Transaction Trends

By Kristy Naylor, LegitScript Legal Counsel

As we mentioned in the first article of this series, online investing has become a mainstream activity with a dizzying array of investing options. Whereas people used to think of trading as simply buying or selling stock, these days there is an entire industry of financial trading that uses the stock market as a data point but doesn’t directly involve the sale of stocks. A popular example of this is contracts for difference (CFDs).

What Are CFDs?
CFDs are popular on online trading platforms. A CFD is an agreement between a buyer and seller to exchange the difference between the current price of an asset (like a stock) and its price when the contract is closed. In general, if a stock’s value goes up during the contract period, you make money; if it goes down, you lose money.

Traders do not actually purchase the stock. CFD trading usually involves the use of leverage and requires only a small deposit on the total amount of the trade, so gains and losses are amplified. CFDs are another type of investment that was previously used only by major institutions but is now being traded by retail investors on online platforms.

CFDs are not permitted in the United States and are subject to strict regulation for retail investors in many countries such as the U.K. and EU member states.

Risks and Problematic Actors
Like forex trading, in addition to the inherent risk of investing, fraud is a significant risk with CFDs. Fraudulent brokers may offer unrealistic deals to get customers to transact on their platforms but may refuse to let customers withdraw earnings. If the platform is unregulated, there may be little recourse for consumers.

Furthermore, the use of leverage creates an especially risky environment for investors, creating a greater possibility of debts owed to the platform. Sometimes these debts have been charged to an investor’s credit card.

CFDs Example: The Capital Stocks
BaFin, the Federal Financial Supervisory Authority of Germany, issued a warning about The Capital Stocks, a platform that entered into CFDs based on forex products, shares, indices, commodities, and cryptocurrencies. According to the notice, the parent company, Kleinman Enterprise Limited, did not hold authorization from BaFin, as required under the German Banking Act, so the government ordered the immediate cessation of its unauthorized proprietary trading activities.

Because CFDs are restricted in the United States, payment service providers operating in the U.S. will want to ensure that none of their merchants are engaged in this form of trading. In an upcoming blog post, we’ll cover risks and warning signs to watch out for.

This post is part of the series Financial Trading Platforms: Regulations and Risks. This series offers a high-level overview of common and popular complex financial instruments — including forex trading, contracts for difference, and binary options — to help payments companies consider key points when onboarding these types of merchants. For more information, download the full guide.

Posts included in the series:
Part One: Forex Trading Regulations and Risks 
Part Two: Contracts for Difference Regulations and Risks 
Part Three: Binary Options Regulations and Risks 
Part Four: Financial Trading Platforms Risks and Warning Signs