February 25, 2013 5:25 pm

Spread betting suffers trading slump

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Judging by the names splashed across broadsheet newspaper advertisements and Premiership footballers’ shirts, spread betting in the UK has never been so popular. But beneath the surface providers of financial spread bets and other retail derivatives have rather less to shout about.

Trading volumes are subdued, costs are either rising or staying stubbornly high and some operators have already conceded that the environment is ripe for acquisitions.

“You’ve got a difficulty in the industry with low volatility and depressed [trading] activity,” explains Robin Savage, an analyst at Canaccord Genuity.

Punters have been starved of the much-desired movements in share prices that create opportunities to make money, with the Vix index of volatility at a five-year low. As a result, they are trading less.

“Smaller spread betting businesses have got real problems because they were barely profitable when volatility was high and, now activity has fallen, their cost bases are too high,” Mr Savage warns.

London Capital Group, which runs Capital Spreads and Pro Spreads, made a pre-tax statutory loss of £2.1m in 2012, having achieved a profit of £6.1m one year earlier.

It has now become a takeover target and has already received “preliminary approaches” about a possible acquisition from City Index and Cantor Fitzgerald Europe. Gain Capital Holdings also made an approach but has decided against making an offer.

Cypriot operators prompt concern

Spread betting companies have raised concerns with regulators about the supervision of Cyprus-based operators that have entered other European markets, writes Vanessa Kortekaas.

In the past two years, dozens of Cypriot betting operators have opened offices in Britain and France to offer trading in foreign exchange and contracts for difference (CFDs) to retail customers, which is allowed under European regulations.

However, UK-based groups say that they threaten the spread betting sector because they do not come under the regulatory scrutiny of the Financial Services Authority.

“Our concern is simply that the firms based in Cyprus are not regulated to the same standard that we are,” says Tim Howkins, chief executive of IG Group, the UK’s largest spread betting provider by sales.

So far, about 100 Cypriot firms have “passported” into the UK, under rules that permit companies to operate across European Economic Area countries (the EU and Iceland, Liechtenstein and Norway), while remaining regulated only in their home country. As a result, the operators are regulated by the Cyprus Securities and Exchange Commission (Cysec), not the FSA.

Industry executives allege that these companies do not advertise the risks of spread betting as clearly as FSA-regulated operators do, and that they are not subject to as much scrutiny. They also claim that Cysec has fewer resources to check that rules about client money segregation are followed.

However, the FSA says that any European operator regulated in its own country must still meet standards agreed across the European Economic Area.

Cypriot regulators dismiss any suggestion of a lack of rigour. “Investment firms based in Cyprus and authorised by the Cysec are subject to the provision of [the] Markets in Financial Instruments Directive, and are thus supervised with the same level of scrutiny and highest standards of supervision, as in any other European Union member state.”

Giles Vardey, chairman of LCG, argues that low trading volumes are a “generic problem” linked to volatility, but adds that LCG needs to adjust its cost base to “the new normal”.

Even IG Group, the UK’s number one spread betting operator by sales, is not immune. Its pre-tax profit in the six months ending November 30 was down 21 per cent on the previous year, while its revenues dropped by 14 per cent.

Analysts believe there are too many small operators pursuing a limited pool of betting clients. “There needs to be some sort of consolidation . . . however, the weaker players could just end up withering on the vine,” says Mr Savage.

Tim Howkins, IG Group’s chief executive, has even challenged his competitors to join together to form a stronger group that could “take on” IG.

“It is an industry where scale matters and [our competitors] are all fairly sub-scale,” he says. “Most of them are breaking even or thereabouts. If they have a bad year they lose a little bit, if they have a good year they make a small profit,” he says.

But if the smaller operators cannot afford to invest in their IT platforms or marketing, they could easily enter a “slow decline”, warns Mr Howkins. “The bigger you are the more you can spend on technology,” he says.

Technology is considered a key battleground for spread betting operators, which compete on the speed and user-friendliness of their trading platforms. Trading on mobile devices now accounts for about a fifth of their revenue.

However, UK operators have also had to look to new markets for growth, as their pool of active clients – and their revenue per client – have both decreased.

Mr Howkins says IG is not a potential consolidator as it already has about a 44 per cent market share. However, he says it is possible there will be mergers among his competitors.

Martin Belsham, chief executive of rival operator City Index, says he is “looking at the acquisition route”, in addition to seeking organic growth.

FXCM, the US foreign exchange agency broker, also says it is looking to make acquisitions this year.

“We would certainly consider any and all [acquisition opportunities],” says Brendan Callan, chief executive.

“It would [be] case by case – what they value their business at versus what we value their business at,” he says, noting that many traders use multiple spread betting platforms.

Unlike like their punters, though, the operators are more likely to deal if the market remains becalmed. Mr Callan says: “If volatility remains low, consolidation will accelerate.”

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