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Contract for difference
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Contract for difference
In finance, a contract for difference (CFD) is a financial agreement between two parties, commonly referred to as the "buyer" and the "seller." The contract stipulates that the buyer will pay the seller the difference between the current value of an asset and its value at the time the contract was initiated. If the asset's price increases from the opening to the closing of the contract, the seller compensates the buyer for the increase, which constitutes the buyer's profit. Conversely, if the asset's price decreases, the buyer compensates the seller, resulting in a profit for the seller.
Developed in Britain in 1974 as a way to leverage gold, modern CFDs have been trading widely since the early 1990s. CFDs were originally developed as a type of equity swap that was traded on margin. The invention of the CFD is widely credited to Brian Keelan and Jon Wood, both of UBS Warburg, during their Trafalgar House deal in the early 1990s.
CFDs were initially used by hedge funds and institutional traders to cost-effectively gain an exposure to stocks on the London Stock Exchange (LSE), partly because they required only a small margin but also, since no physical shares changed hands, they also avoided stamp duty because trades by the prime broker for its own account, for hedging purposes, are exempt from stamp duty.
It remains common for hedge funds and other asset managers to use CFDs as an alternative to physical holdings (or physical short selling) for UK-listed equities, with similar risk and leverage profiles. A hedge fund's prime broker will act as the counterparty to the CFD, and will often hedge its own risk under the CFD (or its net risk under all CFDs held by its clients, long and short) by trading physical shares on the exchange.
Institutional traders started to use CFDs to hedge stock exposure and avoid taxes. Several firms began marketing CFDs to retail traders in the late 1990s, stressing their leverage and tax-free status in the UK. A number of service providers expanded their products beyond the LSE to include global stocks, commodities, bonds, and currencies. Index CFDs, based on key global indexes including the Dow Jones, S&P 500, FTSE, and DAX, immediately gained popularity.
In the late 1990s, CFDs were introduced to retail traders. They were popularized by a number of UK companies, characterized by innovative online trading platforms that made it easy to see live prices and trade in real-time. The first company to do this was GNI (originally known as Gerrard & National Intercommodities). GNI provided retail stock traders with the opportunity to trade CFDs on LSE stocks through its innovative front-end electronic trading system, GNI Touch, via a home computer connected to the Internet. GNI's retail service created the basis for retail stock traders to trade directly onto the Stock Exchange Electronic Trading Service (SETS) central limit order book at the LSE through a process known as direct market access. For example, if a retail trader sent an order to buy a stock CFD, GNI would sell the CFD to the trader and then buy the equivalent stock position from the marketplace as a full hedge.
GNI and its CFD trading service GNI Touch was later acquired by MF Global. They were soon followed by IG Markets and CMC Markets, which started to popularize the service in 2000. Subsequently, European CFD providers such as Saxo Bank and Australian CFD providers such as Macquarie Bank and Prudential made significant progress in establishing global CFD markets.
Around 2001, a number of the CFD providers realized that CFDs had the same economic effect as financial spread betting in the UK, except that spread betting profits were exempt from capital gains tax. Most CFD providers launched financial spread betting operations in parallel to their CFD offering. In the UK, the CFD market mirrors the financial spread betting market and the products are in many ways the same; the FCA defines spread betting as "a contract for differences that is a gaming contract". However, unlike CFDs, which have been exported to a number of countries, spread betting, which relies on a country-specific tax advantage, has remained primarily limited to the UK and Ireland.
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Contract for difference
In finance, a contract for difference (CFD) is a financial agreement between two parties, commonly referred to as the "buyer" and the "seller." The contract stipulates that the buyer will pay the seller the difference between the current value of an asset and its value at the time the contract was initiated. If the asset's price increases from the opening to the closing of the contract, the seller compensates the buyer for the increase, which constitutes the buyer's profit. Conversely, if the asset's price decreases, the buyer compensates the seller, resulting in a profit for the seller.
Developed in Britain in 1974 as a way to leverage gold, modern CFDs have been trading widely since the early 1990s. CFDs were originally developed as a type of equity swap that was traded on margin. The invention of the CFD is widely credited to Brian Keelan and Jon Wood, both of UBS Warburg, during their Trafalgar House deal in the early 1990s.
CFDs were initially used by hedge funds and institutional traders to cost-effectively gain an exposure to stocks on the London Stock Exchange (LSE), partly because they required only a small margin but also, since no physical shares changed hands, they also avoided stamp duty because trades by the prime broker for its own account, for hedging purposes, are exempt from stamp duty.
It remains common for hedge funds and other asset managers to use CFDs as an alternative to physical holdings (or physical short selling) for UK-listed equities, with similar risk and leverage profiles. A hedge fund's prime broker will act as the counterparty to the CFD, and will often hedge its own risk under the CFD (or its net risk under all CFDs held by its clients, long and short) by trading physical shares on the exchange.
Institutional traders started to use CFDs to hedge stock exposure and avoid taxes. Several firms began marketing CFDs to retail traders in the late 1990s, stressing their leverage and tax-free status in the UK. A number of service providers expanded their products beyond the LSE to include global stocks, commodities, bonds, and currencies. Index CFDs, based on key global indexes including the Dow Jones, S&P 500, FTSE, and DAX, immediately gained popularity.
In the late 1990s, CFDs were introduced to retail traders. They were popularized by a number of UK companies, characterized by innovative online trading platforms that made it easy to see live prices and trade in real-time. The first company to do this was GNI (originally known as Gerrard & National Intercommodities). GNI provided retail stock traders with the opportunity to trade CFDs on LSE stocks through its innovative front-end electronic trading system, GNI Touch, via a home computer connected to the Internet. GNI's retail service created the basis for retail stock traders to trade directly onto the Stock Exchange Electronic Trading Service (SETS) central limit order book at the LSE through a process known as direct market access. For example, if a retail trader sent an order to buy a stock CFD, GNI would sell the CFD to the trader and then buy the equivalent stock position from the marketplace as a full hedge.
GNI and its CFD trading service GNI Touch was later acquired by MF Global. They were soon followed by IG Markets and CMC Markets, which started to popularize the service in 2000. Subsequently, European CFD providers such as Saxo Bank and Australian CFD providers such as Macquarie Bank and Prudential made significant progress in establishing global CFD markets.
Around 2001, a number of the CFD providers realized that CFDs had the same economic effect as financial spread betting in the UK, except that spread betting profits were exempt from capital gains tax. Most CFD providers launched financial spread betting operations in parallel to their CFD offering. In the UK, the CFD market mirrors the financial spread betting market and the products are in many ways the same; the FCA defines spread betting as "a contract for differences that is a gaming contract". However, unlike CFDs, which have been exported to a number of countries, spread betting, which relies on a country-specific tax advantage, has remained primarily limited to the UK and Ireland.