This article was written by Jon Light, Head of OTC Platform at Devexperts
Historically, there has been a clear geographical
division between retail traders. CFDs remain one of the most popular
instruments among European traders, while listed securities (including stocks,
futures, options, bonds and mutual funds) have been most popular among US
traders. This is largely down to the respective legality and availability of
these instruments in different regions.
The story of US retail trading has been greatly
influenced by US regulators moving early on to outlaw the marketing of CFD
products to US citizens, and the trading thereof, thus forcing CFD brokers to
look elsewhere for their clientele.
The extent of how comparatively well-developed listed
markets are in the US has made it easier for retail equivalents to be offered
to traders, including smaller sized contracts tailored to retail position
sizing and Zero Days to Expiry (ODTE) options. The latter has seen an explosion
in popularity in recent years, with some estimates placing retail involvement
somewhere between 20-40% of the overall market.
Meanwhile, Europe’s move to legitimize retail CFDs by
harmonizing regulations between jurisdictions (which have also more or less
been adopted by British and Australian regulators), has led to what can only be
described as a provisional detente between brokers/traders, and
regulators.
Both brokers and traders are dissatisfied with the
resultant leverage restrictions, while benefiting from the legitimization that
regulation has brought. Regulators, on the other hand, have managed to rein in
some of the excesses the industry was previously known for both in terms of
risk and in the marketing of these instruments, while avoiding more draconian
measures to shut such a booming industry down.
A shifting landscape
The above describes a situation that remained
relatively stable until recent years. The emergence of the retail prop trading
phenomenon allowed US traders to engage in CFD-like trading activities via a
regulatory loophole, while the global interest in US stocks and other listed
products like futures and options came to be massively popularized by younger
traders.
The mainstream moment for these products among retail
traders occurred during the Covid lockdowns via the WallStreetBets phenomenon.
In its wake, retail traders were presented as having given Wall Street a bloody
nose by forcing institutional participants to wreck their accounts covering
shorts in seemingly hopeless stocks like Gamestop and AMC.
Indeed, US derivatives markets have seen significant
growth since 2019, with retail involvement being a contributing factor.
According to the Securities Industry and Financial Markets Association (SIFMA),
there has been a doubling of notional open interest in US listed markets over
the past four years.
This has contributed to a greater general awareness
of Futures and Options, which were initially regarded as rather esoteric
instruments among the wider retail trading public. Traders outside of the US
have also shown interest in these markets, causing European brokers and
exchange venues to sit up and take note.
Finally, the recent crackdown on brokers
“grey-labeling” their MetaQuotes licenses to US retail prop trading firms has
led to some uncertainty regarding the aforementioned prop trading
loophole.
By offering these trading services in a simulated
trading environment in the form of trading challenges, these firms have been
able to on-board a loyal contingent of US retail traders, eager to test their
skills on these instruments in the hope of receiving funded accounts and a
revenue share.
Many well-known retail traders have since taken to
social media and YouTube to discuss a possible shift to trading futures and
other listed instruments due to the on-going uncertainty surrounding retail
prop trading in the US.
Is retail likely to move
to listed securities?
As mentioned above, the trading of listed securities
in the US is already far more popular than in Europe, owing to much better
developed retail onramps, coupled with a general culture that is much more
familiar with the buying and selling of stocks and other listed securities. The
question is whether this is likely to become normalized in Europe.
Last year, a survey of 72 firms active in the
European retail market by Acuiti revealed some trends in the making. Of the
brokers surveyed, 69% believed that EU countries would eventually move to
impose heavier restrictions on the trading of CFDs. More than half of those
firms stated that they would look to expand into listed markets if this was the
case.
However, quite interestingly, this option ranked
third in the strategies offered by the survey as possible pivots away from an
overreliance on European CFD traders. More than 80% of respondents stated that
they would look to grow in other regions (CFDs are popular in Asia, inroads
have been made in recent years both in South America and Africa, with the MENA
region also becoming a significant regional trading hub), while around 70% of
respondents revealed an interest in attracting institutional flows.
Some of the factors cited as obstacles to wider
retail adoption of European listed securities included unfamiliarity with the
products, and higher costs for brokers, particularly regarding the provision of
market data.
Though not mentioned in the study, the leverage
advantages that CFD traders still enjoy, despite recent regulatory changes,
must also be a concern. The European brokers surveyed who already offer listed
securities revealed that these instruments currently only account for around
10% of their volumes. Also, the majority of respondents agreed that pivoting to
listed securities would require on-going investment in technology.
A tech provider’s
perspective
One of the trends that emerged from the Acuiti
survey, which also mirrors our own initial experience when consulting brokers,
is that around 50% of the firms that recognized the need to invest in
technology were intent on developing their own solutions in-house, while only a
third of respondents said that they were planning a combination of third-party
and in-house solutions.
The Acuiti study went on to highlight that this
stated preference was likely to change as these firms came up against the
complexity of institutional reconciliation and settlement, particularly as
these firms moved from relying on single institutional brokers as their point
of contact with these markets, to taking responsibility for their own order
flows.
The study also went on to explain the focus of EU
retail brokers on technology, and cited a general lack of off-the-shelf
products as part of this trend. We, however, don’t regard this as being so much
of an issue among retail firms today. Perhaps this was the case a decade or so
ago, but today there are a multitude of very flexible third-party options,
which we have been a major contributor to over the years.
This has led to a change in the industry where
third-party solutions have not only become more acceptable to this contingent
of brokers, but are also preferred nowadays due to their rapid time to market,
ease of customization, and on-going support.
Our strategy has always been to do the work ahead of
time, with a view to having mature technological solutions available as the
tide turns and a critical mass of traders starts to vote with their trading
account balances. For example, when the grey-labelling issue arose for prop
firms, we already had a solution ready to go.
As the trading of listed securities continues to grow
in popularity, we will endeavor to show interested brokers that much of the
legwork has already been done for them. While there are technological
challenges involved in accessing listed markets and making these securities
available for a retail clientele, there are solutions currently available.
In our experience with
other asset classes, this allows financial services firms the freedom to invest
in education and marketing, rather than lengthy in-house development
processes.
The development, integration, and maintenance of
capable trading platforms and ready-made integrations, which encompass the
provision of affordable market data, liquidity provision, and clearing
solutions, is now almost as simple and as painless as setting up a CFD
brokerage.
This includes all relevant asset specific risk
management features that the Acuiti study highlighted as a technological
overhead for European brokers, and includes the capabilities to run complex
business models that allow for fractional share order management in a manner
similar to how CFD firms have become familiar with A/B/C book practices.
Final thoughts
As explained above, in our opinion the issue is not
so much technological as it is one of trader preferences. As we have seen in
recent years, these preferences are not set in stone and can change rapidly as
the broader retail climate evolves.
What’s important is the education of traders and the
appropriate marketing of listed instruments to retail clients. Nowadays this is
conducted as much by trading influencers on their social media and YouTube
channels, but there is still work to be done by brokers interested in venturing
into these markets. Historically, this type of trader outreach has been the
strong suit of online brokers. To date, they have inducted several generations
of CFD traders and we anticipate that they will be successful in doing the same
for listed markets.
This article was written by Jon Light, Head of OTC Platform at Devexperts
Historically, there has been a clear geographical
division between retail traders. CFDs remain one of the most popular
instruments among European traders, while listed securities (including stocks,
futures, options, bonds and mutual funds) have been most popular among US
traders. This is largely down to the respective legality and availability of
these instruments in different regions.
The story of US retail trading has been greatly
influenced by US regulators moving early on to outlaw the marketing of CFD
products to US citizens, and the trading thereof, thus forcing CFD brokers to
look elsewhere for their clientele.
The extent of how comparatively well-developed listed
markets are in the US has made it easier for retail equivalents to be offered
to traders, including smaller sized contracts tailored to retail position
sizing and Zero Days to Expiry (ODTE) options. The latter has seen an explosion
in popularity in recent years, with some estimates placing retail involvement
somewhere between 20-40% of the overall market.
Meanwhile, Europe’s move to legitimize retail CFDs by
harmonizing regulations between jurisdictions (which have also more or less
been adopted by British and Australian regulators), has led to what can only be
described as a provisional detente between brokers/traders, and
regulators.
Both brokers and traders are dissatisfied with the
resultant leverage restrictions, while benefiting from the legitimization that
regulation has brought. Regulators, on the other hand, have managed to rein in
some of the excesses the industry was previously known for both in terms of
risk and in the marketing of these instruments, while avoiding more draconian
measures to shut such a booming industry down.
A shifting landscape
The above describes a situation that remained
relatively stable until recent years. The emergence of the retail prop trading
phenomenon allowed US traders to engage in CFD-like trading activities via a
regulatory loophole, while the global interest in US stocks and other listed
products like futures and options came to be massively popularized by younger
traders.
The mainstream moment for these products among retail
traders occurred during the Covid lockdowns via the WallStreetBets phenomenon.
In its wake, retail traders were presented as having given Wall Street a bloody
nose by forcing institutional participants to wreck their accounts covering
shorts in seemingly hopeless stocks like Gamestop and AMC.
Indeed, US derivatives markets have seen significant
growth since 2019, with retail involvement being a contributing factor.
According to the Securities Industry and Financial Markets Association (SIFMA),
there has been a doubling of notional open interest in US listed markets over
the past four years.
This has contributed to a greater general awareness
of Futures and Options, which were initially regarded as rather esoteric
instruments among the wider retail trading public. Traders outside of the US
have also shown interest in these markets, causing European brokers and
exchange venues to sit up and take note.
Finally, the recent crackdown on brokers
“grey-labeling” their MetaQuotes licenses to US retail prop trading firms has
led to some uncertainty regarding the aforementioned prop trading
loophole.
By offering these trading services in a simulated
trading environment in the form of trading challenges, these firms have been
able to on-board a loyal contingent of US retail traders, eager to test their
skills on these instruments in the hope of receiving funded accounts and a
revenue share.
Many well-known retail traders have since taken to
social media and YouTube to discuss a possible shift to trading futures and
other listed instruments due to the on-going uncertainty surrounding retail
prop trading in the US.
Is retail likely to move
to listed securities?
As mentioned above, the trading of listed securities
in the US is already far more popular than in Europe, owing to much better
developed retail onramps, coupled with a general culture that is much more
familiar with the buying and selling of stocks and other listed securities. The
question is whether this is likely to become normalized in Europe.
Last year, a survey of 72 firms active in the
European retail market by Acuiti revealed some trends in the making. Of the
brokers surveyed, 69% believed that EU countries would eventually move to
impose heavier restrictions on the trading of CFDs. More than half of those
firms stated that they would look to expand into listed markets if this was the
case.
However, quite interestingly, this option ranked
third in the strategies offered by the survey as possible pivots away from an
overreliance on European CFD traders. More than 80% of respondents stated that
they would look to grow in other regions (CFDs are popular in Asia, inroads
have been made in recent years both in South America and Africa, with the MENA
region also becoming a significant regional trading hub), while around 70% of
respondents revealed an interest in attracting institutional flows.
Some of the factors cited as obstacles to wider
retail adoption of European listed securities included unfamiliarity with the
products, and higher costs for brokers, particularly regarding the provision of
market data.
Though not mentioned in the study, the leverage
advantages that CFD traders still enjoy, despite recent regulatory changes,
must also be a concern. The European brokers surveyed who already offer listed
securities revealed that these instruments currently only account for around
10% of their volumes. Also, the majority of respondents agreed that pivoting to
listed securities would require on-going investment in technology.
A tech provider’s
perspective
One of the trends that emerged from the Acuiti
survey, which also mirrors our own initial experience when consulting brokers,
is that around 50% of the firms that recognized the need to invest in
technology were intent on developing their own solutions in-house, while only a
third of respondents said that they were planning a combination of third-party
and in-house solutions.
The Acuiti study went on to highlight that this
stated preference was likely to change as these firms came up against the
complexity of institutional reconciliation and settlement, particularly as
these firms moved from relying on single institutional brokers as their point
of contact with these markets, to taking responsibility for their own order
flows.
The study also went on to explain the focus of EU
retail brokers on technology, and cited a general lack of off-the-shelf
products as part of this trend. We, however, don’t regard this as being so much
of an issue among retail firms today. Perhaps this was the case a decade or so
ago, but today there are a multitude of very flexible third-party options,
which we have been a major contributor to over the years.
This has led to a change in the industry where
third-party solutions have not only become more acceptable to this contingent
of brokers, but are also preferred nowadays due to their rapid time to market,
ease of customization, and on-going support.
Our strategy has always been to do the work ahead of
time, with a view to having mature technological solutions available as the
tide turns and a critical mass of traders starts to vote with their trading
account balances. For example, when the grey-labelling issue arose for prop
firms, we already had a solution ready to go.
As the trading of listed securities continues to grow
in popularity, we will endeavor to show interested brokers that much of the
legwork has already been done for them. While there are technological
challenges involved in accessing listed markets and making these securities
available for a retail clientele, there are solutions currently available.
In our experience with
other asset classes, this allows financial services firms the freedom to invest
in education and marketing, rather than lengthy in-house development
processes.
The development, integration, and maintenance of
capable trading platforms and ready-made integrations, which encompass the
provision of affordable market data, liquidity provision, and clearing
solutions, is now almost as simple and as painless as setting up a CFD
brokerage.
This includes all relevant asset specific risk
management features that the Acuiti study highlighted as a technological
overhead for European brokers, and includes the capabilities to run complex
business models that allow for fractional share order management in a manner
similar to how CFD firms have become familiar with A/B/C book practices.
Final thoughts
As explained above, in our opinion the issue is not
so much technological as it is one of trader preferences. As we have seen in
recent years, these preferences are not set in stone and can change rapidly as
the broader retail climate evolves.
What’s important is the education of traders and the
appropriate marketing of listed instruments to retail clients. Nowadays this is
conducted as much by trading influencers on their social media and YouTube
channels, but there is still work to be done by brokers interested in venturing
into these markets. Historically, this type of trader outreach has been the
strong suit of online brokers. To date, they have inducted several generations
of CFD traders and we anticipate that they will be successful in doing the same
for listed markets.
