Euro Retail Innovations Adapt to Turbulence: When Lehman Brothers Collapsed Last Year, It Took with It the Accounts of More Than 60,000 German Retail Derivatives Traders Who Had Purchased Over-the-Counter "Certificates." but Europe's OTC Retail Sector Is Far from Dead

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Two German researchers recently held a press conference in Frankfurt to announce that the notional value of an entire branch of Germany's retail derivatives sector had risen 49% in a single year on a 116% surge in volume.

Just over a year ago, those numbers might have gotten lost in the flurry of reports from exchanges posting new record highs surpassing earlier record highs, but Jens Kleine and Markus Venzin of the Steinbeis Research Center for Financial Services announced the numbers in March.

The instruments in question are "Contracts for Difference" (CFDs), which are over-the-counter (OTC), futures-like instruments that originated in the UK nearly a decade ago and spread to Germany in 2005, but have been deemed too risky for retail in the United States (see "Forbidden Fruits," Futures, December 2007).

Like futures, CFDs offer high leverage and deep liquidity. Unlike futures, they offer flexibility in size but no central clearinghouse and very little in the way of formal regulation. More importantly, they have grown in popularity since last year's financial implosion, but at the expense of an even more popular instrument called Zertificaten (Certificates), which, like CFDs, offer retail traders leveraged exposure to market risk but without the counterparty guarantees of central clearing.

Issuers of both instruments say the past year has made them stronger, faster, and safer than ever before; and some issuers are even beginning to work with established clearinghouses to offer more counterparty certainty.


Kleine and Venzin analyzed the CFD market on behalf of the CFD Verband (CFD Association), a German trade association launched by three CFD issuers who the researchers say brokered more than 10 million CFD transactions in Germany alone last year and issued CFDs with a notional value just shy of 500 billion, roughly 90% of the German market.

The three issuers--MarketIndex (which was launched by ABN Amro and became a subsidiary of the Royal Bank of Scotland after last year's restructuring), IG Markets, and CMC Markets--all hail from the United Kingdom. That prompted other CFD issuers active in Germany to question the numbers. Even Harald Patt of Cefdex, another UK broker that has set up shop in Germany, dismissed the Verband as the "Association of British CFD issuers in Germany."

No one, however, denies that the Big Three dominate CFD trading, not only in Germany but across the Continent and even in Australia.


Tellingly, CFD volume rose throughout 2008 and surged after the Lehman Brothers implosion, in part because investors were sheltering themselves from volatility, but also because they were fleeing Certificates.

There is no formal definition of either CFDS or Certificates that applies across all regulatory regimes, and neither faces consistent regulatory oversight beyond that which covers the underlying instruments. As a general rule, however, CFDS are more liquid and tradable than are Certificates, which are structured products issued in specific tranches, often offering pay-outs triggered by specific events or price breaches.

CFDS tend to be more flexible and smaller than Certificates, but also tend to have higher fees. Niche players such as CMC-Markets Deutschland dominate the CFD trade, while old guard companies like Goldman Sachs and Dresdner Kleinwort dominate the Certificates markets.

CFD providers contend, or at least imply, that their instruments are safer than are Certificates because CFDS are hedged while Certificates are not.

Specifically, CFD providers act as market-makers and live off of the bid/ offer spread, financing charges, and commissions or a combination of all three. In this sense, they are analogous to OTC currency platforms in the United States: their aim is not to be long or short, but to be flat. If their positions don't balance out, they fix that by hedging themselves in the underlying market or in futures. …