN Union regulators have warned investors 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 and the European Securities and Markets Authority said in a joint state- ment.

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 is 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.