For staunch Brexiteers, one of the main motivational factors behind Brexit is the belief that the UK will be able to seize control of its destiny. This has been undermined by talk of a transitional period beyond March 2019, which will keep the UK closely aligned with EU regulations and laws until 2021 at least.
This is set to have a significant impact on the financial markets, particularly with the European Union having announced stringent regulations on derivative and margin-based trading vehicles such as contracts for difference (CFDs) and spread betting.
We’ll explore the impact of these regulations on this type of product in further detail below, while asking whether this will change the way in which individuals invest in bonds.
How have the Regulations Changed?
The good news is that the UK and the EU appear to be naturally aligned in their approach to high-risk financial products, with British regulators having proposed new rules for these asset classes back in December 2016.
It’s interesting to note that the subsequent regulatory measures introduced by the EU in March shared numerous similarities with these proposals, particularly from the perspective of CFDs.
The main consideration here is the restriction placed on the leverage limits applied to opening positions, as well as the new margin close-out rule which is applied to all account holders. This will cause all retail clients’ open positions to close when the minimum total required falls below 50%, as opposed to the previous measure of 20%.
The new regulatory measures also apply a negative balance protection on individual accounts, and this can also cause positions to close abruptly without careful monitoring or management. This will also prevent the use of lucrative incentives by a CFD provider, while compelling firms to issue clear and standardised risk warnings where appropriate.
On a similar note, the EU’s detailed regulatory measures will restrict the marketing and distribution of CFDs, in order to ensure that retail investors are targeted fairly and in a way that does not solicit irresponsible financial behaviour.
How will this Impact Bonds?
Given the diversity and far-reaching nature of these regulations, it’s worth asking how it will impact on trading bonds? To understand this, we first need to understand the primary benefit of using CFDs to trade bonds, which in general terms is the ability to leverage small price movements through considerable margins.
With margin requirements having being squeezed, however, it may be argued that the EU’s new regulatory measures will limit the profitability of bonds traded through CFDs. This is offset by the relatively limited price range associated by the asset, of course, although some investors may choose to access bonds through alternative means in the future.
Ultimately, the value of bonds is intrinsically linked to both interest rate shifts and the relationship between supply and demand, and in this respect the new regulations will not be impactful as they may be on alternative assets. Still, the changes in margin and leverage will need to be accounted for, particularly for risk-averse investors who are more concerned with the sustainability of their returns.