Saturday, April 14, 2012

Another Market Not Available to U.S. Citizens

By Jon Matonis
Monday, April 9, 2012

I find this incredible. U.S. citizens blocked out a market that the rest of the developed world has access to. Of course, I am speaking about the CFD market. CFD stands for "contract for difference" and it is a marketplace where regular people can trade the markets of the large trading houses without the same capital requirements. So, basically it is a form of democratized financial trading for the masses.

In financial parlance, a contract for difference is a contract between two parties stipulating that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time. Alternatively, if the difference is negative, then the buyer pays instead to the seller. Utilizing leverage, CFDs are traded on margin without the need for ownership of the underlying asset and positions may be either long or short. Unlike futures contracts, CFDs have no fixed contract size or expiry date. Investors appreciate these instruments because of their flexibility as CFDs can be traded in an almost endless variety of contracts that are sometimes unavailable at the traditional exchanges, such as diamonds and even bitcoin.

Due to restrictions by the Securities and Exchange Commission on over-the-counter financial instruments, trading in the CFD market is not an option for U.S. residents and U.S. citizens but curiously you can still buy a book about the practice on Amazon's U.S. site. Having lived and worked in both Ireland and the United Kingdom, the choices available to foreigners in the area of online trading and online gaming puts the U.S. market to shame. CFD markets and spread betting are prevalent in other locales not to mention the smorgasbord of voluntary online gambling and poker choices.  Gibraltar has staked their jurisdictional reputation on supporting the online wagering industry and they are the leader.

America's puritanical heritage has traditionally steered it away from such pursuits but that is changing slowly. Legislation continues to be evolving in the direction of permitting online casinos and gambling provided that the established gaming lobbies and layered tax jurisdictions can receive their pound of flesh.

The restrictions against the CFD market in America are just another example of protecting us from ourselves, but instead of protection from the "sin of compulsive wagering" it is protection from the "sin of excessive leverage".

Now, there is also the sin of illiquid asset trading. Recently, the SEC charged SharesPost and Felix Investments over pre-IPO trading in the illiquid shares of Facebook. This activity occurs over an online trading platform for private shares that provides a way for small and large shareholders to cash out and new entrants to participate prior to a formal IPO event. Eventually, successful innovations such as SharesPost and SecondMarket may be driven overseas as well due to excessive regulation.

Although I disagree with Josh Brown's capitulatory conclusions of while-the-rules-aren’t-perfect-they’re-the-only-rules-we've-got attitude for the private shares secondary market, he certainly has a colorful way of describing it:
"Imagine a private market where tech-savvy people and the Digerati could buy and sell within their own little bubble stretching from San Francisco to the off-campus housing around Stanford to the Diablo Mountain range bordering the eastern fringe of San Jose.  There would be no need for all that physical “dead tree” paperwork or the prying eyes of CNBC and the Wall Street Journal.  There could be less rules because, frankly, these would be negotiated transactions between millionaires and billionaires – a brotherhood of enlightened self-interest, in it for the challenge and intellectual self-satisfaction with the money being a mere afterthought."
But we do want our private markets if we so choose, sorry Mr. Brown. It isn't all millionaires and billionaires. Marketplaces like the CFD market and the private shares secondary market are alternative free-market solutions to a financial world rife with favoritism and increasing regulatory chokeholds. Regulating these emerging markets in the U.S. under the guise of "it's for your own protection" doesn't fly and it's offensive. Markets will always seek a way to self-regulate and to survive.


  1. Hey man, I usually agree with you, but this time you're off the mark.

    CFD creates counterparty risk that isn't present when buying/shorting a stock. Assuming your broker hasn't done anything outright illegal (i.e. MF Global), a stock trader is not exposed to the solvency of his broker. A CFD trader is *always* exposed to the solvency of his broker, who is in turn exposed to the solvency of the other clients.

    The usual solution to counterparty risk is exchange clearing: clear all trades through an exchange. This creates a single counterparty (the exchange) whose solvency can easily be monitored by regulators.

    But here's the rub: exchange-cleared CFD's are EXACTLY THE SAME THING as ordinary stock trades! So it's not CFD's that are prohibited -- it is "non-exchange-cleared CFDs" that are prohibited.

    At the end of the day this is all about minimizing systemic risk. Prior to 2007 you might have been able to try to claim that the government doesn't have a right to regulate systemic risk, but those days are long gone. By accepting TARP and FED funds instead of filing for bankruptcy, the financial industry as a whole voluntarily gave up the right to ever try to make that claim again.

  2. I corresponded with Bart Chilton about this ban. The reason given was that the fraud by platform providers was endemic and uncontrollable by existing regulatory enforcement means, particularly in precious metals.