Contracts for difference

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15. Opening an account with a broker

To protect investors, the Financial Services Authority imposes strict conditions on CFD trading. Only 'intermediate customers' with suitable knowledge and experience are allowed to open accounts, and the onus is firmly on brokers to check that applicants fulfil the requirement.

In practice this means that your broker will ask for proof of experience both in frequent share trading and in margined products, and that you will have to fill in lots of forms before you can start to trade CFDs. The corollary of being an 'intermediate customer' is that you will not be accorded the same level of protection from the regulatory system as ordinary private investors.

• CFD traders do not have the option of using the FSA's free Financial Ombudsman service to settle disputes with the CFD provider.
• There is less onus on the CFD provider to make sure that the customer understands the risks involved in transactions.
• There is less onus on the CFD provider to make sure that the customer understands the costs they will incur for the services given.
• If a financial promotion is made to the customer, the CFD provider does not have to include the same level of explanation as it would if the client was a private investor.
• It also does not have to warn intermediate customers to get advice on whether the investment concerned is 'suitable' for them.
• The provider is not obliged to provide periodic statements or confirmations immediately after a trade is made (although the firm may well do so anyway).
• The provider does not have a duty to provide best execution to the customer so in theory, he or she may not get the best price obtainable.
• Client money held by the CFD provider does not have to be segregated in the same way as it would for a private investor.
• The firm also has much more freedom over when and how frequently it provides custody statements to the intermediate customer.

What it all boils down to is that intermediate customers - i.e. all private individuals who trade CFDs - are expected to be able to look out for themselves. Once their account is set up, they will receive fewer warnings, statements and explanations than a private investor trading shares or spread bets would get.

That does not make CFD trading the Wild West. Far from it. The FSA keeps a close eye on how CFD providers conduct their business, and has the powers to take punitive action if they breach any rules.

• In the first place, financial sector companies can only get permission to trade CFDs if they can convince the FSA that they have the right people and the right systems in place to run this business.
• Directors and key employees of a CFD trading house have to be approved by the FSA. This process involves checking their CVs for any convictions or disciplinary breaches in the past, and also ensuring that they have adequate knowledge of the regulatory system and the products they will be dealing in. New recruits from outside the markets will be asked to take the Securities Institute exams.
• The CFD provider has to provide regular reports to the FSA. Details of trades undertaken by customers are likely to be submitted to the regulator every day; a detailed report on the provider's financial position and exposures is likely to be submitted monthly.
• Although CFD investors normally agree to have their client money 'pooled', the FSA will still keep a close eye on the way that the provider treats client funds.
• The regulator will also be involved in watching for suspicious activity by clients. Each FSA authorised firm has to have a money laundering reporting officer as well as a compliance officer.
• When dealing staff at a CFD provider spot a trade that they suspect might be based on inside information, they have to report it to the firm's compliance officer, who in turn will pass the details onto the FSA.
• The FSA makes sure CFD providers handle complaints made against them adequately, and that the process is recorded. It also lays down rules for the use of financial promotions, and for the avoidance of conflicts of interest on the part of the financial firm.

1. What are CFDs? 2. The benefits of CFDs 3. Initial margin 4. Variation margin 5. Commission costs 6. Interest payments 7. Dividends 8. Example of a long and short trade 9. Comparison of CFDs to share investing 10. Comparison of CFD trading to spread betting 11. Types of order 12. Stop losses 13. Strategies: Pairs trading 14. Strategies: Hedging an equity portfolio 15. Opening an account with a broker 16. Conclusion

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