The History of CFDs

The history of CFDs looks at the motives for the creation of these fashionable risk management instruments.

The history of contracts for difference (CFDs) started in the early 1980s after the Financial Services Act or ‘big bang’ as it was commonly called was passed in Parliament.

The History of CFDs:

This new legislation encouraged the general public to participate in financial activities that they had not had access to in the past in financial markets. Several public industries were privatised, and everyone had the opportunity of possessing shares in these public companies.

This increased financial action had the outcome of greatly escalating the volatility of the markets, and shaped a new level of shifting prices that people could trade or hedge. As the behaviour and the movements of the markets became In particular, the market movements became more distinctive which pushed them in the direction of particular kind of trading. To gain a benefit from these price changes, spread betting began to play an greater than ever role.

The United Kingdom does not tax income from gambling. Because of this, institutional investors required more capability to make spread betting on markets so as to hedge their assets, by using leverage. This rise in price action together with the then missing regulations and tax laws caused the government who were worried that the increased activity would cause damaging volatility in the markets, to intervene in the markets.

This increased volatility which caused wild swings in the market could eventually lead to speculators taking control of the markets or even worse the normal behaviour of the markets might be drastically altered and there would not be appropriate indicators of the underlying markets. However, everyone recognised a growing need to give investors the appropriate tools to limit their risk exposure and guide them to make correct decisions as to what side of the market they should be on.

The initial solution was to utilize equity derivative swaps, as these were becoming more popular in the interbank markets and rapidly becoming a preferred instrument of stock investors. The swaps rationale was to indemnify positions in underlying shares, and they worked so well that today institutional investors are still using them. However, for the new investor, the retail investor and the non-institutional medium sized investors the swaps seemed too complex and were seen as not being regulated enough. A new product was needed to meet the needs of these new investors. So a new product (CFDs) was created.

Throughout the 90’s CFDs were strongly marketed to by brokers and CFDs became increasingly popular with all kinds of investors particularly individual investors, as a way to use leverage to trade CFD trading positions. As CFDs proved more successful and more and more investors were locking in their profits CFDs spread to other financial markets around the world and established themselves across Europe, Asia and America.

Over the years CFDs have been adapted to meet the increasing demands of investors and as the number of CFD brokers has risen to meet the needs of the growing number of retail traders, the competition drives innovation and efficiency.

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