A combination of quieter markets and a regulatory clampdown has sunk the valuations of London’s spread betting specialists. Shares in the sector’s main players have lost the ground made up since the European Securities and Markets Authority (ESMA) announced it would restrict leverage limits for retail clients, and now trade at a two-year low.
The new rules – which came into force in August – include lowering leverage limits on the opening position by a client to between 30:1 and 2:1 depending on the volatility of the underlying instrument (previous multiple limits on certain instruments were as high as 300:1). At the top end of the leverage boundaries are major currency pairs, a relatively staid affair, while cryptocurrencies are, unsurprisingly, considered the riskiest. Other restrictions include mandatory negative balance protection on client accounts and a ‘margin closeout rule’, whereby the provider must close one or more contracts for difference (CFDs) if the balance of the account falls below 50 per cent of the ‘margin requirement’ – loosely defined as the minimum required deposit in an underlying instrument.
Given that many retail investors lack the funds to meet the new margin requirements, future revenue expectations for IG (IGG), CMC Markets (CMCX) and Plus500 (PLUS) are naturally lower, with only a limited number of clients within the ESMA region passing the threshold tests to elect as professionals. Under Financial Conduct Authority (FCA) rules, investors can qualify for ‘elective’ professional status if two out of three criteria are met: the client has carried out significantly-sized transactions of an average frequency of 10 per quarter over the previous four quarters; the size of their portfolio – including cash deposits and financial instruments – exceeds €0.5m (£0.45m); and the client has worked in a professional position within the financial sector for at least a year at any time in their career.
However, the impact of those regulatory restrictions has been compounded by subdued markets, which has led all three of the UK-listed constituents to report a marked reduction in trading activity during the first three months of the year. What’s more, the increased contribution from professional clients – which are more sensitive to market volatility – worsened the reduction in revenue.
“The ideal environment is one where you have got intra-day volatility but with a slightly more certain [political] backdrop,” says Paul McGinnis, deputy head of research, at Shore Capital.
The impact of calmer markets and more stringent regulation has been most pronounced for Plus500 during the first three months of the year, with the Israel-based group reporting an 82 per cent year-on-year decline in revenue. Part of the reason for the more dramatic swing in revenue is the way in which the group hedges against client trading positions, capping trading activity and offsetting client trades against each other, although it does not hedge client positions on the open market. Therefore, everything’s kept in-house.
The shares were heavily marked down in February after management confirmed press speculation that its 2017 accounts had incorrectly stated that it had not suffered a decline in revenue from stronger client trading. The group took a $103m (£79m) hit to revenue in 2017, as clients benefited from the sharp rise in the value of cryptocurrencies and rising equity markets, particularly during the final quarter of that year. That followed a $19.5m negative revenue impact from client trading positions in 2016. By contrast, the group enjoyed a $172m revenue gain after investors were caught out by a downturn in equity markets during the fourth quarter.
IG nets client trades against each other and when this is not possible hedges the trade in the open market, “to ensure they are never taking the opposite position to their clients”, the group says.
Similarly CMC aggregates client trades each day, offsetting opposing positions against each other. Once a threshold is reached it hedges client positions via brokers on the open market.
Yet Peel Hunt’s Anthony Da Costa argues that breaking out the profits and losses from client trades gives investors “better visibility” on Plus’s revenue compared with CMC and IG. However, “the usefulness of it is somewhat symbolic”, says Mr McGinnis, as there is no way of forecasting what that might be prior to the event.
Plus500’s traditionally higher customer churn rate than peers has also exacerbated the decline in customer numbers, resulting from the regulatory clampdown. The group has also had to increase marketing spending to attract clients, part of the reason management was forced to warn that profits for 2019 would miss market expectations in February. However, Mr Da Costa says: “When trading conditions are good, Plus should outperform CMC and IG because of the high churn rate.”
